INTRO
Economics Definition:
- The study of how society manages its scarce resources
- Alfred Marshall: The study of mankind in the ordinary business of life
- Economy: Greek meaning “one who manages household”
Household:
- Must delicate its time and people (scarce resources) to get tasks done
- Face many decisions (society must face who to allocate to do jobs and the
goods/services they will produce)
Scarcity:
- society has limited resources and therefore cannot produce all the goods and services
people wish to have
- People can’t have all their wants
Economists Jobs:
- Study how people make decisions, how people interact with one another (ex. Buyers
and sellers determine sales price and quantity supplied), and analyze the forces and
trends that affect the economy as a whole, including the growth in average income, the
fraction of the population that cannot find work, and the rate at which prices are rising.
1 - 1 How People Make Decisions
Principle 1: People Face Trade-Offs
- “No free lunch”, allocating time, countries - “guns and butter”, clean environment and
high income
-Efficiency means that society is getting the maximum benefits from its scarce
resources.
-Equality means that those benefits are distributed uniformly among society’s members.
- efficiency refers to the size of the economic pie, and equality refers to how the pie is
divided into individual slices.
- Greater equality can lead to less efficiency (when the government tries to cut the
economic pie into more equal slices, the pie shrinks.) Ex. When the government
redistributes income from the rich to the poor, it reduces the reward for working hard; as
a result, people work less and produce fewer goods and services.
- Trade offs are necessary (Ex. Society should not stop protecting the environment just
because environmental regulations would reduce our material standard of living. The
government should not ignore the poor just because helping them would distort work
incentives.)
Principle 2: The Cost of Something Is What You Give Up to Get It
- People face trade-offs, making decisions requires comparing the costs and benefits of
alternative courses of action. (Ex. College - time, money for school & food, giving up the
ability to work at a job and earn money)
- The opportunity cost of an item is what you give up to get that item. (Next best
alternative - what you are giving up - I am giving up sleeping to be studying right now)
- Ex. College athletes dropping out to play professionally (they decide that the benefit of a
college education is not worth the cost)
- Q: Your opportunity cost of going to a movie is - b. the total cash expenditure needed to
go to the movie plus the value of your time.
- Implicit cost (time of going to college), Explicit cost (cost of college tuition)
Principle 3: Rational People Think at the Margin
-Rational people systematically and purposefully do the best they can to achieve their
objectives, given the available opportunities.
- Ex. firms that decide how many workers to hire and how much product to make and sell
to maximize profits. Individuals decide what goods and services to but for satisfaction.
- Decisions usually gray (not black and white) Ex. Should I Binge or Starve, Gray would
be: should I take an extra helping of mashed potatoes?
- Economists use the term marginal change to describe a small incremental adjustment
to an existing plan of action. (adjustments around the edges of what you are doing.)
- Q: Marginal Change is one that - a. incrementally alters an existing plan
-Rational people make decisions by comparing marginal benefits and marginal costs.
- Ex. marginal cost of streaming netflix (zero because you already pay for streaming, but it
takes away from other activities such as studying)
- Ex. The average cost of flying a passenger is , but the marginal cost is merely the cost of
the can of soda that the extra passenger will consume and the small bit of jet fuel
needed to carry the extra passenger’s weight. As long as the standby passenger pays
more than the marginal cost, selling the ticket is profitable.
- Ex. The marginal benefit, in turn, depends on how many units a person already has.
(water: low marginal benefit, diamonds large marginal benefit)
Principle 4: People Respond to Incentives
- An incentive is something that induces a person to act, such as the prospect of a
punishment or reward.
- People respond to incentives. A higher price in a market provides an incentive for buyers
to consume less and an incentive for sellers to produce more.
- Ex. Congress had an incentive to require laws about seat belts (too many injuries from
accidents)
- Ex. Rational people: driving safely is the marginal benefit (marginal cost is it takes more
time and energy) - incentive is to not get into an accident
- Ex. The result of a seat belt law, therefore, is a larger number of accidents. (people drive
more carelessly with a seatbelt - cost benefit analysis.
- If the policy changes incentives, it will cause people to alter their behavior.
