Page 13 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes 2. “Real” Values and Index Numbers: Since we measure production and related quantities in
dollar terms, we have to correct for inflation. Index numbers are a pretty good workable
solution, but there are some problems and criticisms.

3. Measurement of Inequality: Another issue is that the “average income” may not mean
very much, because nobody is average and income is unequally distributed. Even if we
cannot correct for that we can get a rough measure of the relative inequality and see where
it is going.

1.4.8 Medium of Exchange

Money is whatever is generally acceptable as a medium of exchange. That means a bank, or
similar institution, can literally create money, so long as people trust the bank enough to accept
its paper as a medium of exchange. We might call this magical fact the Fiduciary Principle.

1.4.9 Income-Expenditure Equilibrium

Like the market equilibrium principle, but even more so, this model pulls together a number of
subsidiary principles that complement one another and together constitute the “Keynesian”
theory of aggregate demand. The implications of this theory are less controversial than the
word “Keynesian” is — controversy has to do more with the details than the applications.
Among the subsidiary principles are
1. Coordination Failure
2. The income-consumption relationship

3. The Multiplier
4. Unplanned inventory investment
5. Fiscal Policy
6. The Marginal Efficiency of Investment

7. The influence of money on interest
8. Real Money Balances
9. Monetary Policy

1.4.10 Surprise Principle

People respond differently to the same stimuli if the stimuli come as a surprise than they would
if the stimuli do not come as a surprise. This new economic principle plays the key role with
respect to aggregate supply that “Income-Expenditure Equilibrium” plays with respect to
aggregate demand.

Rational Expectations: People don’t want too many unpleasant surprises. If they use the
information available to them efficiently, then they won’t be surprised in the same way very
often. This can lead to:
(a) Policy ineffectiveness
(b) Permanence
(c) Path Dependence

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