Boudreaux Study Guide
Boudreaux Study Guide econ 103-004
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This 19 page Study Guide was uploaded by Wesley Hunt on Sunday October 11, 2015. The Study Guide belongs to econ 103-004 at George Mason University taught by Donald Boudreaux in Fall 2015. Since its upload, it has received 735 views. For similar materials see Microeconomic Principles in Economcs at George Mason University.
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Date Created: 10/11/15
ECON REVIEW FOR BOUDREAUX The Highlights of my Notes The Pencil AllegoryEvery professor gives this sooner or later Pencils are made out of many materials and they all have to come together to make a plain ordinary pencil Part of stock and value of resources pencils not high on the totem pole of values No one ever knows or can possibly know how to make a pencil One would have to o Find a cedar tree Make just the right shape Then find iron ore Mold that into shape Adz the bark of the tree into form Round the hole in the center perfectly Search for graphite in the mines of Mississippi Mix it with the exact right kind of clay Make bauxite into aluminum Find rubber for the eraserrubber trees directly in the rainforest in ideal spot Find transport to get everywhere Grind the paint and make it soikey drill and refine oil 0 Make the paint exactly the right color Just to make one simple pencil One simple pencil is the knowledge of billions of people in collaboration Someone knows how to do one of these things so one person does not have to and none of them know you and they re not getting money from it The same principles apply for everything else Everything we consume in modern society is a collaborative effort Somehow everything comes together just so to produce something at a decent price Before this they either made it upfront or knew someone who could Only humans care how things are organized and used Can t throw something in a pot and hope for the bestwill usually be useless You want specific people with a specific set of skills in the right places to make it work The world around you is supposed to change through hearing these stories To tell this story of economics one must start from somewhere Fundamental Building Blocks 1 We live in a world of inescapable scarcitynot necessarily something difficult to obtain just not enough to supply every desire for it at zero cost nearly everything is scarce 0 Not Scarce Breathable Air Gravity Barometric Pressure 2 Scarcity gt Choice gt Cost Arrange needs in order on a limited budget eg Supermarket on only 50 cash 0 Buy what you need at first and in proper order of needs What you give up is what you bought instead Cost of toilet paper is root beer CHOOSING MEANS GIVING UP SOMETHING ELSE o In order to obtain something of equal value must first be lost 0 You don t care about the money only what it can give 948 is worthless on a desert island 0 Bill Gates is rich because he knows how to use his money 3 More is preferred to Less when all else is equal 0 Order large pizza over small if priced the same 4 We assume individuals each human is rational and selfinterested RATIONAL DOES NOT MEAN That people are logical That people are flawless That people always choose wisely That people are intelligent RATIONALITY IS People act with an individual purpose in mind one simple goal eyes set on a prize 0 We learn from our mistakes we keep making them but we take them into account for next time 0 People have preferences that are transitive if apples gt bananas gt cantaloupe then apple gt cantaloupe If choices intransitive no choices are made can change but always transitive SELF INTEREST IS 0 Each of us cares most about those closest to us more so than strangers o How willing you are to incur on the behalf of others More willing to give brother a kidney than professor This is just the way humans are ethics beside the point in economics 5 People respond to incentives If grade guaranteed less study incentive Incentive to attend classlectures based on the exams Economists always ask what incentives are 6 Tastes and preferences are subjective Only each individual understands what he or she experiences in a certain action Only you know how much you like vanilla ice cream Some people less averse to smoking evaluates more the benefits In economics there is no right or wrong answer 7 Choices are made at the margin Margin Additional unitsnever dealt in absolutes WaterDiamonds Paradox higher stakes and circumstances affected the immediate choice Adam SmithThe Wealth of Nations Diamonds worth more than water despite being less useful than water People make decisions based on margin When people choose they don t choose all the water or diamonds just the one they see 8 All social phenomena are explained as a result of individual human actions Economics assumes the only entities in the social world with minds are human beings Society on the whole does not move on its own Churches made of individuals who choose to act similarly 9 People remain the samefundamentallywhen they change jobs Rationality and selfinterest do not change automatically Incentives change but not people 10 Intentions are not results Don t judge merits by any intentions Beware of scammers unintended consequences Gordon Tullochtestified congress in the 60s Tulloch was asked to reduce highway fatalities Tulloch proposed every car have a steel dagger that cannot be removed Make cars dangerous Safer Cars lead to more reckless driving Sword of Damocles allegory 198688 Sioux City IA plane crash home video revolution Only a few passengers died Had the child been strapped into the seat they would have survived Economists said it should not be law though Under age 2 incentive is kid flies free in the lap of an adult If the child takes a seat charge goes up and less incentive to fly What you have to think about is marginal cost o More kids would die in car crashes than in plane crashes Economic Theory Positive Analysis Pertaining to verifiable data Economic fact but