Notes for Chapters 1-4
Notes for Chapters 1-4 ECON-E 201 Peter Olsen
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Microeconomics Lecture 1 Notes 1 Economics Choice constrained by scarcity a Microeconomics individual choice individual markets b Macroeconomics aggregate issues 2 Scarcity limited not enough to go around a wants gt resources 3 Resources used to produce goods and services a Land all natural resources b Labor human effort in production i Entrepreneurship organize manage assume risk c Capital goods used to produce other goods i Physica capital machines tools buildings ii Human capital skills and knowledge of workers d Note real capital vs nancial capital 4 Given resources individuals and societies must decide a What to produce b How to produce it c Who gets the output Chapter 1 Ten Principles of Economics l Principle 1 People Face TradeOffs 1 Making decisions requires trading off one goal against another A Society faces the trade off between ef ciency and equality 1 Ef ciency the property of society getting the maximum bene t from its scarce resources 2 Equalitythe property of distributing bene ts uniformly among society s members ll Principle II The Cost of Something is What You Give Up to Get It 1 In many cases the cost is not as obvious as it rst appears A Opportunity Cost whatever must be given to obtain some item lll Principle lll Rational People Think at the Margin A Rational People people who systematically and purposefully do the best they can to achieve their objectives VI VII W B Marginal Change a small incremental adjustment to a plan of action a Rational people compare marginal bene ts to marginal costs b Marginal bene t gt marginal cost good decision Principle 4 People Respond to Incentives 1 Incentive something that induces a person to act a Incentives are crucial to analyzing how markets work b Failing to consider how policies affect incentives leads to unintended consequences c Incentives cause people to alter their behavior Principle 5 Trade Can Make Everyone Better Off A Trade allows each person to specialize in what they do best B Trade creates competition but everyone is still better off trading than isolating themselves from markets Principle 6 Markets are Usually a Good Way to Organize Economic Activity A Market Economy an economy that allocates resources through the decentralized decisions of many rms and households as they interact in markets for goods and services B Prices are the instrument that direct the individuals in the market to make decisions that bene t the market as a whole kind of like an quotinvisible handquot C An outside source controlling the prices impedes the ability of the invisible hand to bene t the market Principle 7 Governments can Sometimes Improve Market Outcomes A The government exists to enforce the rules and maintain the institutions in a market economy B Property Rights the ability of an individual to own and to exercise control over scarce resources C Government also exists to promote ef ciency or equality D Market Failure a situation in which a market left on its own fails to allocate resources ef ciently a Externality the impact of one person s actions on the wellbeing of a bystander E Market Power the ability of a single economic actor or small group of actors to have a substantial in uence on market prices F Government policies typically aim to promote equality Principle 8 A Country s Standard of Living Depends on its Ability to Produce Goods and Services A Living standards differ substantially around the world B Productivity the quantity of goods and services produced from each unit of labor input i Growth rate of productivity depends on growth rate of average income C Raise productivity by educating workers providing them with tools and giving them access to the best available technology IX Principle 9 Prices Rise When the Government Prints Too Much Money A In ation an increase in the overall level of prices in the economy B High in ation imposes various costs on society C In ation is caused by the growth in the quantity of money X Principle 10 Society Faces a ShortRun TradeOff between In ation and Unemployment A Increasing amount of money Increases spending and demand B Higher demand Higher prices more workers larger supply C More workers Lower unemployment D Business Cycle uctuations in economic activity such as employment and production Lecture 2 Notes 1 Scarcity wantsgtresources a Nothing is free everything has a cost b You can t have everything c Free is an attempt to con 2 Human Behavior a Humans i Produce ii Trade iii Consume b Motivation to make themselves better off Ri es Pints of Ice Cream Opp Cost of each Ri e 0 180 1 170 10 pints 2 150 20 pints 3 120 30 pints 4 7O 50 pints 5 O 70 pints 3 Production Possibilities Frontier shows the maximum output combinations of two goods using existing resources to their full potential at the given state