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econ 1 study guides

econ 1 study guides

Description

School: New York University
Department: Engineering
Course: Intro to Macroeconomics
Professor: Gerald mcintyre
Term: Fall 2016
Tags: Macroeconomics, Macro, and Economics
Cost: 50
Name: Macroeconomics Midterm 1 Study Guide
Description: These notes are basically a compilation of the past four weeks of notes (a little less extensive though)...Aplia readings are incorporated into these notes. Combining these notes with the practice from both Aplia and non-Aplia problems should put you in good place for the exam. Good Luck!!
Uploaded: 10/04/2016
36 Pages 9 Views 25 Unlocks
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Midterm 1: Thursday, October 6th, 2016 11:00-12:15  


how many principles economics have?



Bring 4-function calculator!!  

The first exam covers Chapters: 1, 2, 4, 10 and 11  

Exam questions are drawn from:  

Lectures;  

Non-Aplia problem sets;

Aplia problem sets.  

In general, you will not be tested on material in the textbook unless it has been covered in one of these  three ways.  

Chapters 1 and 2  

The Key Method of Economics  

 --Systematic observation and measurement  

An interpretation of data: we measure rates, observed over time the government budget de fect, income inequality, how income has grown  

 --Formulation of a hypothesis  

We do this by using a model, can be simple or complex; going to college and pursuing a de gree can come out at income inequality  

 --Test the Hypothesis 

We do this with new data and assess it...then we either reject or fail to reject  If there is a rejection then we modify  


what is the purpose of Consumer Price Index (CPI)?



 --Modification or rejection of the hypothesis  

**exactly like the scientific method**  We also discuss several other topics like psyc 3400

NOTE: THE METHOD OF ECONOMICS IS THE SCIENTIFIC METHOD  

Economics is a Social Science  Don't forget about the age old question of ee16b spring 2019

What are some other alternative models/guesses for the recent rise in income inequality in the  US?  

 -globalization: jobs being outsourced overseas, only people at top benefiting from the  growth, closing shops in the United States (this would only benefit owners)   -deregulation: loosening of laws and therefore easier for the big guys to get more mon ey  If you want to learn more check out mat136

-cost of living vs. taxes: could try figuring out inflation, what are taxes, how does infla tion and taxation affect different groups of people  

-technology: sometimes known as "skill biased technological change"; those who are  not technologically skilled are not given those advantages  


what is used to calculate inflation?



--Microeconomics vs Macroeconomics

 -Micro: small; studies the individual household, business firm or market, impor tant crucial MICRO decisions on your life, individual markets (like housing market, stock market,  oil market)  Don't forget about the age old question of psych 410 study guide

 -Macro: the BIG picture; studies the entire US economy; unemployment reces sions, expansions, rapid growth, inflation, monetary policy (tools government can use to con trol the money supply), fiscal policy (tax spending policies, etc...)  

 --Positive and Normative Economics *

 -positive: descriptive, describing income shares, growth, education impacts,  etc...; it makes a claim about how the world is  

 --ex. "minimum wage laws CAUSES unemployment" (speaking like a sci entist and making a claim)  

 -normative: prescriptive (aka doing something about it); it claims about how the  world SHOULD be; differences in views and so prescriptive statements are different   --ex. "the government SHOULD raise the minimum wage"  Economics uses models to understand complex reality  Don't forget about the age old question of ua math 112

 --simplifies the world so we can understand it; helps us ignore what's unimportant and  focus on what IS important  

 --all models are "wrong", but some models are useful: models are a HUGE simplifica tion, but some give us understanding  

TEN PRINCIPLES OF ECONOMICS (7 ARE MENTIONED IN LECTURE)  Principle 1: People face trade offs 

--this means that we can't always get everything we want/like, and will have to sacrifice  one over the other  

--we live in a world of limits and have to make choices due to scarcity  Don't forget about the age old question of french 101 study guide

 -ex: you start making choices as soon as you wake up in the morn ing; do i get up or sleep in

Principle 2: The cost of something is what you give up to get it (opportunity cost) --opportunity costs will vary from person to person because people value things  differently and costs are ultimately subjective  

 ex: going to college--> benefits include getting an education and  better opportunities, but costs are tuition and especially TIME  

--be aware of the opportunity costs that accompany each possible decision  total costs=explicit costs vs. implicit costs  

total costs=explicit costs vs. opportunity costs  

efficiency vs. equality  

 --efficiency means getting the MOST out of our resources   --equality means distributing our prosperity more equally to our  society  

**the two often come in conflict, one becomes the other's OC, and therefore  reduces incentives**

Principle 3: Rational people think at the margin"the edge"

--rational people understand that life is hardly ever this or that, black or white,  but rather a mixture or shades of gray; not one extreme or the other when mak ing a decision  

 -rational people make decisions by comparing marginal costs vs  marginal benefits (marginal change)  

if MB>MC, then a rational person would want more of that  

if MB<MC, then a rational person would do less  

if MB=MC, then a rational person is fine with the circumstances  

 --this is also known as the optimal stopping point (optimality  point)

--Principle 4: People respond to incentives 

-many policies change costs or benefits people face, therefore altering incentive  -benefits are like rewards; costs are like punishments  

 --therefore, people decide according to marginal benefits and  costs  

 --ex. when oil prices rise, quantity demanded of oil falls (law of  demand); people decide to drive hybrids, drive less, take public transportation,  etc...  