not opinionated detailing Positive StatementObjective right or wrong regardless of opinion Positive Statements can be wrong Normative StatementsOpinionated statements not right or wrong regardless of if you agree Opinions are a part of human nature not worse than positivejust subjective Economics proper is about positive statementNot about what should be but what is Economics gives understanding of how the world operates in different levels of unemployment Ceteris Paribus All other things are the same Ceteris Paribus makes economic analysis easier by making one change and ignoring others eg If I drop the marker it will fall all else unchanged underline is implied assumes nothing blocks it Adam SmithFather of modern capitalism and economics An Inquiry into the Nature and Causes of the Wealth of Nations Smith investigated why average wealth went up for some nations Not about povertyBack then everyone was poor Economics is obviousness made consistent and complex Wealth is the ability of men and women to gain access to goods and services to make their lives generally improved to not be forced to anything to have the right to enhance their lives what we all take for granted today Not about luxuries The fact that everyone has access to ordinary needs Smith noted some countries had more wealth Why is England more wealthy than Germany Nature of Wealth is the mere access to basic needs Causes are The wealth of nations is caused by the division of labour Specialization Richer countries have more labour specialization Certain people just choose one job and practice being proficient in it Cause of Wealth of Nations is in more specialization diversity Pin Factory Allegory A pin factory that employs ordinary workers gives 1020 pins per 10 workers but in Smith s time we now had one person doing one thing and only one thing in making the pins Pin factory with specialization makes about 43000 pins daily Total output of society is increased through specialization more is available for everyone Why Why do workers make so much when they work in a specialized manner 1 When workers specialize they save time by not moving from task to task 2 When people specialize they become more skilled at a task 3 When workers specialize it is more likely that someone will make a machine to do the job instead 0 The worker moves on to make something else 0 Machines are important because people do not have to If each party specializes in producing the lower cost item and trades them it ends as a winwin 2 fish to make 1 bananas vs 1 fish to 1 banana Don Wesley 50 fish 200 fish 50 bananas 100 bananas Look beyond absolute advantage How much of one can be made at the expense of another When Smith meets RicardoSpecialization makes gains go higher for both parties Don Wesley 50 fish 300 fish 50 bananas 100 bananas Because more fish I gather fewer bananas and it becomes more costly for them While Don s numbers remain the same his specialty becomes bananasnow 13rd the total cost Introduce a Machine Intermediate Goods Not consumed used to make other goods Wesley decides to build a net Capital Goods used to obtain Consumption Goods The net has value only insofar as to be used to produce other goods The net increases Wesley s productivity even furtherbut how does he get it We ll just say net materials were in ready supplytakes a month to make not worth the effort Have to save on resources to live for a monththen eat down the savings Savings become higher future output Transform production into more efficiency later Always an element of risk to investingjust the way of the world If I don t want to invest just call another worthy investor Don gives Wesley a bananafish deal but also charges interest Third Option third person who builds a net We bargain a price for Lauren the net builder YOU CANNOT MAKE A CAPITAL GOOD UNLESS SOMEONE INVESTS Somebody must sacrifice consumption and sacrifice otherwise consumable resources to make a capital good Every capital good is expensivehence the term capitalism University leads to the production of human capital If nobody saved nothing could be built How many capital goods can we make Our world is governed by money One of the functions of money is as a medium of exchange We don t want dead presidents we want what they can give To specialize is to produce just one thing You are good at one thing and give it to people who make what you want In a world without money exchange only takes place in a coincidence of wants Money allows exchange even when there is no coincidence of wants Nobody cares where you got the money or what you can do money helps move things along Money allows more specialization Lasik eye surgeons make a good salary and they can use that money well For money to actually be useful it has to be sturdy can t get paid in Trident Layers Salt was the earliest currency salary comes from there Gold came nextbut easily stolen creates gold deposits and storage Too much time back and forth to the bank Show a bank note to transfer gold Banker already made notes for certain bank ammts Paper money originally backed by goldcurrency is spent currently Several transactions can be made without anyone withdrawing any gold at all You accept money because you know other people will accept it New banking agreement He can grant loans but at a set amounthe observes the best prospects You give money to the bank they loan it out to other businesses that pays interest the financial intermediary allows savings to become capital All finance is is a method of taking resources not being used and transferring them to where they are needed Exchange without money is barter Barter economymost exchange is money Money outmodes barter Other financial institutions are convenient for people to go for moneymakes barter unnecessary Circulate amongst people who trust the central bank If the economy is more productive then it can create greater productions of various goods If you want more bananas you have to sacrifice a portion of all other goods Never the case that you can