CHAPTER 1: Principles and Policy
●What is economics?
○Why do public discussions of economic policy so often show the abysmal
ignorance of the participants? Why do I so often want to cry at what public
figures, the press, and television commentators say about economic affairs?
●IDEAS FOR BEYOND THE FINAL EXAM
●Below are macro and microeconomic principles that you may see in everyday life
1. How much does it really cost?
a. Opportunity cost
i. Value of next best alternative forgone
ii. Ex: The cost of college
1. What is the cost of college → will look into tuition, fees,
books, room and board
iii. Explicit costs: tuition, fees, books, room, and board
iv. Implicit costs: not the outlay of money (will not count this), this is
seen as hypothetical costs
1. Ex: Make 25K each year for five years during college, by
the time you graduate it is 125K
a. You give it up and this is the opportunity cost
b. This comes in when we make decisions
2. Attempts to repeal laws of supply and demand — Market strikes back
a. Price ceilings
i. Prices you cannot go above
1. Ex: Government saying you charge above this price for a
certain item
a. If the market goes in it by itself, it might hit an
equilibrium that is up in a higher price but is
artificially lower
b. It keeps the price lower for consumers who can get
the goods but for suppliers, if the price is very low
they are not willing to supply the good
i. Less of that item
b. Price floors
1. The lowest price that can be legally charged
a. Lower price floors are ineffective
b. Suppliers might charge something that is more than
what it really is
c. Allows suppliers to charge something higher but
places a disadvantage for consumers
i. Less likely to buy the item as it too high
3. Surprising principle: comparative advantage
a. Law of comparative advantage
i. If you can produce something with a lower opportunity cost, you
should specialize in that production
1. Meaning: if you are able to produce a good or service for a
lower opportunity cost, it gives companies to the ability to
sell goods and services at prices that are lower than
competitors
a. They are able to gain stronger sales margins and
greater profitability
b. Ex: if there is a movie star that sells many pictures (making a profit) and is
also a greater barber
i. Movie: 20 M
ii. Barber: 500K
1. If they decide to only focus on being a barber, they lose the
opportunity cost of 19.5 K because they only focused on
one thign and not the other
2. If they did both, they do not lose anything?
4. Trade = win-win situation
a. Voluntary trade – all parties gain
i. I.e. if not forced into trading, you are freely giving up one thing to
get something else back
1. Ex: if you do not like potato chips and you see someone
have something you want (but they do not like) by having
you both trade the items it is a win-win!
2. Intervening in trade can be seen negatively but can also be
positive
b. Voluntary exchange is mutually beneficial
c. Laws that prevent some exchanges
5. Importance of thinking at the margin
a. Marginal analysis
i. Marginal costs
1. Ex: Buying coffee for $3.00
ii. Marginal benefits
1. Ex: The benefit of the coffee is greater than $3.00
b. Average cost vs. marginal cost of an airline passenger
6. Externalities – a shortcoming of the market cured by market methods
a. Social costs (or benefit) that affect parties external to the economic
transactions that cause them
i. Ex: the consumer is getting the benefit of purchasing this item
ii. The seller/producer gets the profit of providing this item
iii. In many cases, the third party has a cost thrust upon them when
they were not even a part of the transaction between the consumer
and producer
1. Ex: pollution, so imagine living close to a factory and you
are drying your clothes outside
2. The consumer received a product from this factory and the
factory made a profit however for you, your clothes got
dirty from the pollution the factory created!
a. You have not compensated in any way and this
placed a disadvantage on you
3. Externality: pollution!
b. Externalities – social costs
7. Trade-off between efficiency and equality
a. The size of the pie versus a piece of the piece
b. The world is a pie for instance
i. To make it efficient, you can create a huge pie but not everyone
would have an equal slice of pie (some would have a bigger slice
than others)
ii. To make equality, you c an give equal slices to everyone but the
efficiency would not be as huge since it limits the growth
- There is no correct answer on how we can represent both ideas and it
really depends on what you value more
8. Government policies – limit economic fluctuations – but don’t always succeed
a. Fiscal policy: control of taxes and government spending
i. Using tax to get resources or cutting taxes to promote economic
growth
ii. And taking the money to spend it in ways that can benefit the
citizens
b. Monetary policy: control of money and interest rates
i. The central bank used its ability to control interest rates and the
amount money in the economy
1. In the attempt to expand the economy or contract the
economy (depending on what the goals might be)
9. The short-run trade-off between inflation and unemployment
a. In the short-run, there is an inverse relationship between unemployment
and inflation
b. Low unemployment = high inflation
i. To get people back to work, you have to put a lot of money our
there and spreading this allows more business to hire more people
c. High unemployment = low inflation
i. People do not have jobs and spending is not great, there is not
nearly any pressure on prices
10. Productivity growth is almost everything in the long run
a. A small increase in labor productivity → higher living standard
b. Slowdown in labor productivity → lower living standard
- Ex: going to an urban or suburban area where you see individuals that have a roof over
their head, hopefully not starving and some type of communication/entertainment is seen
that you are in the middle class
- What makes the economy go forth is the ability of being productive with the items
we have ie access to certain gadgets
●INSIDE THE ECONOMIST’S TOOL KIT
●Economics as a discipline
○Mix of mathematics, history, statistics…
●Need for abstraction
○Abstraction is necessary to understand the functioning of anything as complex as
the economy
○Ignore many details
○Helps understand the most important elements of data
●Which map is best if you want to go from the Los Angeles Civic Center to the Los
Angeles Country Museum of Art?