NOTE: not all people respond to every incentive all the time  

Principle 5: Trade can make everyone better off  

--rather than have one country beat the other in trade, it benefits both (or multi ple) sides/countries  

--it allows an individual or a country to specialize in what they are best at  (whether it be sewing, farming, etc)  

--by trading, people can buy a greater variety of goods and services at a lower  cost  

Principle 6: Markets are usually a good way to organize economic activity --many countries have developed market economies, rather than a central plan ner controlling everything  

--although decentralized and self-interest decisions, has proven to successful in  organizing government activity  

--"invisible hand" helps guide economy  

Principle 7: Governments can sometimes improve market outcomes --needs to enforce rules that are key to market economics in order for the "invis ible hand" to work  

--must encourage institutions to enforce property rights over the things we pro duce, by means of laws, police, courts  

ex. A restaurant won't serve meals unless they know that they will get  paid before customer leaves  

Principle 8: a country's standard of living depends on its ability to produce goods and  services  

--variation in living standards (like annual income and luxuries) are based on a  country's productivity

--the larger the quantity of goods and services produced, the higher the stan dard of living  

--the growth of a nation's productivity determines the growth rate of its average  income  

--productivity influences public policy  

Principle 9: prices rise when the government prints too much money 

--too much money printed = inflation

--the larger the quantity of money that is circulating, the larger the decrease in  value of the money  

Principle 10: society faces a short-run trade off between inflation and unemployment  --an increase in money printed leads to an increase in overall spending, aka an  increase in demands for goods and services  

--an increase in demands causes firms to raise prices, but also encourages firms  to hire more workers to meet those demands  

--hiring more workers = lower unemployment  

--keep in mind this is SHORT-RUN: that means changes in policies that affect un employment and inflation are within 1-2 year periods  

CHAPTER 4  

Market Forces of Demand and Supply: basic work tool of economists  

Markets and Competition  

 --markets: group of buyers and sellers of a good or service  

 -this can be in an actual marketplace, online, etc...  

 --assume that these markets are in perfect competition  

 -goods are exactly the same from market to market  

 -many buyers and sellers: businesses competing for $, and the buyer competing  with others to buy that good  

 --we cannot affect the market individually  

 --sellers are forced to sell at market price  

**we assume no government intervention**  

DEMAND

Quantity Demanded (QD)  

 --amount of goods buyers are willing/able to purchase at a particular price   --it is a particular point on the demand curve  

 

Law of Demand: when price (P) of a good rises, quantity demanded (QD) falls, other things  equal  

 --it is an inverse relationship b/w price and quantity demanded  

Individual Demand and Market Demand  

 --market demand is the horizontal sum of quantities demanded by all buyers

 --leads to the market demand curve  

Shifting Demand Curve  

 --shifts when some other variable changes: "other things" that affect the buyers' will ingness  

 if demand increases, the graph shifts RIGHT  

 if demand decreases, the graph shifts LEFT  

Factors That Increase Demand:  

 1. the number of buyers increases 

 -the larger the number of buyers, more demand and curve will shift right   2. income increases  

 -normal goods: income increase increases demand  

 -inferior goods, if income increases then demand falls  

 3. price of substitute goods 

 -ex) coke vs Pepsi: if coke prices increase, some people will buy more Pepsi   4. price of complements goes down  

 ex) tea and sugar: if the prices of tea goes down, people will buy more sugar  ***NOTE: Factors 3 and 4 make the market interrelated***  

 5. tastes change of the good 

 -if more people demand the good the curve shifts RIGHT   -if buyers start preferring an alternate good, then the demand of a current good  will fall and the demand curve will shift LEFT  

 6. changes in expectations (about the future) 

 ex) I like dark chocolate, but cocoa beans are scarce, so dark chocolate price will  increase: I buy more dark chocolate NOW  

 -if buyers expect prices to rise, the current demand will shoot up  

SUPPLY  

quantity supplied: the amount that sellers are willing and able to sell when price (P) is high   --selling the good is profitable so firms are willing to sell more  

Law of Supply  

 --positive relationship: when price (P) rises, quantity supplied (QS) of the good raises,  given that everything else is held at a constant  

 --when sellers can get higher prices for goods, producing and selling become more  profitable  

 ex) rise in the price of laptops but not desktops will encourage computer makers  to focus more on laptops, not computers  

 --this translates to an upward curve on a graph, in contrast to the demand curve   -each point on the curve shows the quantity that sellers would choose to sell at a  specific price  

 --a shift in the supply curve

 -when variables that we once held constant change (like to cost of transportation  of a good)  

Factors that Increase Supply  

 1. input prices fall  

 -there are many other factors and sources of labor that create a product, and a  change in price in any of those sectors shifts the supply curve: in sectors of labor and energy to  create that good  

 -a rise in price of input shifts the curve to the left  

 2. technology improves  

 -company can make more or the same amount at a lower cost   -technological advances increase the supply of a good  

 -not only is it more advanced, but it's cheaper and more new   3. the number of sellers increases 

 -this is due to the entry of more firms  

 -if more people decide to get involved in a particular market, the supply of that  good would increase and curve shifts RIGHT  

 -if firms decide to leave the market, supply decreases and curve shifts LEFT   4. changes in expectations  

 -if firms expect that the price (P) of a good will fall, they make more today but  not as much in the future  

 -expectations of future prices of a good will affect the supply and therefore shift  the supply curve  

 -if expectation of a future price rising, the curve shifts LEFT   -if expectation of a future price falls, the curve shift RIGHT  

When supply and demand curves are COMBINED, we have THREE outcomes   --equilibrium 

 -the quantity of goods that buyers are willing/able to buy EXACTLY balances the  quantity of goods that sellers are willing/able to sell  

 -on a graph, the point where demand and supply curves intersect   --surplus 

 -QS>QD  

 -"excess supply"  

 -they then respond by lowering prices  

ex) New Technology Reduces Cost of Producing Cars  

 

--cut the price and when it falls consumers will buy  

more of this product

 