- Q: Because people respond to incentives, a. policymakers can alter outcomes by
changing punishments or rewards & b. policies can have unintended consequences & c.
society faces a trade-off between efficiency and equality.
1 - 2 How People Interact
Principle 5: Trade Can Make Everyone Better Off
- Trade allows countries to specialize in what they do best and to enjoy a greater variety of
goods and services.
- Other countries are partners & competitors
- Q: International trade benefits a nation when - b. all nations are specializing in producing
what they do best.
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
- Communism (government controlled economic decisions) moved to market
- In a market economy, the decisions of a central planner are replaced by the decisions
of millions of firms and households.
- Market economy successful despite people being self interested and no one looking out
for society as a whole
- In any market, buyers look at the price when deciding how much to demand, and sellers
look at the price when deciding how much to supply. (outcomes tend to benefit society)
- Government setting prices impedes the invisible hand.
- Q: Adam Smith's "invisible hand" refers to - the ability of free markets to reach desirable
outcomes, despite the self-interest of market participants.
- These planners (government) lacked the necessary information about consumers’ tastes
and producers’ costs, which in a market economy is reflected in prices.
- Surge pricing (uber can raise prices, taxis are mandated), ubers respond to incentives
Principle 7: Governments Can Sometimes Improve Market Outcomes
- the invisible hand can work its magic only if the government enforces the rules and
maintains the institutions that are key to a market economy.
- market economies need institutions to enforce property rights so individuals can own
and control scarce resources.
- Need government to to promote efficiency or to promote equality. That is, most policies
aim either to enlarge the economic pie or to change how the pie is divided.
- Economists use the term market failure to refer to a situation in which the market on its
own fails to produce an efficient allocation of resources.
- one possible cause of market failure is an externality, which is the impact of one
person’s actions on the well-being of a bystander. Ex. producing goods can cause air
pollution, which can lead to health problems
- Another possible cause of market failure is market power, which refers to the ability of a
single person or firm (or a small group of them) to unduly influence market prices. Ex. if
one person owns the only source of water, they can create unreasonable prices
- In the presence of externalities or market power, well-designed public policy can
enhance economic efficiency.
- In practice, many public policies, such as the income tax and the welfare system, aim to
achieve a more equal distribution of economic well-being.
- Ex. education is a positive externality - society benefits from you being educated. A
concert can be very noisy - negative externality
- Q- Governments may intervene in a market economy in order to - a. protect property
rights & b. correct a market failure due to externalities & c. achieve a more equal
distribution of income.
1-3 How the Economy as a Whole Works
Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and
Services
- Almost all variation in living standards is attributable to differences in countries’
productivity—that is, the amount of goods and services produced by each unit of labor
input.
- the growth rate of a nation’s productivity determines the growth rate of its average
income. (productivity - not competition, labor unions, of minimum wage laws)
- To boost living standards, policymakers need to raise productivity by ensuring that
workers are well educated, have the tools they need to produce goods and services, and
have access to the best available technology.
Principle 9: Prices Rise When the Government Prints Too Much Money
-inflation, an increase in the overall level of prices in the economy.
- Cause of inflation - the culprit is growth in the quantity of money.
Principle 10: Society Faces a Short-Run Trade-Off between Inflation and Unemployment
- Most economists describe the short-run effects of money growth as follows:
- Increasing the amount of money in the economy stimulates the overall level of
spending and thus the demand for goods and services.
- Higher demand may over time cause firms to raise their prices, but in the
meantime, it also encourages them to hire more workers and produce a larger
quantity of goods and services.
- More hiring means lower unemployment.
- a short-run trade-off between inflation and unemployment (This simply means that, over a
period of a year or two, many economic policies push inflation and unemployment in opposite
directions.) Inflation and unemployment go in opposite directions
- This short-run trade-off plays a key role in the analysis of the business cycle—the irregular
and largely unpredictable fluctuations in economic activity, as measured by the production of
goods and services or the number of people employed.
- Policy making can use various instruments to help - By changing the amount that the
government spends, the amount it taxes, and the amount of money it prints, policymakers can
influence the overall demand for goods and services. Changes in demand in turn influence the
combination of inflation and unemployment that the economy experiences in the short run.