have your cake and eat it too First Law of Equivalent Exchange TANSTAAFL There Ain t No Such Thing As A Free Lunch Nothing is for free in the grander scheme of society Someone has to pay for one person in some way Wesley could make more fish and bananas but had to give bananas to make fish Which combination of goods should we produce Not too much of one thingneed a mechanism to prevent that lntroducingPrice Theory Price Theory helps to gauge the amounts of resources How is it that decisions are made daily Not every product works but many of them do Heart of Economics You need a buyer and a seller Easier to understand in the online market place Ultimate goal of economic activity is consumption not production Production alone is not very productive Everyone is a consumer Utilitywhy we buy what we buy the satisfaction gained when something is consumed Consumers seek to maximize utility Law of Diminishing Marginal Utility The Law is defined asThe more access a consumer has to a good or service the less utility that person gets from any one unit of that particular good or service More water you drink the less you want More accurate examplePair of jeans are cool have a large closet and one pair magically appears in your size Happy to see it this is marginal utility Another one poofs in and somewhat happier 100 jeans happiness is the least happy as the first The more you have the less you want Giving them away is another diminishing margin cost gets higher and higher The last unit is so useless you wouldn t pay a lot Last unit of diamonds still worth more than last drop of water Law of Demand Key to Reading Demand Graphs Price is on yaxis Xaxis is quantity over time Always a slanted line sloping down Shows relationship between price of apples and quantity demanded of apples Furthest right is highest quantity Price is lower with more supply price of 30k you would only buy 1 price of 30 means you buy 3 Quantity demanded goes up price goes down Quantity demanded goes down price goes up Merchant lowers price to have maximum profits If price goes up quantity will go down and vice versa Any movement along a demand curve caused by a price change causes a change in quantity demanded Price axis shows maximum charge in order to get maximum profits Downward slope shows law of diminishing marginal returns Merchants must sell low to sell more When the price of a good changes quantity of a good demanded changes Price is not the only thing justifying price If income lowers you may buy items at lower value Demand curve assumes ceteris paribus When one thing changes the demand curve itself moves Curve movement is a change is demand When curve stays put and price changes a change i Change in Demand and Change in Quantity Demanded Will be on the Test Curve moves is change in demand Change along a curve is change in quantity demanded only caused by change in price There are six determinants of demand Pmice Demand ane Quantity Demanded Left shift allcng Demand Cum dictates change in i uanti demanded 39lll39he cnllyt thing that can change demand is a change in mice Six Determinants of Demand 1 Consumer Taste and Preferences Information Some things you are expected to outgrow Taste in ideas and products can change More or less willing to buy things when tastes change If you realize apples are healthy you go after them and vice versa A Change in the price of substitute Goods Two goods are considered substitutes if the prices for one item changes then demand for another changes in the same direction If pears and apples are substitutes price of pears will decline and demand in apples will decHne LEFTWARD shift is a decline in demand A rise in the price of a substitute causes a shift to the right a fall in the demand causes a shift to the left Substitutes are also subjectivemost realworld goods can be determined as substitutes Prices of Complementary Goods Goods that are compatiblecoffee and creamer world s full of them Two goods are complementary if as one price rises the demand falls Price of coffee goes through the roof so there s less creamer demanded Consumer Income The dosh in your bank has some impact on what you buy Normal vs Inferior Goods nothing to do with quality If as consumer income changes demand changes in that directionNormal Goods lnferior GoodsThe more money you have the less you want Income determines demand and direction depends upon your preference for the good Goods can be so cheap they are neither normal nor inferior Consumer Expectation of Future Availability of the Goods lf consumers come to expect the good will become more scarce in the future demand rises in anticipation lf consumers believe goods become easier to obtain in the future demand falls If a hurricane hits tomorrow gas demand goes up today Market Demand measures two or more purchasing individuals Demand of apples for a group or at a specific location Greater number of consumers the higher a good s demand Fewer consumers lower demand For any given demand curve the only thing that can cause the quantity demanded for a good to change are a change of the price of this good Will be on the TestDifferences in change of quantity demanded and change in demand Ellasticii Bra in More Elastic Graph Elasticity detemmiines a harder mice change ElasticityBy how much does a price change Elasticity answers that question As long as there is a downward slope it is a valid demand curve Easiest way to understand demandcompare relative elasticity amongst two curves The greater the increase in quantity demanded the more elastic the demand becomes E on oP Elasticity Formula Price range listed either elastic or inelastic Absnumber does not matter Elasticity Quotient is either greater or less than 1 E1 Elastic E1 Inelastic Elasticity measures how strongly the price change affects quantity Elasticity DOES NOT mean slope Total RevenueNothing other than the amount of revenue a firm takes in when they sell something Profit TR Cost Net gains You sell tomatoes at a market and you sell 10 lbs at 3lb How much did