 

 --shortage 

 -buyers are unable to get all they want of a particular good or service at the go ing price  

 -QS<QD  

 -"excess demand"  

Ex) The Market For Electric Cars  

 --tastes change and people want more: demand shifts RIGHT  

 --the price rises because there is a shortage, it can wade off some of the Quantity De manded and increase is Quantity Supplied  

NOTE:  

 --if both demand and supply shift right, you can't determine the outcome for both  quantity and price  

 --same goes to both demand and supply shifting left  

The Mathematics of Supply and Demand  

Demand Function: Qd=100-2P  

NOTE: the minus implies an INVERSE relationship  

Supply Function: Qs=3P  

NOTE: the positive coefficient indicated an upward slope  

How do we get quantities? Insert price into either demand or supply function

Qs=3(20)=60  

Qd=100-2(20)  

Equilibrium  

 --QD=QS  

Total Expenditure (TE)  

 --price is multiplied by quantity  

 --in this case: (20)(60)=1200  

Different Ways of Reading Supply and Demand

PUTTING IT ALL TOGETHER

Chapter 10: Measuring a Nation's Income  

 if we want to know someone's wellbeing, we ask for their income; same goes for the  country  

 --we could ass up national expenditures (national income); every seller earns in come  

GDP: "the final value (intended for the LAST user) of goods and services produced within a  country at a certain point in time"  

 --"value"=market value  

 --"goods and services"=tangibles (food, clothing, cars) and intangibles (haircuts, house cleaning, doctor visits)  

 --"produced": CURRENTLY produced; does not include transactions involving items  produced in the past  

 --"within": example is the 50 states plus foreigners  

 --it adds together many different kinds of products into a single measure of the value of  economic activity  

NOTE: goods not sold in market are NOT included in the GDP  

 ex) grandma babysitting her grandkids or illegal drugs  

GNP: "the value of final goods produced by domestic nationals regardless of where they live  and excludes the incomes that foreigners earn "  

 --the total income produced by a nation's residents (nationals)  

 ex) the income and production as a Canadian teacher in America counts as GDP for the  United States and GNP in Canada

Components of GDP on the Spending Scale  

 (C) consumption: all spending by households  

 --  

 (I) investment: business firms for plant and equipment  

 (G) government purchases: for consideration (for something in return; government gets  something back)  

 --DOES NOT include transfer payment  

 -a negative tax: payments the government makes to us and gets nothing  in return  

 (NX) net exports= exports-imports  

GDP(Y)=C+I+G+NX. <<<the four expenditure categories  

NOTE: key feature of C+I: it has to last more than 1 year to be considered investment  

Real GDP vs Nominal GDP  

 GDP= a measurement of the total spending on goods and services in all markets of the  economy  

Two Ways GDP Can Increase:  

 --Price increases (countries are not getting better off)  

 --the number of goods produced increases  

Nominal (NGDP): not adjusted for price or inflation  

Real (RGDP): adjusted for price or inflation; value using prices in some kind of base (past) year   --it answers the hypothetical question: what would be the value of goods and prices  produced this year if we valued these goods and services at the prices that prevailed in a spe cific year in the past  

 --shows how the economy's overall production of goods and services changes over time  

Components of GDP on the Spending Side  

 

GDP=total income=total spending  

 --in general, GDP(Y) falls during recessions (though there are exceptions)  Trends  

 --investment: volatility is more pronounced during recessions than in consumption   -often the first sign that there is trouble in the economy: inventories   --consumption: less volatile; smoother  

Nominal GDP (NGDP) is measured using CURRENT prices  

Real GDP (RGDP) is measured using CONSTANT prices

Definition for GDP deflator (index)  

 **GDP deflator=100 X NGDP/RGDP**  

 --this gives us the percent change from year to year, but is not the only way to  discuss inflation  

 --this equation includes C,I,G and EX but NOT IM  

 --always assuming it's 100 in the base year when applying the GDP calculator   --when we cross multiply...  

NGDP/P*100  

Another Approach to Measuring GDP: Value Added Approach

ex)  

$1.00+$0.50+$0.75+$1.25+$1.50=$5.00  

**the values that were created at each stage*

Another Approach: Factor Payments Approach  

Factor Payments: Y= wages+salaries+interest+rent+profit=household income   --measured  

 --the easiest way  

GDP and Wellbeing  

 RGDP is an ok measure  

 --quality of environment not counted  

 --does not measure the health of our children, but countries with higher GDP have ac cess to better healthcare  

 --does not measure value of non-market activity (like grandma babysitting kids)   --doesn't measure pleasure that goes along with these goods and services   --there is more to life than GDP  

 --study taken...  

 -people in richer countries didn't appear to be any happier than people in poor  countries  

 -no evidence for a link between countries' income and peoples' reported state  of happiness

 --approach to fix this:  

 -to enhance GDP with other objective factors such as inequality, leisure and life  expectancy  

 -in other places in the world, additional leisure time and lower levels of inequali ty led to increase living standards and accounted for longer life expectancy  

Recent Research: GDP, Life Satisfaction and Happiness  

Kahnemean and Deaton  

 --emotional well being: emotional quality of a person's everyday life experience   --life evaluation: reflecting life satisfaction  

 --surveyed 100 US residents and found that...  

