01 Introduction to Macroeconomics

Lecture from: 16.09.2025 | Video: Video ETHZ

Course Context & Logistics

This course is a core component of ETH’s Department of Management, Technology, and Economics (D-MTEC). The department’s vision centers on analyzing the interplay of technology, organizations, and society to foster the sustainable use of resources. Macroeconomics provides the essential framework for understanding these large-scale systems.

Administrative Essentials

• Moodle: The central hub for all course materials, including slides, problem sets, and announcements. Link to Moodle.
• Textbook: N. Gregory Mankiw & Mark P. Taylor (2023), Economics, 6th Ed. This single book covers both macro and micro principles. A 25% discount is available via instructions on Moodle.
• Recordings: Lectures are recorded and accessible via ETH Multimedia Services for enrolled students. Login details are posted on Moodle.
• Contacts:
  • Prof. Dr. Jan-Egbert Sturm (sturm@kof.ethz.ch)
  • Assistants: Roxane Spitznagel & Aline Scheurer (emails on Moodle).
  • Office hours are by appointment.

Assessment & Exam

The grade is 100% based on the final exam.

• Date (Tentative): Tuesday, 13.01.2026, 14:15-15:45.
• Format: 90-minute, closed-book, written paper exam.
• Registration: Registration for the exam must be completed on myStudies during the 3rd/4th week of the semester. Course enrollment is not exam registration.
• Retake (Tentative): Monday, 23.02.2026. Available only for students who fail the first attempt.

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The Core of Economics: Scarcity and Choice

At its root, economics is the study of how society manages its scarce resources. Scarcity means that resources are finite and therefore cannot satisfy every human want. This fundamental constraint forces choices, which are governed by a set of core principles.

Why Study Economics?

Economics is not merely about money or markets, it is a framework for understanding human behavior under constraint. Every decision, from personal time allocation to national policy, involves trade-offs. The principles outlined here apply universally: in business, government, and daily life.

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How People Make Decisions

Principle #1: People Face Trade-offs

“There is no such thing as a free lunch.” Every decision involves a trade-off, giving up one thing to get another.

• Guns vs. Butter: A society’s classic trade-off between defense spending and consumer goods.
• Efficiency vs. Equity: A fundamental policy dilemma.
  • Efficiency: Maximizing the output from scarce resources (the size of the economic pie).
  • Equity: Distributing economic prosperity fairly among society’s members (how the pie is sliced).

The Efficiency-Equity Trade-off

Policies that promote equity, such as progressive taxation or welfare programs, can reduce the incentive to produce. A high marginal tax rate might discourage an entrepreneur from working harder, as a larger share of additional income goes to taxes. Thus, efforts to slice the pie more evenly can sometimes shrink the pie itself. This trade-off is central to many political debates.

Principle #2: The Cost of Something Is What You Give Up to Get It

The true cost of any action is its opportunity cost, the value of the best alternative that is forgone. Cost is not just about money spent; it is about opportunities lost.

The Opportunity Cost of an ETH Degree

The cost of a degree is not just tuition and living expenses. The most significant component is often the income that could have been earned by working instead. That forgone salary represents the opportunity cost of time spent studying.

Calculation: If a software engineer earns CHF 80,000/year and a degree takes 4 years, the opportunity cost of time alone is CHF 320,000, often dwarfing tuition fees.

Principle #3: Rational People Think at the Margin

Economists model individuals as rational agents who systematically and purposefully pursue their objectives. Rational decisions are not made on an all-or-nothing basis but through marginal analysis, comparing the additional benefits (marginal benefits, $MB$) and additional costs (marginal costs, $MC$) of a small, incremental change.

The Decision Rule: Action is taken only if:

$$MB>MC$$

Marginal Thinking in Practice

Consider whether to study one more hour for an exam. The marginal benefit is the expected improvement in the grade. The marginal cost is what else could be done with that hour (sleep, leisure, another subject). A rational student studies until the marginal benefit of the next hour equals the marginal cost, not simply “as much as possible.”

Principle #4: People Respond to Incentives

An incentive is anything that motivates a person to act. Since rational people weigh costs and benefits, their behavior changes when those costs or benefits change. Understanding incentives is central to analyzing markets and designing effective public policy.

The Law of Unintended Consequences

Policies can have unforeseen effects by altering incentives in unexpected ways.

The Cobra Effect: In colonial India, the British government offered a bounty for dead cobras to reduce the snake population. Initially effective, the policy backfired when people began breeding cobras for the reward. When the bounty was cancelled, breeders released the now-worthless snakes, making the problem worse than before.

Lesson: Good policy design requires anticipating how incentives will be altered and what behavioral responses will follow, including perverse ones.

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How People Interact

Principle #5: Trade Can Make Everyone Better Off

Trade is not a zero-sum game. By allowing for specialization, trade enables individuals and nations to focus on what they do best. This increases total production and allows everyone to consume a greater variety and quantity of goods and services.