-Q: If a central bank uses the tools of monetary policy to reduce the demand for goods and
services, the likely result is ________ inflation and ________ unemployment in the short run -
lower inflation, higher unemployment
1 - 4 Summary
Ten Principles of Economics
How People Make Decisions
1.People face trade-offs.
2.The cost of something is what you give up to get it.
3.Rational people think at the margin.
4.People respond to incentives.
How People Interact:
5.Trade can make everyone better off.
6.Markets are usually a good way to organize economic activity.
7.Governments can sometimes improve market outcomes.
How the Economy as a Whole Works:
8.A country’s standard of living depends on its ability to produce goods and services.
9.Prices rise when the government prints too much money.
10.Society faces a short-run trade-off between inflation and unemployment.
____________________________________________________________________________
2.1 The Economist as Scientist
- Economists: devise theories, collect data, and then analyze these data to verify or refute
their theories. Use the scientific method: devise theories, collect data, and then
analyze these data to verify or refute their theories.
The Scientific Method: Observation, Theory, and More Observation
- Interplay between theory and observation (Ex. Theory might assert that high inflation
arises when the government prints too much money. To test this theory, the economist
could collect and analyze data on prices and money from many different countries.)
- In economics, conducting experiments is often impractical. (economists studying inflation
are not allowed to manipulate a nation’s monetary policy simply to generate useful data.)
- To find a substitute for laboratory experiments, economists pay close attention to the
natural experiments offered by history.
The Role of Assumptions
- Assumptions can simplify the complex world and make it easier to understand.Ex. We
could assume the world has two countries to focus in on a problem
- economists use different assumptions when studying the short-run (usually fixed price)
and long-run (usually flexible price) effects of a change in the quantity of money.
Economic Models
- Diagrams and equations(built with assumptions
Our First Model: The Circular-Flow Diagram
- we need a model that explains, in general terms, how the economy is organized and
how participants in the economy interact with one another.
- Circular flow model
-
-
- Market for goods and services
- Households work in order to earn money to buy goods and services, households buying
things is firms revenue
- Firms produce goods and services, firms are sellers
-Factors of production are land, labor, capital.
- Households sell their time (people work) and firms buy it (they hire them)
- Firms use their profits to buy people to work and pay rent
- Q: The circular-flow diagram illustrates that, in markets for the factors of production - a.
households are sellers, and firms are buyers.
- Households own factors of production, firms buy the factor of production, goods and
services flow from firms to households
- One set of arrows is flow of funds, one set of arrows is flow of goods in circular flow
diagram
Our Second Model: The Production Possibilities Frontier
- Most economic models, unlike the circular-flow diagram, are built using the tools of
mathematics.
- The production possibilities frontier is a graph that shows the various combinations of
output—in this case, cars and computers—that the economy can possibly produce given
the available factors of production and the available production technology that firms use
to turn these factors into output.
- Shows trade offs, The cost of something is what you give up to get it - This is called the
opportunity cost.
- Curve moves outwards when economy grows
- Equal opportunity cost is a linear production possibility frontier
Microeconomics and Macroeconomics
-Microeconomics is the study of how households and firms make decisions and how
they interact in specific markets. Ex. the effects of rent control on housing in New York
City, the impact of foreign competition on the U.S. auto industry, or the effects of
education on workers’ earnings
-Macroeconomics is the study of economy-wide phenomena. Ex. the effects of
borrowing by the federal government, the changes over time in the economy’s
unemployment rate, or alternative policies to promote growth in national living standards
- Q: All of the following topics fall within the study of microeconomics except - a. the role of
Microsoft's market power in the pricing of software & b. the effectiveness of antipoverty
programs in reducing homelessness & the impact of cigarette taxes on the smoking
behavior of teenagers & d. the influence of the government budget deficit on economic
growth. (D is correct)
2-2 The Economist as Policy Advisor
Positive versus normative analysis
-Positive statements are descriptive. They make a claim about how the world is. Ex:
Minimum Wage laws cause unemployment. Evaluate by analyzing data
-Normative statements are prescriptive. They make a claim about how the world ought
to be. Ex. The government should raise the minimum wage. Can’t be judges using data
alone. When you hear economists making normative statements, you know they are
speaking not as scientists but as policy advisers.