 -emotional well-being is positively correlated to health and care-giving  and negatively related to loneliness and smoking  

 -life evaluation is positively correlated to income and education and in creases steadily with income  

 --emotional well being also rises w/income but STOPS at about $75,000  

Does money correlate to happiness? To some degree

 --despite problems, we still use GDP  

 -an increased GDP means citizens can afford better healthcare, better schools,  cleaner and a modern healthcare system  

 -poorer countries with a lower GDP have higher child mortality rates, shorter life  expectancy and lower literacy rate  

NOTE: an increased GDP, in return, can generate higher levels of happiness  Chapter 11  

The Consumer Price Index (CPI)  

--a measure of the overall costs of good  

--used to monitor changes in the cost of living over time  

--measures average URBAN consumer's cost of living by measuring the cost of typical URBAN  consumer's shopping basket  

 -BLS (Bureau of Labor Statistics) measures the average and what it costs across time and  we want to standardize it  

--the goods in the basket are fixed but prices are allowed to change  

what was that good was worth 40 years ago, 20 years ago, now?  

 --the average shopping basket in 1956 was VERY differently than in 2016  Change in CPI is CRUCIAL  

 --when it changes, it indicated that we have recalibrate social security payments  --when CPI increases, the payment to social security increase (same with other payment plans)   -COLA (cost of living allowance); automatically raises the wage when the CPI ris es

CPI Inflation, Deflation and Dis-Inflation  

 --CPI is used to calculate inflation  

 -"inflation": the general increase of ongoing prices (this is in general level of  prices not specific things such as prices in milk or gas)  

 -Inflation is a measure of OVERALL price (P) change  

 --a change in latte prices if scarcity, NOT inflation  

"Deflation"=negative inflation  

 --it means that prices are falling on average  

 --one year inflation rate is 6%, the next it's 4%  

"Dis-inflation"=inflation has fallen, but it's still rising and above the 0  

Measuring CPI  

the CPI is a weighted average  

 -not like arithmetic average

NOTE: all their factors end up adding to 1 (or in other terms, 100%)  

 -if price (P) levels fall, there is a deflation in housing prices  Core CPI (or in other words, CPI excluding food and energy)

--a better predictor of where CPI inflation will be  

 --if you wanna predict inflation, use Core CPI b/c the CPI itself is very volatile  

How to Calculate the CPI: 5 Steps, 3 of which we can do  

 1. Calculate the shopping basket itself 

 --done via survey (but not every year) because we want a FIXED BASE basket   --done for URBAN consumers  

 -not farmers in the Midwest  

 --determine which prices are most important to the typical consumer and weigh  them accordingly  

 ex) if someone buys burgers more than hotdogs, then burgers more im portant given greater weight  

 2. Find Prices  

 --this is done monthly  

 --collects data on prices of all the goods in the baskets  

 3. Compute the Cost of the Shopping Basket itself 

 --use data on prices to compare total cost  

 --note that only the prices in this calculation change  

 -but by keeping contents the same (like with hotdogs and burgers), we  isolate the effects of these price (P) changes  

 4. Choose Base Year and Compute Index

 5. Compute Annual Basket 

Compute CPI in each year using 2013 as base year..  

2013: 100*(60/60)=100  

2014?  

2014: 100*(69/60)=115  

*PRACTICE: calculate 2015 on your own*  

 Inflation Rate:  

 ((115-110)/100)*100=15%  

 ((130-115)/100)*100=13%  

Problems with CPI  

 1. substitution bias  

 --some good prices rise faster than others, so people will change what they buy  in order to compensate for that but still meet needs  

 --consumers substitute toward goods that have become relatively less expensive   --CPI doesn't pick this up and therefore overstates inflation    

 2. outlet bias

 --consumers tend to shop more at outlets or discounted stores when prices be gin to rise  

 --CPI does not take this into account, so prices are slightly higher in the CPI in dex  

 3. introduction of new goods  

 --an increase in the variety of goods allows consumers to find products that  more closely meet their needs  

 --the dollar becomes more valuable because there is more to choose from

 4. unmeasured quality change

 --improvements in the quality of goofs in the basket increase the value of each  dollar  

 --if the quality of a good deteriorates from one year to the next, then the value  of the dollar decreases  

 --CPI can't keep up with these quality changes  

NOTE: all of the problems mentioned above suggest that the CPI OVERSTATES the cost of liv ing  

 --Michael Boskin estimates that this overstatement is about 1% per year  

Why does it matter???  

 --CPI is used to adjust living conditions  

 --Social security, personal income deductions, etc are larger because CPI is overstated  

Two Aggregate Price Indexes: GDP vs CPI  

 1. CPI reflects consumer prices (the typical, average, everyday prices)   --reflects all goods and services bought by consumers  

 GDP deflator looks at ALL goods produced in the economy, but does not pick up  price on imports  

ex) Oil: much of the oil we use is imported from other countries, and we use oil for gasoline  and heating  

 --as a result, oil and oil products make up a larger amount of consumer spending than  of GDP so CPI is affected much more  

 

 2. CPI is a fixed basket  

 GDP deflator looks at THIS YEAR'S production

NOTE: **while CPI is fixed and GDP looks at current prices, both give us the same general  reading**  

ex) Imported Consumer Goods  

 --included in CPI  

 --excluded in GDP  

Correcting Variables for Inflation  

 --comparing dollar figures from different times  

 -inflation makes it harder to compare dollar amounts

MEMORIZE THE EQUATION BELOW FOR THE EXAM 

 

--we use this to compare prices from different times and to see if something was cheaper back  then in REAL TERMS  

TERMS TO STUDY:  

scarcity  

economics  

economists  

efficiency  

equality  

opportunity cost (OC)  

rational people  

marginal change  

incentive  

market economies  

invisible hand  

property rights  

productivity  

inflation  

NGDP  

RGDP  

CPI (inflation, dis-inflation, deflation)  

circular flow diagram: simplifies the workings of an economy into two types of decision makers firms and households; very useful in gaining basic understanding  

 factors of production:  

 --inputs in goods or services (labor, land, capital, etc)  

 market for goods and services:  

 --households are buyers, firms are sellers  

markets for the factors of production:  

 --households are sellers, firms are buyers

**production possibilities frontier (PPF)**: a graph that shows various combinations of  output (goods/services) that the economy could produce given its resources/factors of  production  

 --when an economy is EFFICIENT, that means that it making the most of  the scarce resources made available to it  

 -points ON the PPF frontier  

--when an economy is INEFFICIENT, that means that the economy is not meeting its full  potential with the scare resources it is given and producing less  

 -points INSIDE the PPF

Midterm 1: Thursday, October 6th, 2016 11:00-12:15  

Bring 4-function calculator!!  