of technology a Technology how resources are combined in production 200 180 gt 160 140 120 100 80 60 40 20 b Model i Abstract representation explanation or theory that helps us understand complex phenomena c Scienti c Method i Use logic to formulate theories and test them against evidence d Role of Assumptions i Simplify and focus Production Possibilities Frontier ltgt Pints I I I I I l 2 3 4 5 6 e Implications i More ri es output means less ice cream ii Cost exists 1 Costsacri ce 2 Nothing is free so you can t have everything iii Points on the Graph 1 On the PPF Line Efficient 2 Beyond the line unattainable 3 Inside the line inefficient iv Slope of the PPF Negative 1 Implication cost exists because of scarcity v Shape of the PPF Concave bowed out 1 Implication cost rises due to diminishing marginal returns vi Best output combination 1 Can t say It depends on what the consumers want f Opportunity Cost the next best use of a resource given UP i Opp Cost is an incrementalmarginal cost ii Sunk cost a sacri ce from a past decision iii Different Time Horizon Different costs are relevant g Positive vs Normative Statements i Positive statements 1 Describe what is 2 Describe what will occur if 3 They are testable TrueFalse a Ex If welfare payments are raised labor force participation will fall ii Normative statements 1 Valuejudgment 2 Can t be tested 3 State what is better fairer just etc a Ex Welfare payments should be bigger 4 Goals are normative 5 Policy advocacy is normative Chapter 2 Thinking Like an Economist The Economist as Scientist A The Scienti c Method Observation Theory and more Observation 1 The interplay between theory and observation also occurs in economics a However conducting experiments is impractical b They must make use of whatever data the world provides them throughout history B The Role of Assumptions 1 Assumptions can simplify the complex world and make it easier to understand a Scienti c thinking is deciding which assumptions to make C Economic Models 1 Models consist of diagrams and equations a All models are built with assumptions b Models simplify reality to improve our understanding of it D Our First Model The CircularFlow Diagram 1 A visual model of the economy that shows how dollars ow through markets among households and rms a Factors ofProductionIand labor capital b Markets for Goods and Serviceshouseholds are buyers rms are seers c Markets for the Factors of Productionhouseholds are sellers rms are buyers E Our Second Model The Production Possibilities Frontier 1 A graph that shows the various combinations of outputs that the economy can possibly produce given the available factors of production and technology a Not every conceivable outcome is feasible b Ef cientthe economy is getting all it can from the scarce resources it has available points on the PPF c Inef cientthe economy is producing less than it could point inside the PPF 2 People face tradeoffs a The cost of something is what you give up to get it 3 PPFs often have a bowed shape a The tradeoff within a PPF can change over time F Microeconomics and Macroeconomics 1 Microeconomicsthe study of how households and rms make decisions and how they interact in speci c markets 2 Macroeconomicsthe study of economywide phenomena a ln ation unemployment and economic growth The Economist as Policy Adviser A Positive vs Normative Analysis 1 Positive Statements claims that attempt to describe the world as it is 2 Normative Statements claims that attempt to prescribe how the world should be B Economists in Washington 1 The president gets his information in the annual Economic Report of the President 2 There are economists in every division of the government a The Federal Reserve employs hundreds of economists C Why Economists Advice is Not Always Followed 1 Leaders don t only have to pick the right policy they also have to communicate and enforce it after it is approved by the Congress Why Economists Disagree A Differences in Scienti c Judgments 1 Economics is a young science and there is still much to be learned 2 Disagree because they have different hunches about a The validity of alternative theories b The size of important parameters that measure how economic variables are related B Differences in Values C Perception versus Reality 1 Realities of the political process stand as immovable obstacles Lecture 3 Notes WarmUp When the unemployment rate drops the PPF of the US Economy production possibility changes from a point severely interior to a point closer to the PPF line but still interior WarmUp Labor force in the United States has fallen This results in the point of production changing from being on the curve assuming there is no unemployment to a point interior Production Possibilities Frontier A Shift of PPF 1 Occurs when there is a change in resources or technology available a Rightward Shift More resources or improved technology i More