- Q: Which of the following is a positive, rather than a normative, statement? a. Congress
ought to pass law X. b. Law X will reduce national income. c. The president should veto
law X. d. Law X is a good piece of legislation. (B is correct)
2-3 Why Economists Disagree
- Different theories and values
- Why do policies such as rent control and trade barriers persist if the experts are united in
their opposition? It may be that the realities of the political process stand as immovable
obstacles. But it also may be that economists have not yet convinced enough of the
public that these policies are undesirable.
Proposition
(and
percentage
of
economists
who
agree)
1.
A
ceiling
on
rents
reduces
the
quantity
and
quality
of
housing
available.
(93%)
2.
Tariffs
and
import
quotas
usually
reduce
general
economic
welfare.
(93%)
3.
Flexible
and
floating
exchange
rates
offer
an
effective
international
monetary
arrangement.
(90%)
4.
Fiscal
policy
(e.g.,
tax
cut
and/or
government
expenditure
increase)
has
a
significant
stimulative
impact
on
less
than
fully
employed
economy.
(90%)
5.
The
United
States
should not
restrict
employers
from
outsourcing
work
to
foreign
countries.
(90%)
6.
Economic
growth
in
developed
countries
like
the
United
States
leads
to
greater
levels
of
well-being.
(88%)
7.
The
United
States
should
eliminate
agricultural
subsidies.
(85%)
8.
An
appropriately
designed
fiscal
policy
can
increase
the
long-run
rate
of
capital
formation.
(85%)
9.
Local
and
state
governments
should
eliminate subsidies
to
professional
sports
franchises.
(85%)
10.
If
the
federal
budget
is
to
be
balanced,
it
should
be
done
over
the
business
cycle
rather
than
yearly.
(85%)
11.
The
gap
between
Social
Security
funds
and
expenditures
will
become
unsustainably
large
within
the
next
50
years
if
current
policies
remain
unchanged.
(85%)
12.
Cash
payments
increase
the
welfare
of
recipients
to
a
greater
degree
than
do
transfers-in-kind
of
equal
cash
value.
(84%)
13.
A
large
federal
budget
deficit
has
an
adverse
effect
on
the
economy.
(83%)
14.
The
redistribution
of
income
in
the
United
States
is
a
legitimate
role
for
the
government.
(83%)
15.
Inflation
is
caused
primarily
by
too
much
growth
in
the
money
supply.
(83%)
16.
The
United
States
should
not
ban
genetically
modified
crops.
(82%)
17.
A
minimum
wage
increases
unemployment
among
young
and
unskilled
workers.
(79%)
18.
The
government
should
restructure
the
welfare
system
along
the
lines
of
a
“negative income
tax.
(79%)
19.
Effluent
taxes
and
marketable
pollution
permits
represent
a
better
approach
to
pollution
control
than
the
imposition
of
pollution
ceilings.
(78%)
20.
Government
subsidies
on
ethanol
in
the
United
States
should
be
reduced
or
eliminated.
(78%)
____________________________________________________________________________
3. 1
- Specialization for a variety of goods
- Becomes unclear if one person is better at producing everything
- Trade offs between which products to produce
- Trade / Interdependence increases the production possibilities
3. 2
- Absolute Advantage: compares the productivity of someone to someone else. Producer
with a smaller quantity of inputs to produce goods has the absolute advantage
- Comparative advantage: describing the opportunity costs faced by two producers.
Producer who gives up producing a smaller number of the other product to specialize in
one product has a lower opportunity cost or the comparative advantage.
- You can have absolute advantage in both goods, but only comparative advantage in one
- For both parties to gain from trade, the price at which they trade must lie between their
opportunity costs.
3.3
- Ex. Lebron James has absolute advantage in mowing lawn vs. girl next door (hes faster),
girl next door has comparative advantage (Lebron could be earning money playing
basketball)
- Imports: Goods produced abroad and sold domestically, Exports: Goods produced
domestically and sold abroad are called exports.