Comparative Advantage Preview

Switzerland specializes in watches, pharmaceuticals, and financial services; Germany specializes in automobiles and machinery. Both countries trade with each other and both benefit, Switzerland gets cars it couldn’t produce as efficiently, and Germany gets precision instruments. The full logic of why this works (comparative advantage) is developed in later lectures on international trade.

Principle #6: Markets Are Usually a Good Way to Organize Economic Activity

In a market economy, the decentralized decisions of millions of households and firms allocate resources. Adam Smith’s “invisible hand” describes how prices act as signals, guiding self-interested actors to outcomes that often maximize society’s overall welfare.

The Invisible Hand

No central planner tells bakeries how much bread to bake or farmers how many potatoes to grow. Yet bread and potatoes appear in shops in roughly the right quantities. How?

Prices convey information:

• If bread is scarce, its price rises → bakeries earn more → they bake more.
• If potatoes are abundant, their price falls → farmers plant less next season.

Through this feedback mechanism, markets coordinate the actions of millions without anyone being in charge.

Principle #7: Governments Can Sometimes Improve Market Outcomes

The invisible hand needs a government to protect it. The government’s role is to:

1. Enforce property rights: Without secure ownership, people lack the incentive to invest or produce.
2. Correct market failures: Situations where the market alone fails to produce an efficient allocation of resources.

Key causes of market failure:

• Externalities: When an action impacts a bystander who did not choose to be affected.
  • Negative: A factory pollutes a river, harming downstream fishermen.
  • Positive: Vaccinations benefit not just the vaccinated but also those around them.
• Market Power: When a single entity (e.g., a monopoly) can unduly influence prices, allocating resources inefficiently.

When Should Governments Intervene?

This is one of the most debated questions in economics. Economists generally agree that markets fail in certain cases (externalities, public goods, monopolies), but they disagree about:

• How severe the failure must be to justify intervention
• Whether government intervention will actually improve outcomes
• The unintended consequences of policy

This course focuses on positive analysis, understanding how the economy works, rather than making normative judgments about what policies should be.

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How the Economy as a Whole Works

This is the domain of macroeconomics, the study of economy-wide phenomena rather than individual markets.

Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

The vast differences in living standards across the globe are almost entirely explained by differences in productivity, the amount of goods and services produced per unit of labor.

$$\text{Productivity}=\frac{\text{Output}}{\text{Labor Input}}$$

Higher productivity leads to higher incomes and a better standard of living. This principle is explored deeply in the Solow growth model.

Principle #9: Prices Rise When the Government Prints Too Much Money

Inflation, a general increase in the price level, is almost always caused by excessive growth in the quantity of money. When a central bank prints too much money, its value falls.

The Quantity Theory of Money (Preview)

The relationship is formalized by the quantity equation: $M\times V=P\times Y$

Where:

• $M$ = Money supply
• $V$ = Velocity (how fast money circulates)
• $P$ = Price level
• $Y$ = Real output

If $V$ and $Y$ are stable, an increase in $M$ leads directly to an increase in $P$. This is developed fully in later lectures.

Principle #10: Society Faces a Short-Run Trade-off between Inflation and Unemployment

In the short run, policymakers face a trade-off known as the Phillips Curve: lowering inflation often leads to a temporary rise in unemployment, and vice versa.

Why the Trade-off?

When the central bank increases the money supply:

1. Spending increases (more money chasing goods)
2. Firms respond by both raising prices AND producing more/hiring more
3. Result: Higher inflation but lower unemployment (in the short run)

This trade-off is central to the analysis of the business cycle, the short-term fluctuations in economic activity. The Phillips Curve is covered in depth later in the course.

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The Economist’s Way of Thinking

The Economist as Scientist

Economists use the scientific method: theories are developed, data is collected, and analysis is performed to test those theories. Because controlled experiments are rare in economics, reliance on historical events as “natural experiments” is common.

To simplify a complex world, economists use models built on assumptions. A good model strips away irrelevant details to reveal important underlying relationships.

Models are Simplifications, Not Reality

A model is judged not by whether its assumptions are “realistic” but by whether it generates useful predictions. A map that includes every tree and pebble is useless for navigation, useful maps simplify.

Example: The assumption that firms “maximize profit” is not literally true for every business decision, but it generates accurate predictions about how firms respond to price changes.

Positive vs. Normative Analysis

• Positive statements: Descriptive claims about how the world is. They are testable with data.
  • Example: “An increase in the minimum wage will cause a decrease in employment among the least-skilled.”
• Normative statements: Prescriptive claims about how the world ought to be. They involve value judgments and cannot be tested.
  • Example: “The income gains from a higher minimum wage are worth more than any slight reductions in employment.”

This course focuses primarily on positive analysis, understanding the mechanisms of the economy.

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