output per unit of resources b Change in resources or technology affecting only one output i Maximum output of that good changes but the maximum output of the other good stays the same i More of both outputs is possible Right triangle effect 1 Resources from good 1 production are freed up to produce good 2 c Production of Capital Goods i If capital goods are produced in period 1 there are more resources for use in period 2 so the PPF shifts to the right i The more capital goods produced the further the shift rightward MORE GROWTH iiThere s a tradeoff because in order to grow more consumption goods must be given up in period 1 1 Growth is key to raising living standards B Rate at Which You Discount the Future i Question of whether to satisfy a want of defer grati cation ii By investing now for the future the economy will grow But that growth requires the sacri ce of some consumption now C Types of Goods 1 Consume now consumption goods 2 Consume later capital goods a resource Chapter 3 Interdependence and the Gains from Trade l A Parable for the Modern Economy Minutes Needed to Amount Produced in 8 Make 1 Ounce Hours Meat Potatoes Meat Potatoes Frank the 60 min 15 min 8 oz 32 oz Farmer Rose the 20 min 10 min 24 oz 48 oz Rancher A Production Possibilities 1 If Frank and Rose both specialize they can trade and both get more potatoes and meat then they would if they made it on their own ll Comparative Advantage The Driving Force of Specialization A Absolute Advantage the ability to produce a good using fewer inputs than another producer B Opportunity Cost and the Comparative Advantage Opportunity Cost of 1 oz of Meat 1 oz of Potatoes Frank the Farmer 4 oz potatoes 14 oz of meat Rose the Rancher 2 oz potatoes 12 oz of meat 1 Comparative Advantage the ability to produce a good at a lower opportunity cost than another producer a Rose has a higher opportunity cost than Frank therefore Frank has a comparative advantage over her in both goods b It is impossible to have absolute advantage in both goods and a comparative advantage in either good C Comparative Advantage and Trade 1 Gains from specialization and trade are based on comparative advantage 2 Trade can bene t everyone in society because it allows people to specialize in activities in which they have a comparative advantage D The Price of the Trade 1 For both parties to gain from trade the price at which they trade must lie between the two opportunity costs lll Applications of Comparative Advantage A Should Tom Brady Mow his Own Lawn 1 Brady should hire someone else even though he s the fastest at it because his opportunity cost is higher than that of a landscapen B Should the United States Trade with Other Countries 1 Imports goods produced and abroad and sold domestically 2 Exports goods produced domestically and sold abroad 3 Trade allows all countries to achieve greater prosperity but it affects individual citizens differently Lecture 4 Notes Humans A H Produce Consume Trade 1 How is it possible to consume more than I can produce beyond the PPF a Specialization and trade b David Ricardo 17721823 wrote a book about it Basic Proposition 1 As long as the opportunity costs between trading partners differ both parties can bene t by specializing in trading Absolute Advantage more output from the same resources or fewer resources produce the same output Comparative Advantage produce at a lower opportunity cost 1 The opportunity cost of one good is the reciprocal of the opportunity cost of the other good 2 It is impossible to have a comparative advantage in both goods Mutually bene cial trade is possiblealways 1 The price of trade must lie between the two differing opportunity costs Steps for Solving a Comparative Advantage Problem 1 Make table 2 Find opportunity cost per unit of one output a Lower opportunity cost l comparative advantage 3 Find opportunity cost per unit of other output a Lower opportunity cost l comparative advantage 4 Find terms of trade a Compare internal opportunity costs b Pick rate of trade in between c Verify mutual gain Without trade consumption possibilities are bounded by production possibilities 1 With trade consumption possibilities are biggerthan production possibilities a quotBuying localquot will make you worse off Trade based on comparative advantage is quotRoundabout Productionquot Real World A Costs are increasing so it may be efficient to produce a good up to some level then import the rest from lowercost producers B A comparative advantage can change over time Chapter 4 The Market Forces of Supply and Demand I Markets and Competition A What is a Market 1 Market a group of buyers and sellers of a particular good or service a Buyers determine demand sellers determine supply B What is Competition 1 Competitive Market A market in which there are many buyers and many sellers so that each has a negligible impact on the market price a We assume that markets