- Comparative advantage proves that trade makes everyone better off
____________________________________________________________________________
Airplanes Soybeans 30,000 labor hours
0 1200
10 950 1 ton soybeans: 25 labor hours
20 700 1 airplane: 625 labor hours
30 450
48 0 10*625=6250
30000-6250=23750
23750/25=950
(Given all the info except for the soybean column)
____________________________________________________________________________
____________________________________________________________________________
4.1
- The terms supply and demand refer to the behavior of people as they interact with one
another in competitive markets.
- A market is a group of buyers and sellers of a particular good or service
- The buyers as a group determine the demand for the product, and the sellers as a
group determine the supply of the product.
- Price and quantity are determined by all buyers and sellers as they interact in the
marketplace.
-competitive market to describe a market in which there are so many buyers and so
many sellers that each has a negligible impact on the market price. (ex. Purchasing Ice
Cream)
- Assuming markets are perfectly competitive - To reach this highest form of
competition, a market must have two characteristics:
1. The goods offered for sale are all exactly the same, and
2. the buyers and sellers are so numerous that no single buyer or seller has any
influence over the market price.
- Because buyers and sellers in perfectly competitive markets must accept the price the
market determines, they are said to be price takers.
-Monopoly: market that has only one seller, and this seller sets the price (Ex. one local
cable company for a small town)
Demand Curve
- The quantity demanded of any good is the amount of the good that buyers are willing
and able to purchase. - determined by the goods price
-Law of demand: Other things being
equal, when the price of a good rises,
the quantity demanded of the good
falls, and when the price falls, the
quantity demanded rises.
-Demand schedule, a table that shows
the relationship between the price of a
good and the quantity demanded,
holding constant everything else that
influences how much of the good
consumers want to buy.
- The line relating price and
quantity demanded is called the
demand curve. The demand
curve slopes downward
because, other things being
equal, a lower price means a greater quantity demanded.
-Market demand: the sum of all the individual demands for a particular good or service.
- we sum the individual demand curves horizontally to obtain the market demand curve
- Any change that increases the quantity demanded at every price, such as our imaginary
discovery by the American Medical Association that ice cream helps you live a longer
life, shifts the demand curve to the right and is called an increase in demand. Any
change that reduces the quantity demanded at every
price shifts the demand curve to the left and is called a
decrease in demand.
- If the demand for a good falls when income falls, the
good is called a normal good.
-If the demand for a good rises when income falls, the
good is called an inferior good. Ex. you demand
more frozen pizza when you are a poor college kid
- When a fall in the price of one good reduces the
demand for another good, the two goods are called
substitutes (Ex. frozen yogurt and
ice cream)
- When a fall in the price of one good
raises the demand for another
good, the two goods are called
complements (Ex. peanut butter
and jelly)
- Factors that affect individual
demand: tastes, future
expectations,
- Factors that affect market demand:
number of buyers
Supply Curve
-quantity supplied of any good or service is the amount that
sellers are willing and able to sell.
- When the price of ice cream is high, selling ice cream is
quite profitable, and so the quantity supplied is large; when
the price of ice cream is low, the business is less profitable,
so sellers produce less ice cream. This
relationship between price and quantity
supplied is called the law of supply. when
the price of a good rises, the quantity
supplied of the good also rises, and when
the price falls, the quantity supplied falls as
well.
- The curve relating price and quantity supplied is called the supply curve. The supply
curve slopes upward because, other things being equal, a higher price means a greater
quantity supplied.
- Just as market demand is the sum of the demands of all buyers, market supply is the
sum of the supplies of all sellers.
- Any change that raises quantity supplied at every price, such as a fall in the price of
sugar when making ice cream, shifts the supply curve to
the right and is called an increase in supply (more ice
cream will be supplied). Any change that reduces the
quantity supplied at every price shifts the supply curve to
the left and is called a decrease in supply.
- Variables that shift the supply curve: input prices (Ex. if
sugar cream prices increase, quantity supplied
decreases), technology, future expectations
- Market supply depends on the number of sellers
- input prices, technology, expectations, and the number of sellers are not measured on
either axis, a change in one of these variables shifts the
supply curve.