The first exam covers Chapters: 1, 2, 4, 10 and 11  

Exam questions are drawn from:  

Lectures;  

Non-Aplia problem sets;

Aplia problem sets.  

In general, you will not be tested on material in the textbook unless it has been covered in one of these  three ways.  

Chapters 1 and 2  

The Key Method of Economics  

 --Systematic observation and measurement  

An interpretation of data: we measure rates, observed over time the government budget de fect, income inequality, how income has grown  

 --Formulation of a hypothesis  

We do this by using a model, can be simple or complex; going to college and pursuing a de gree can come out at income inequality  

 --Test the Hypothesis 

We do this with new data and assess it...then we either reject or fail to reject  If there is a rejection then we modify  

 --Modification or rejection of the hypothesis  

**exactly like the scientific method**  

NOTE: THE METHOD OF ECONOMICS IS THE SCIENTIFIC METHOD  

Economics is a Social Science  

What are some other alternative models/guesses for the recent rise in income inequality in the  US?  

 -globalization: jobs being outsourced overseas, only people at top benefiting from the  growth, closing shops in the United States (this would only benefit owners)   -deregulation: loosening of laws and therefore easier for the big guys to get more mon ey  

-cost of living vs. taxes: could try figuring out inflation, what are taxes, how does infla tion and taxation affect different groups of people  

-technology: sometimes known as "skill biased technological change"; those who are  not technologically skilled are not given those advantages  

--Microeconomics vs Macroeconomics

 -Micro: small; studies the individual household, business firm or market, impor tant crucial MICRO decisions on your life, individual markets (like housing market, stock market,  oil market)  

 -Macro: the BIG picture; studies the entire US economy; unemployment reces sions, expansions, rapid growth, inflation, monetary policy (tools government can use to con trol the money supply), fiscal policy (tax spending policies, etc...)  

 --Positive and Normative Economics *

 -positive: descriptive, describing income shares, growth, education impacts,  etc...; it makes a claim about how the world is  

 --ex. "minimum wage laws CAUSES unemployment" (speaking like a sci entist and making a claim)  

 -normative: prescriptive (aka doing something about it); it claims about how the  world SHOULD be; differences in views and so prescriptive statements are different   --ex. "the government SHOULD raise the minimum wage"  Economics uses models to understand complex reality  

 --simplifies the world so we can understand it; helps us ignore what's unimportant and  focus on what IS important  

 --all models are "wrong", but some models are useful: models are a HUGE simplifica tion, but some give us understanding  

TEN PRINCIPLES OF ECONOMICS (7 ARE MENTIONED IN LECTURE)  Principle 1: People face trade offs 

--this means that we can't always get everything we want/like, and will have to sacrifice  one over the other  

--we live in a world of limits and have to make choices due to scarcity  

 -ex: you start making choices as soon as you wake up in the morn ing; do i get up or sleep in

Principle 2: The cost of something is what you give up to get it (opportunity cost) --opportunity costs will vary from person to person because people value things  differently and costs are ultimately subjective  

 ex: going to college--> benefits include getting an education and  better opportunities, but costs are tuition and especially TIME  

--be aware of the opportunity costs that accompany each possible decision  total costs=explicit costs vs. implicit costs  

total costs=explicit costs vs. opportunity costs  

efficiency vs. equality  

 --efficiency means getting the MOST out of our resources   --equality means distributing our prosperity more equally to our  society  

**the two often come in conflict, one becomes the other's OC, and therefore  reduces incentives**

Principle 3: Rational people think at the margin"the edge"

--rational people understand that life is hardly ever this or that, black or white,  but rather a mixture or shades of gray; not one extreme or the other when mak ing a decision  

 -rational people make decisions by comparing marginal costs vs  marginal benefits (marginal change)  

if MB>MC, then a rational person would want more of that  

if MB<MC, then a rational person would do less  

if MB=MC, then a rational person is fine with the circumstances  

 --this is also known as the optimal stopping point (optimality  point)

--Principle 4: People respond to incentives 

-many policies change costs or benefits people face, therefore altering incentive  -benefits are like rewards; costs are like punishments  

 --therefore, people decide according to marginal benefits and  costs  

 --ex. when oil prices rise, quantity demanded of oil falls (law of  demand); people decide to drive hybrids, drive less, take public transportation,  etc...  