are perfectly competitive i Goods offered for sale are exactly the same ii Buyers and sellers are so numerous that no single buyer or seller has any in uence over the market price i Buyers and sellers are price takers in a perfect market b A monopoly occurs when there is only one seller II Demand A The Demand Curve The Relationship between Price and Quantity Demanded 1 Quantity Demanded the amount of a good that buyers are willing and able to purchase 2 Law of Demand the claim that other things being equal the quantity demanded of a good fails when the prices rises 3 Demand Schedule A table that shows the relationship between the price of a good and the quantity demanded 4 Demand Curve a graph of the relationship between the price of a good and the quantity demanded B Market Demand vs Individual Demand 1 Market Demand the sum of all individual demand C Shifts in the Demand Curve 1 The demand curve shifts when there is an increase or decrease in overall demand changes the quantity demanded at every price a Increase in Demand i Curve shifts to the right b Decrease in Demand i Curve shifts to the left 2 Income 3 4 a Normal Good the demand for a good fails when income falls b Inferior Good the demand for a good rises when income falls Prices of Related Goods a Substitutes two goods for which an increase in the price of one leads to an increase in the demand for the other b Complements two goods for which an increase in the price of one leads to a decrease in the demand for another Tastes Expectations Number of Buyers etc Ill Supply A The Supply Curve The Relationship between Price and Quantity SuppHed 1 2 3 4 Quantity Supplied the amount of a good that sellers and willing and able to sell Law of Supply other things constant the quantity supplied of a good rises when the price of a good falls Supply Schedule a table that shows the relationship between the price of a good and the quantity supplied Supply Curve a graph of the relationship between the price of a good and the quantity supplied B Market Supply vs Individual Supply 1 Market Supply the sum of all the supplies of the sellers C Shifts in the Supply Curve 1 2 3 Increase in supply a Shifts to the right Decrease in supply a Shifts to the left Input Prices Technology Expectations and Number of Sellers all have the ability to shift the supply curve IV Supply and Demand Together A Equilibrium 1 Equilibrium a situation in which the market price has reached the level at which quantity supplied equals quantity demanded Equilibrium Price the price that balances quantity supplied and quantity demanded a Market Clearing price Equilibrium Quantity the quantity supplied and the quantity demanded at equilibrium price Surplus a situation in which quantity supplied is greater than quantity demanded a Excess suppy Shortage a situation in which quantity demanded is greater than quantity supplied a Excess demand B Three Steps to Analyzing Changes in Equilibrium 1 Decide whether the event shifts the supply or demand curve or both 2 Decide in which direction the curve shifts 3 Use the supply and demand diagram to see how the shift changes the equilibrium price and quantity Lecture 5 Notes Supply and Demand Model A How a Decentralized choice mechanism resolves problem of scarcity Demand A Assume 1 2 Many buyers each negligible Rationality buyers know their preferences make consistent choices B Demand D a schedule of the quantities of a good that will be purchased at various prices over some time period other things constant P P FP NE Schedule function Quantities Pdces Willingness to buy Time period Ceteris parbus all else equal a Demand is i NOT a quantity ii NOT a psychological construct iii NOT what we wish we could have iv NOT what we can afford to have v Demand Schedule Price per Quantity per Quantity Per Market download month Joe MonthFresca Quantity 150 0 0 0 130 5 0 5 110 10 3 13 90 15 6 21 70 18 9 27 50 23 10 33 A Market Demand 1 Sum of quantities at each price by all individuals in the market B Law of Demand Other things constantas the price rises the quantity demanded decreases and vice versa 1 Inverse relationship between price and quantity demanded 2 Exceptions to the Law of Demand a Gasoline Nope Lower prices mean people are willing to drive more b Humans Nope As minimum wage rises rms hire fewer worker c Gold Nope The future expectation of the price changes so other things were not constant 3 Rationale for the Law of Demand a A change in price causes a change in opportunity cost to consume i When price drops a good becomes relatively cheaper than it was before so quantity demanded rises 4 Substitution Effect changing prices causes people to make substitutions a People respond to relative prices i It s a marginal effect iiThose who change their behavior due to small price changes are called buyers at the margin b Buyers voluntarily sortthemselves i Those who keep consuming ii