●Detailed Road Map of Los Angeles
●Major Los Angeles Arteries and Freeway
●Greater Los Angeles Freeways
Solution: there is no such thing as one “right” degree of abstraction. Depends on the objective of
your analysis.
●Abstraction, simplification
○Unimportant details
○Necessary
■Understand complex economy
●Degree of abstraction
○Objective of analysis
●Role of Economic Theory
○A theory is a deliberate simplification of a relationship used to explain how it
works
○Explains how relationships work
○Difference between correlation and causation
●Statistical correlation:
○Something to back up the theories of why the relationship works
○Look at variables that go up or down together
■A relationship of what occurs if you change one variable, the other
variable has a similar type of reaction
■All the two things happened together, it does not mean one occurred
because of the other
○Fallacy of competition: letting one member represent an entire group
■Have to be careful because one member cannot be representing the entire
group
●What is an Economic Model
○A simplified version of some aspects of the economy
○A good economist can express models with equations, graphs, and words
●Reasons for disagreements: imperfect information and value judgments
○Among economists, agreement > disagreement
■Imperfect information → disagreement
●If one person asks is different from what another person asks,
given two different sets of this information it can lead to
disagreements
■Value judgments → disagreements
●Not based on fact but based on opinion
●Normative and positive statements
○Normative → opinion
○Positive → can be proved, true or false (facts)
●Economics focuses more on pragmatism (ends, how successful you
are achieving the ends) than values (means, what you got)
○Most questions on the economy deal with efficiency
■What is the most efficient way of getting from one
spot to the end
○One with resources on one side and results on the other side
○“If all the earth’s economists were laid end to end, they could not reach an
agreement”
○Sometimes important facts are unknown
○Different economists make different value judgments
USING GRAPHS: A REVIEW:
●Two variables diagram
○Shows what happens to one variable when another variable change
○Plot one variable on the x-axis and the other on the y-axis
○At the origin the value of both values is zero
●How would you graph the following relationship between price and quantity demanded
natural gas?
Table 1: quantities of natural gas demanded at various prices
Figure 1: hypothetical demand curve for natural gas: St. louis
- Since be an inverse or negative relationship!
●Definition and measurement of slope
○Straight lines
■Slope = vertical change/horizontal change = rise/run
■4 general cases
Figure 2: different types of slope of a straight-line graph
●Zero slope
○Y value does not change
●Infinite slope
○X value does not change
●The slope of a straight line
○Same numerical value
Figure 3: different types of slope of a straight-line graph
- Curved lines
- Slopes change and can be positive and/or negative
FIGURE 4: BEHAVIOR OF SLOPES IN CURVED GRAPHS
● •Curved lines
○ •Slopes change and can be positive and/or negative
○ •Slope at a point on the curve is the slope of a line tangent to that point
FIGURE 5: HOW TO MEASURE SLOPE AT A POINT ON A CURVED GRAPH
- Y-intercept
- X-intercept
- Ray through origin
- Y-intercept = zero
- 45-degree lines
- Rays through origin
- Slope = 1
- Angle = 45 degrees
- X =Y
FIGURE 6: RAYS THROUGH THE ORIGIN
●Contour map (topographical map)
○Three pieces of data
■Latitude
■Longitude
■Altitude
FIGURE 7: A GEOGRAPHIC CONTOUR MAP (mount everest)
●Production indifference map
○Axes – quantities of two inputs
○Curve – given quantity of output
■Points on curve
●Different quantities of two inputs
●Just enough — produce given output
FIGURE 8: AN ECONOMIC CONTOUR MAP
●For Z = 10, for every point on this line the z value equals to 10
●In the second line, for every point on that line the z value equals to 20
●So.. they can all have different values of x values that make them up but the z value is
constant
●•Squeezing three dimensions into two: Contour Maps
○•Business decision making
■•Labor, raw materials, and output
○•Physical map: latitude, longitude, altitude
○•Production indifference map: two inputs, output