NOTE: not all people respond to every incentive all the time  

Principle 5: Trade can make everyone better off  

--rather than have one country beat the other in trade, it benefits both (or multi ple) sides/countries  

--it allows an individual or a country to specialize in what they are best at  (whether it be sewing, farming, etc)  

--by trading, people can buy a greater variety of goods and services at a lower  cost  

Principle 6: Markets are usually a good way to organize economic activity --many countries have developed market economies, rather than a central plan ner controlling everything  

--although decentralized and self-interest decisions, has proven to successful in  organizing government activity  

--"invisible hand" helps guide economy  

Principle 7: Governments can sometimes improve market outcomes --needs to enforce rules that are key to market economics in order for the "invis ible hand" to work  

--must encourage institutions to enforce property rights over the things we pro duce, by means of laws, police, courts  

ex. A restaurant won't serve meals unless they know that they will get  paid before customer leaves  

Principle 8: a country's standard of living depends on its ability to produce goods and  services  

--variation in living standards (like annual income and luxuries) are based on a  country's productivity

--the larger the quantity of goods and services produced, the higher the stan dard of living  

--the growth of a nation's productivity determines the growth rate of its average  income  

--productivity influences public policy  

Principle 9: prices rise when the government prints too much money 

--too much money printed = inflation

--the larger the quantity of money that is circulating, the larger the decrease in  value of the money  

Principle 10: society faces a short-run trade off between inflation and unemployment  --an increase in money printed leads to an increase in overall spending, aka an  increase in demands for goods and services  

--an increase in demands causes firms to raise prices, but also encourages firms  to hire more workers to meet those demands  

--hiring more workers = lower unemployment  

--keep in mind this is SHORT-RUN: that means changes in policies that affect un employment and inflation are within 1-2 year periods  

CHAPTER 4  

Market Forces of Demand and Supply: basic work tool of economists  

Markets and Competition  

 --markets: group of buyers and sellers of a good or service  

 -this can be in an actual marketplace, online, etc...  

 --assume that these markets are in perfect competition  

 -goods are exactly the same from market to market  

 -many buyers and sellers: businesses competing for $, and the buyer competing  with others to buy that good  

 --we cannot affect the market individually  

 --sellers are forced to sell at market price  

**we assume no government intervention**  

DEMAND

Quantity Demanded (QD)  

 --amount of goods buyers are willing/able to purchase at a particular price   --it is a particular point on the demand curve  

 

Law of Demand: when price (P) of a good rises, quantity demanded (QD) falls, other things  equal  

 --it is an inverse relationship b/w price and quantity demanded  

Individual Demand and Market Demand  

 --market demand is the horizontal sum of quantities demanded by all buyers

 --leads to the market demand curve  

Shifting Demand Curve  

 --shifts when some other variable changes: "other things" that affect the buyers' will ingness  

 if demand increases, the graph shifts RIGHT  

 if demand decreases, the graph shifts LEFT  

Factors That Increase Demand:  

 1. the number of buyers increases 

 -the larger the number of buyers, more demand and curve will shift right   2. income increases  

 -normal goods: income increase increases demand  

 -inferior goods, if income increases then demand falls  

 3. price of substitute goods 

 -ex) coke vs Pepsi: if coke prices increase, some people will buy more Pepsi   4. price of complements goes down  

 ex) tea and sugar: if the prices of tea goes down, people will buy more sugar  ***NOTE: Factors 3 and 4 make the market interrelated***  

 5. tastes change of the good 

 -if more people demand the good the curve shifts RIGHT   -if buyers start preferring an alternate good, then the demand of a current good  will fall and the demand curve will shift LEFT  

 6. changes in expectations (about the future) 

 ex) I like dark chocolate, but cocoa beans are scarce, so dark chocolate price will  increase: I buy more dark chocolate NOW  

 -if buyers expect prices to rise, the current demand will shoot up  

SUPPLY  

quantity supplied: the amount that sellers are willing and able to sell when price (P) is high   --selling the good is profitable so firms are willing to sell more  

Law of Supply  

 --positive relationship: when price (P) rises, quantity supplied (QS) of the good raises,  given that everything else is held at a constant  

 --when sellers can get higher prices for goods, producing and selling become more  profitable  

 ex) rise in the price of laptops but not desktops will encourage computer makers  to focus more on laptops, not computers  

 --this translates to an upward curve on a graph, in contrast to the demand curve   -each point on the curve shows the quantity that sellers would choose to sell at a  specific price  

 --a shift in the supply curve

 -when variables that we once held constant change (like to cost of transportation  of a good)  

Factors that Increase Supply  

 1. input prices fall  

 -there are many other factors and sources of labor that create a product, and a  change in price in any of those sectors shifts the supply curve: in sectors of labor and energy to  create that good  

 -a rise in price of input shifts the curve to the left  

 2. technology improves  

 -company can make more or the same amount at a lower cost   -technological advances increase the supply of a good  

 -not only is it more advanced, but it's cheaper and more new   3. the number of sellers increases 

 -this is due to the entry of more firms  

 -if more people decide to get involved in a particular market, the supply of that  good would increase and curve shifts RIGHT  

 -if firms decide to leave the market, supply decreases and curve shifts LEFT   4. changes in expectations  

 -if firms expect that the price (P) of a good will fall, they make more today but  not as much in the future  

 -expectations of future prices of a good will affect the supply and therefore shift  the supply curve  

 -if expectation of a future price rising, the curve shifts LEFT   -if expectation of a future price falls, the curve shift RIGHT  

When supply and demand curves are COMBINED, we have THREE outcomes   --equilibrium 

 -the quantity of goods that buyers are willing/able to buy EXACTLY balances the  quantity of goods that sellers are willing/able to sell  

 -on a graph, the point where demand and supply curves intersect   --surplus 

 -QS>QD  

 -"excess supply"  

 -they then respond by lowering prices  

ex) New Technology Reduces Cost of Producing Cars  

 

--cut the price and when it falls consumers will buy  

more of this product

 

 

 --shortage 

 -buyers are unable to get all they want of a particular good or service at the go ing price  

 -QS<QD  

 -"excess demand"  

Ex) The Market For Electric Cars  

 --tastes change and people want more: demand shifts RIGHT  

 --the price rises because there is a shortage, it can wade off some of the Quantity De manded and increase is Quantity Supplied  

NOTE:  

 --if both demand and supply shift right, you can't determine the outcome for both  quantity and price  