Those who switch iii Preferences are revealed by behavior Price only changes quantity demand not total demand Quantity Demanded the amount bought at a given price a Very important distinction quantity demanded vs demand mu Lecture 6 Notes Demand Cont A Change in Quantity Demanded 1 Caused by change in price 2 Point moves along the curve B Change in Demand 1 Shift of entire demand schedule C Demand Shifters 1 Tastespreferences 2 Income of consumers in a market a Normal Goods increase in income leads to increase in demand for good b Inferior Good increase in income leads to decrease in demand for good 3 Prices of substitutions a Substitutions satisfy the same wantneed b Increase in price of one leads to increase in demand for substitute c Decrease in price of one leads to decrease in demand for substitute 4 Prices of complements a Complements jointly consumed b Decrease in price of one leads to increase in demand for complement c Increase in price of one leads to decrease in demand for complement 5 Expectations of buyers about price in future a If buyers expect a soontooccur increase in price of a good the demand for that good now increases b If buyers expect a soontobe decrease in price of a good the demand for that good now decreases 6 Number of consumers a Changes in populations or demographics b If number of consumers increases demand increases c If number of consumers decreases demand decreases ll Supply A ProducerSeller behavior B Assume 1 Many Sellers 2 Rationality a Respond to incentives in a predictable way C Supply a schedule of quantities of a good that will be offered for sale at various prices over some time period other things constant 1 Supply is a Willingness to sell not a physical stock 2 Supply Schedule Price per Bagel Quantity Supplied 300 60 250 42 200 30 150 20 100 10 050 0 Supply Curve 3J5 2J5 2 x 0 Price 115 15 0 ll l l l l l l 0 10 20 30 40 50 60 70 3 Supply Curve a Positive slope b Direct relationship between price and quantity supplied c Increase in price leads to an increase in quantity supplied and vice versa d Costs rise as rate of output rises so they will only sell more if they can make a higher pro t D Quantity Supplied amount offered for sale at a particular price 1 Ex 30 is the amount supplied at 200 2 Change in quantity supplied a Caused by a change in price i Movement along the supply curve E Change in Supply 1 Moreless offered for sale at each price 2 Rightwardleftward shift Lecture 7 Notes Supply Curve Shifts quotother things constantquot A Cost Conditions 1 quotCostquot and Price are not the same idea 2 Changes in cost of production a Input prices b Technology i Voluntary Change increases supply ii Mandatory Change Decreases supply c Taxes d Regulations 3 Cost rises shifts down 4 Cost falls shifts up B Availability 1 Physical amount 2 Usually agricultural output markets or natural resource markets C Number of Sellers 1 Increase in number of sellers l increase in supply 2 Decrease in number of sellers l decrease in supply D Expectations of sellers about future price 1 Expect price to rise in future decrease in supply now hoarding 2 Expect price to fall in future increase in supply now quotdumpingquot The Market Mechanism A Interaction of demand and supply to determine price B A price system uses individual choice to decide 1 What goods are produced 2 How goods are produced 3 Who gets the goods C Consider three cases in the banana market 1 Price quottoo lowquot a Shortagemore bananas demanded than exist to be bought b Quantity Demanded gt quantity supplied C Is the low price stable NO d Price will be bid up 2 Price quottoo highquot a Surplusmore bananas supplied than people are willing to buy b Quantity supplied gt quantity demanded C Is the high price stable NO d Price will be bid down 3 Price quotjust rightquot Not just Not quotrightquot Not a moral value Quantity Demanded Quantity Supplied e Price is stable f Equilibrium price D Summary 1 Price rises when Qd gt Q5 2 Price fails when Qd lt Q5 3 Price changes eliminate shortages and surpluses 4 ShortageSurplus a Not a problem with output or consumption goom b Not a problem with demand or supply c They result from an interference with prices E Helpful Terms 1 Equilibrium Price PE a Qd Qs b quotMarketClearing Pricequot c No shortagesurplus 2 Equilibrium Quantity QE Lecture 8 Notes I Supply and Demand Analysis A Start from equilibrium B Event occurs affecting a market C Market adjusts D New equilibrium attained ll StepByStep Process Don t think Draw the welllabeled market supply and demand curves Think which shifter changed 1 TlPPENdemand CANEsupply Which curve is affected Demand or Supply Which direction Right or left F Do it Hi Note on lnputs cost conditions vs Complements A Complements 1 Jointly consumed goods 2 Shift Demand B Inputs 1 Used to produce goods 2 Shift supply quotquotU 09 39
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