Chapter 2: How to Think & Do Macroeconomics
Discuss the fallacy of composition in the following contexts:
1. Determination of wage by firms & laborers versus economy wide determination of the real wage.
2. The paradox of thrift -- individual decisions to save may lead to dis-saving in the aggregate
3. Increased demand for imports may lead to decline in total quantity of imports
Needs more details, and especially mention of Aggregate Demand as driver of the total production; in particular, imports are a leakage, they reduce domestic aggregate demand, leading to reduction in GDP and lower income --
DISCUSSION OF FALLACY OF COMPOSITION
Fallacy of composition is the fact that certain phenomenon can be different from a perspective at individual level than from that at aggregate level
1. Determination of real wage by firms and laborers versus economy wide determination of real wage
In the case of the economy there are two concepts for real wage determination : wage-setting curve and price setting curve.
Wage setting curve is the relation between unemployment and real wage. W/P= f(U, Z). U equals unemployment and Z equals other factors as minimum wages etc. It is downward sloping
Price setting curve is horizontal as it does not depend on both real wages and unemployment rate. W/P= 1/1+m where m is the market power of the firm. Real wage in aggregate is determined at the intersection of both curves. We can see that in aggregate real wage the power of the firm or alternatively the power of unions come to play a part and thus can be a reason for the difference between firm level and economy level real wage determination.
2. The paradox of thrift
When an individual saves he is earning future consumption but if everyone saves in the econom, aggregate savings fall which is the opposite of what was tried to be achieved.
If savings occur collectively then productivity falls because output decisions are made according to consumption patterns. Since output declines so does employment. If national income falls then consumption declines and consequently total savings also decline in absolute terms. Thus when everyone saves total savings decline.
3. Demand for imports and total quantity of imports
Demand for imports increases thus increasing prices of imported goods which are paid for in another currency. That currency becomes strong and it becomes expensive to buy the same amount of product with the same money decreasing the quantity of imports.
Mitchell Wray Watts MMT Text Ch 2 Thinking and Doing Macroeconomics — 1hr Video Lecture covers chapter 2 of textbook