Equilibrium
- point at which the supply and demand curves intersect is
called the market’s equilibrium. The price at this
intersection is called the equilibrium price, and the quantity
is called the equilibrium quantity
-equilibrium price, the quantity of the good that buyers are
willing and able to buy exactly balances the quantity that
sellers are willing and able to sell. AKA
market-clearing price because, at this
price, everyone in the market has been
satisfied: Buyers have bought all they want
to buy, and sellers have sold all they want to
sell.
- A surplus is sometimes called a situation of
excess supply. Surplus causes price to fall,
prices falling increase the quantity
demanded and decrease the quantity
supplied. Prices fall until equilibrium reached.
(movements along curves, not shifts)
- A shortage is sometimes called a situation
of excess demand.
- law of supply and demand: The price of
any good adjusts to bring the quantity supplied and
quantity demanded of that good into balance.
-Supply refers to the position of the supply
curve, whereas the quantity supplied
refers to the amount producers wish to sell.
- To summarize, a shift in the supply curve is
called a “change in supply,” and a shift in
the demand curve is called a “change in
demand.” A movement along a fixed
supply curve is called a “change in the
quantity supplied,” and a movement
along a fixed demand curve is called a
“change in the quantity demanded.”
- Price does not shift the supply or demand curve
____________________________________________________________________________
-GDP measures two things at once: the total income of
everyone in the economy and the total expenditure on
the economy’s output of goods and services. GDP can
perform the trick of measuring both total income and
total expenditure because these two things are the
same. For an economy as a whole, income must equal
expenditure. An economy’s income equals its
expenditure because every transaction has two parties:
a buyer and a seller. Every dollar of spending by some
buyer is a dollar of income for some seller.
-Gross domestic product (GDP) is the market value of
all final goods and services produced within a country
in a given period of time.
- These exclusions from GDP can at times lead to
paradoxical results. For example, when Karen pays
Doug to mow her lawn, that transaction is part of GDP. But suppose Doug and Karen get
married. Even though Doug may continue to mow Karen’s lawn, the value of the mowing
is now left out of GDP because Doug’s service is no longer sold in a market. Thus, their
marriage reduces GDP.
- When International Paper makes paper, which Hallmark then uses to make a greeting
card, the paper is called an intermediate good and the card is called a final good.
-GDP includes both tangible goods (food, clothing, cars) and intangible services
(haircuts, housecleaning, doctor visits).
- It does not include transactions involving items produced in the past (selling a used car
is not part of GDP)
- GDP only includes items produced domestically
- GDP measures the value of production that takes place within a specific interval of time.
Usually, that interval is a year or a quarter (three months). GDP measures the
economy’s flow of income, as well as its flow of expenditure, during that interval.
- To do this, GDP (which we denote as Y) is divided into four components: consumption(c)
, investment(i) , government purchases (g), and net exports (nx): Y=c+i+g+nx
-Consumption is spending by households on goods and services, with the exception of
purchases of new housing.
-Investment is the purchase of goods (called capital goods) that will be used in the future
to produce more goods and services.
- Ex. the purchase of a new house is the one type of household spending categorized as
investment rather than consumption.
-Government purchases measure spending on goods and services by local, state, and
federal governments. This component includes the salaries of government workers as
well as expenditures on public works.
-Transfer payments because they are not made in exchange for a currently produced
good or service. Ex. government pays a Social Security benefit to an elderly person or
an unemployment insurance benefit to a recently laid off worker
-Net exports equal the foreign purchases of domestically produced goods (exports)
minus the domestic purchases of foreign goods (imports).
- If total spending rises from one year to the next, at least one of two things must be
true: the economy is producing a larger output of goods and services, or goods and
services are being sold at higher prices.
-Real GDP, which is the production of goods and services valued at constant prices.
- The production of goods and services valued at current prices, is called nominal GDP.
-GDP deflator, measures the current level of prices relative to the level of prices in the
base year GDP deflator equals nominal GDP/Real GDP * 100
-inflation to describe a situation in which the
economy’s overall price level is rising. The
inflation rate is the percentage change in some
measure of the price level from one period to the next.