they spend 30 Determinants of Elasticity 1 Number of available substitutes o The greater the number of available substitutes the more elastic the demand and vice versa 0 Coke has ample substitutes which means if Coke hikes prices other goods can be bought o If you are a consumer you want the demand to be as elastic as possibleyou want more substitutes for greater choices 2 Time Consumers have to adjust to price change 0 Law of demand says something different o If gas prices rise overnight they would not cut back right away 0 Quantity demanded will fall longer over a year than it did when gas prices initially tripled o If hiking in Death Valley without water the seller can hike the price of water and not have to worry 3 Percentage of Budget spent on Good 0 Greater the budget the more elastic the good becomes 0 The more you spend the more elastic your demand stays 0 Favorite gum bought each week for 1 When price of gum hiked to 2 the idea to buy is not deterred Smallbudget items near inconsequential Supply Graph Pmme GFFERED Supply Quantity Supplied We want to explain what happens in markets to make prices You need buyers and sellers to make pricelook to the demand size Change in quantity demanded moves along the demand curve Several things affect willingness to purchase anything If demand increases rightward shift Supply is the other side of the market Supply comes from anywhere when anyone can sell something If you offer 5k you may not get a house it all depends on how much the supplier wants Most people supply labour services Supply can change Not a physical concept but the willingness of the owner to transfer ownership to someone else Whether or not my house is part of the supply of housing depends on price given Wouldn t sell an original Rembrandt for 10 Though Rembrandt is dead supply is not physical Higher price means greater quantity supplied Supply curve can shiftrightward increase leftward decrease Supply curve changes is a change in supplydifferent from quantity demanded Supply has its own determinants Changes in cost of production can change the supply of a good If cost in production rises supply fallsand vice versaan inverse relationship Higher production cost means that something will be less likely to sell sole determinant of supply If you sell crafts at a set price if your time making things goes upYou need a higher markup price What causes cost of production to change Why does GM cost of making cars go up or down 1 Change in price of input 0 Input is the seed of an apple tree something used to supply something else 0 Farmers are an input 0 Prices of inputs are a large production cost of the suppliers 0 Any time a price of an input rises supply begins to fallraises production costs 2 Change in production technologies 0 If the producer learns of another way to produce the producer can use the same resources to make 10 apples at 5lb 0 Supply increases when number of inputs falls 0 Once you learn of a method that works people tend to stick with it 0 As technology improves more materials are produced 0 Change the way workers are organized in pin factories change the way workers work is a change in technology 0 What the supply curve shows is minimum price at which a seller can sell a product 3 Cost of complying with Government or Social Regulations 0 TAXES 0 Not bad per se but still a cost 0 Cost of regulations goes up supply falls as a result 0 Producers not only have to cover other costs but government costs as well A change in any of these changes production cost and by extension supply One more determinant of Supply But if there is a high elasticity number of sellers in the market changes Number of sellers is the second determinant this ups the supply A change in any of those things will change the supply inward More supply means a shift outward Amt ensuimers Get Equilibrium is where the price is set Supply meets Demand 39lfee muslin situpplyr maltes a Surplus mere tll1ain seller I DD little isa erlageless z39 consumersI gain I I u li The number of apples asked for is greater than the quantity that can be given If the selling price goes up a bit demand is unaffected Whenever price is below equilibrium demand is greater than supply meaning a shortage Equilibrium is where supply and demand intersect As prices rise demand falls and supply risesyou have to hit a balance If price is ABOVE equilibrium supply is greater than demand meaning a surplus Cut in price is common solution for a surplus It s all trial and error to determine an equilibrium price Price compromises desires of buyers and sellers Equilibrium is best coordination of the two Price theory does not change demand or supply at all Supply and Demand not an idea of greed No reason to assume disasters lead to greed Greed is around and does not change it does not explain why prices go up right after hurricanes Supply goes down and demand goes up Supply goes down as inventories and supply lines are destroyed Demand is raised due to property loss Equilibrium itself is changed Price Gougingrising prices higher in the wake of disaster Economic perspective says prices are not arbitrary or determined by sellers Supply and demand together generate a fair price Market price is underlying reality of underlying scarcity in flux Don t shoot the messenger destroying the consequences does not change the outcome Price is merely a messenger a gauge of an inconvenient reality As a consumer you use the product more frugally than previously used Prices go for the higher priority not use resources wastefully People make money by price gouging right before the hurricanetaking advantage of people in need This theory illustrates what determines pricessupply and demand and their constant flux are the ultimate determinant not greed If one or the other or both change prices change If supply goes up prices start to fall Demand is shifted by price In all cases the price falls from equilibrium and the amount consumers get will be at its peak
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