 --same goes to both demand and supply shifting left  

The Mathematics of Supply and Demand  

Demand Function: Qd=100-2P  

NOTE: the minus implies an INVERSE relationship  

Supply Function: Qs=3P  

NOTE: the positive coefficient indicated an upward slope  

How do we get quantities? Insert price into either demand or supply function

Qs=3(20)=60  

Qd=100-2(20)  

Equilibrium  

 --QD=QS  

Total Expenditure (TE)  

 --price is multiplied by quantity  

 --in this case: (20)(60)=1200  

Different Ways of Reading Supply and Demand

PUTTING IT ALL TOGETHER

Chapter 10: Measuring a Nation's Income  

 if we want to know someone's wellbeing, we ask for their income; same goes for the  country  

 --we could ass up national expenditures (national income); every seller earns in come  

GDP: "the final value (intended for the LAST user) of goods and services produced within a  country at a certain point in time"  

 --"value"=market value  

 --"goods and services"=tangibles (food, clothing, cars) and intangibles (haircuts, house cleaning, doctor visits)  

 --"produced": CURRENTLY produced; does not include transactions involving items  produced in the past  

 --"within": example is the 50 states plus foreigners  

 --it adds together many different kinds of products into a single measure of the value of  economic activity  

NOTE: goods not sold in market are NOT included in the GDP  

 ex) grandma babysitting her grandkids or illegal drugs  

GNP: "the value of final goods produced by domestic nationals regardless of where they live  and excludes the incomes that foreigners earn "  

 --the total income produced by a nation's residents (nationals)  

 ex) the income and production as a Canadian teacher in America counts as GDP for the  United States and GNP in Canada

Components of GDP on the Spending Scale  

 (C) consumption: all spending by households  

 --  

 (I) investment: business firms for plant and equipment  

 (G) government purchases: for consideration (for something in return; government gets  something back)  

 --DOES NOT include transfer payment  

 -a negative tax: payments the government makes to us and gets nothing  in return  

 (NX) net exports= exports-imports  

GDP(Y)=C+I+G+NX. <<<the four expenditure categories  

NOTE: key feature of C+I: it has to last more than 1 year to be considered investment  

Real GDP vs Nominal GDP  

 GDP= a measurement of the total spending on goods and services in all markets of the  economy  

Two Ways GDP Can Increase:  

 --Price increases (countries are not getting better off)  

 --the number of goods produced increases  

Nominal (NGDP): not adjusted for price or inflation  

Real (RGDP): adjusted for price or inflation; value using prices in some kind of base (past) year   --it answers the hypothetical question: what would be the value of goods and prices  produced this year if we valued these goods and services at the prices that prevailed in a spe cific year in the past  

 --shows how the economy's overall production of goods and services changes over time  

Components of GDP on the Spending Side  

 

GDP=total income=total spending  

 --in general, GDP(Y) falls during recessions (though there are exceptions)  Trends  

 --investment: volatility is more pronounced during recessions than in consumption   -often the first sign that there is trouble in the economy: inventories   --consumption: less volatile; smoother  

Nominal GDP (NGDP) is measured using CURRENT prices  

Real GDP (RGDP) is measured using CONSTANT prices

Definition for GDP deflator (index)  

 **GDP deflator=100 X NGDP/RGDP**  

 --this gives us the percent change from year to year, but is not the only way to  discuss inflation  

 --this equation includes C,I,G and EX but NOT IM  

 --always assuming it's 100 in the base year when applying the GDP calculator   --when we cross multiply...  

NGDP/P*100  

Another Approach to Measuring GDP: Value Added Approach

ex)  

$1.00+$0.50+$0.75+$1.25+$1.50=$5.00  

**the values that were created at each stage*

Another Approach: Factor Payments Approach  

Factor Payments: Y= wages+salaries+interest+rent+profit=household income   --measured  

 --the easiest way  

GDP and Wellbeing  

 RGDP is an ok measure  

 --quality of environment not counted  

 --does not measure the health of our children, but countries with higher GDP have ac cess to better healthcare  

 --does not measure value of non-market activity (like grandma babysitting kids)   --doesn't measure pleasure that goes along with these goods and services   --there is more to life than GDP  

 --study taken...  

 -people in richer countries didn't appear to be any happier than people in poor  countries  

 -no evidence for a link between countries' income and peoples' reported state  of happiness

 --approach to fix this:  

 -to enhance GDP with other objective factors such as inequality, leisure and life  expectancy  

 -in other places in the world, additional leisure time and lower levels of inequali ty led to increase living standards and accounted for longer life expectancy  

Recent Research: GDP, Life Satisfaction and Happiness  

Kahnemean and Deaton  

 --emotional well being: emotional quality of a person's everyday life experience   --life evaluation: reflecting life satisfaction  

 --surveyed 100 US residents and found that...  

 -emotional well-being is positively correlated to health and care-giving  and negatively related to loneliness and smoking  

 -life evaluation is positively correlated to income and education and in creases steadily with income  

 --emotional well being also rises w/income but STOPS at about $75,000  

Does money correlate to happiness? To some degree

 --despite problems, we still use GDP  

 -an increased GDP means citizens can afford better healthcare, better schools,  cleaner and a modern healthcare system  

 -poorer countries with a lower GDP have higher child mortality rates, shorter life  expectancy and lower literacy rate  

NOTE: an increased GDP, in return, can generate higher levels of happiness  Chapter 11  

The Consumer Price Index (CPI)  

--a measure of the overall costs of good  

--used to monitor changes in the cost of living over time  

--measures average URBAN consumer's cost of living by measuring the cost of typical URBAN  consumer's shopping basket  

 -BLS (Bureau of Labor Statistics) measures the average and what it costs across time and  we want to standardize it  

--the goods in the basket are fixed but prices are allowed to change  

what was that good was worth 40 years ago, 20 years ago, now?  

 --the average shopping basket in 1956 was VERY differently than in 2016  Change in CPI is CRUCIAL  

 --when it changes, it indicated that we have recalibrate social security payments  --when CPI increases, the payment to social security increase (same with other payment plans)   -COLA (cost of living allowance); automatically raises the wage when the CPI ris es

CPI Inflation, Deflation and Dis-Inflation  

 --CPI is used to calculate inflation  

 -"inflation": the general increase of ongoing prices (this is in general level of  prices not specific things such as prices in milk or gas)  

 -Inflation is a measure of OVERALL price (P) change  

 --a change in latte prices if scarcity, NOT inflation  

"Deflation"=negative inflation  

 --it means that prices are falling on average  

 --one year inflation rate is 6%, the next it's 4%  

"Dis-inflation"=inflation has fallen, but it's still rising and above the 0  

Measuring CPI  

the CPI is a weighted average  

 -not like arithmetic average

NOTE: all their factors end up adding to 1 (or in other terms, 100%)  

 -if price (P) levels fall, there is a deflation in housing prices  Core CPI (or in other words, CPI excluding food and energy)

--a better predictor of where CPI inflation will be  

 --if you wanna predict inflation, use Core CPI b/c the CPI itself is very volatile  

How to Calculate the CPI: 5 Steps, 3 of which we can do  

 1. Calculate the shopping basket itself 

 --done via survey (but not every year) because we want a FIXED BASE basket   --done for URBAN consumers  

 -not farmers in the Midwest  

 --determine which prices are most important to the typical consumer and weigh  them accordingly  

 ex) if someone buys burgers more than hotdogs, then burgers more im portant given greater weight  

 2. Find Prices  

 --this is done monthly  

 --collects data on prices of all the goods in the baskets  

 3. Compute the Cost of the Shopping Basket itself 

 --use data on prices to compare total cost  

 --note that only the prices in this calculation change  

 -but by keeping contents the same (like with hotdogs and burgers), we  isolate the effects of these price (P) changes  

 4. Choose Base Year and Compute Index

 5. Compute Annual Basket 

Compute CPI in each year using 2013 as base year..  

2013: 100*(60/60)=100  

2014?  

2014: 100*(69/60)=115  

*PRACTICE: calculate 2015 on your own*  

 Inflation Rate:  

 ((115-110)/100)*100=15%  

 ((130-115)/100)*100=13%  

Problems with CPI  

 1. substitution bias  

 --some good prices rise faster than others, so people will change what they buy  in order to compensate for that but still meet needs  

 --consumers substitute toward goods that have become relatively less expensive   --CPI doesn't pick this up and therefore overstates inflation    

 2. outlet bias

 --consumers tend to shop more at outlets or discounted stores when prices be gin to rise  

 --CPI does not take this into account, so prices are slightly higher in the CPI in dex  

 3. introduction of new goods  

 --an increase in the variety of goods allows consumers to find products that  more closely meet their needs  

 --the dollar becomes more valuable because there is more to choose from

 4. unmeasured quality change

 --improvements in the quality of goofs in the basket increase the value of each  dollar  

 --if the quality of a good deteriorates from one year to the next, then the value  of the dollar decreases  

 --CPI can't keep up with these quality changes  

NOTE: all of the problems mentioned above suggest that the CPI OVERSTATES the cost of liv ing  

 --Michael Boskin estimates that this overstatement is about 1% per year  

Why does it matter???  

 --CPI is used to adjust living conditions  

 --Social security, personal income deductions, etc are larger because CPI is overstated  

Two Aggregate Price Indexes: GDP vs CPI  

 1. CPI reflects consumer prices (the typical, average, everyday prices)   --reflects all goods and services bought by consumers  

 GDP deflator looks at ALL goods produced in the economy, but does not pick up  price on imports  

ex) Oil: much of the oil we use is imported from other countries, and we use oil for gasoline  and heating  

 --as a result, oil and oil products make up a larger amount of consumer spending than  of GDP so CPI is affected much more  

 

 2. CPI is a fixed basket  

 GDP deflator looks at THIS YEAR'S production

NOTE: **while CPI is fixed and GDP looks at current prices, both give us the same general  reading**  

ex) Imported Consumer Goods  

 --included in CPI  

 --excluded in GDP  

Correcting Variables for Inflation  

 --comparing dollar figures from different times  

 -inflation makes it harder to compare dollar amounts

MEMORIZE THE EQUATION BELOW FOR THE EXAM 

 

--we use this to compare prices from different times and to see if something was cheaper back  then in REAL TERMS  

TERMS TO STUDY:  

scarcity  

economics  

economists  

efficiency  

equality  

opportunity cost (OC)  

rational people  

marginal change  

incentive  

market economies  

invisible hand  

property rights  

productivity  

inflation  

NGDP  

RGDP  

CPI (inflation, dis-inflation, deflation)  

circular flow diagram: simplifies the workings of an economy into two types of decision makers firms and households; very useful in gaining basic understanding  

 factors of production:  

 --inputs in goods or services (labor, land, capital, etc)  

 market for goods and services:  

 --households are buyers, firms are sellers  

markets for the factors of production:  

 --households are sellers, firms are buyers

**production possibilities frontier (PPF)**: a graph that shows various combinations of  output (goods/services) that the economy could produce given its resources/factors of  production  

 --when an economy is EFFICIENT, that means that it making the most of  the scarce resources made available to it  

 -points ON the PPF frontier  

--when an economy is INEFFICIENT, that means that the economy is not meeting its full  potential with the scare resources it is given and producing less  

 -points INSIDE the PPF

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