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ECON1: Lecture 2 (9/2716)

by: Viola You

ECON1: Lecture 2 (9/2716) ECON 1

Viola You

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Continuing chapter 1, starting chapter 2.
Principles of Economics
R. Rojas
Class Notes
Economics, Microeconomics
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This 11 page Class Notes was uploaded by Viola You on Wednesday September 28, 2016. The Class Notes belongs to ECON 1 at University of California - Los Angeles taught by R. Rojas in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Economics in Economics at University of California - Los Angeles.


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Date Created: 09/28/16
BIG IDEA #7 ­ Institutions matter (cont.) CENTRAL IDEA: Public policy may promote efficiency. CENTRAL IDEA: Government may alter market outcome to promote equity. If the market’s distribution of economic well­being is not desirable, tax or welfare policies can  change how the economic “pie” is divided BIG IDEA #8 ­ Economic booms and bursts cannot be avoided but can be moderated CENTRAL IDEA: Policymakers use Fiscal Policy and Monetary Policy to attempt to smooth out  this economic volatility. Question: Can we make the economy smoother? Define fiscal policy ­ the use of government revenue collection (taxation) and expenditure  (spending) to influence the economy. Define monetary policy ­ the process by which the government controls the supply of money,  often targeting a rate of interest for the purpose of promoting economic growth and stability. Define Market failure ­ when the market fails to allocate society’s resources efficiently ● One way to account the outcomes of our actions ● Education (externality) ● Causes of market failure: ○ Externalities ­ when the production or consumption of good affects bystanders (pollution) ○ Market power ­ a single buyer or seller has substantial influence  on market price (monopoly) ● Public policy may promote efficiency ● Government may alter market outcome to promote equity BIG IDEA #9 ­ Prices rise when the government prints too much money Define inflation ­ increase in the general level of prices ● In the long run, inflation is almost always caused by the excessive growth in the  quantity of money, which causes the value of money to fall ○ Correlates with unemployment ● The faster the government creates money, the greater the inflation rate But shortage of money isn’t good either ● The short term effect: increase in prices  CENTRAL IDEA ­ society faces a short­run trade­off between inflation and unemployment ●  In the short run (1­2 years), many economic policies push inflation and  unemployment in opposite directions ● Other factors can make this trade­off more or less favorable, but the trade­off is  always present BIG IDEA #10 ­ Central banking is a hard job The Federal Reserve is the U.S.’s central bank ● “The Fed” is in charge of money supply ○ Helping the economy be stable ○ Balancing inflation and unemployment ○ Preventing banking crises? CHAPTER 2 Look for the answers to these questions: ● What are economists’ two roles? How do they differ? ● What are models? How do economists use them? ● What are the elements of the Circular­Flow Diagram? What concepts does the  diagram illustrate? ● How is the Production Possibilities Frontier related to opportunity cost? What  other concepts does it illustrate? ● What is the difference between microeconomics and macroeconomics? Between positive and normative. The economist as a scientist Economists play two roles: 1. Scientists: try to explain the world a. Scientific hypothesis 2. Policy advisors: try to improve it a. Ex: interest rates, moderating government spending, setting  minimum wage In the first, economists employ the scientific method, the dispassionate development and testing of theories about how the world works Assumptions & Models Assumptions simplify the complex world, make it easier to understand Ex: To study international trade, assume two countries and two goods ● Unrealistic, but simple to learn and gives useful insights about the real world Define model ­ a highly simplified representation of a more complicated reality ● Economists use models to study economic issues The Circular­Flow Diagram Define The Circular­Flow Diagram ­ a visual model of the economy, shows how dollars flow  through markets among households and firms Two types of “actors” 1. Households 2. Firms Two markets 1. The market for goods and services 2. The market for “factors of production” Define factors of production ­ the resources the economy uses to produce goods and services ● Such as labor, land, and capital (buildings, machines used in production) Households: ● Own the factors of production, sell/rent them to firms for income ● Buy and consume goods and services Firms: ● Buy/hire factors of production, use them to produce goods and services ● Sell goods and services The Production Possibilities Frontier Define the production possibilities Frontier (PPF) ­ a graph that shows the combinations of two  goods the economy can possibly produce given the available resources and the available  technology Example: U.S. and Japan ● Two goods: computers and wheat ● One resource: labor (measured in hours) ● We will look at how much of both goods each country produces and consumes ○ If the country chooses to be self­sufficient ○ If it trades with the other country Example: U.S. ● 50,000 hours of labor available for production, per month ● Producing one computer requires 100 hours of labor ○ Seems more expensive in terms of hours ● Producing one ton of wheat requires 10 hours of labor ● The economist as a  scientist The U.S. would like to consume both goods, but it can only consume what it can produce.  Staying along the line is what we want, we are restricted. But, both U.S. and Japan would  benefit from consumption above the line.  Example: Japan ● Japan has 30,000 hours of labor available for production, per month ● Producing one computer requires 125 of labor ○ Not problematic factor, it’s to scale ● Producing one ton of wheat requires 25 hours of labor ● Looks like it’s more expensive than U.S. for both ● Looks like should not trade because it seems more expensive for Japan ­ but we  need to capitalize on this U.S. seems to enjoy the goods, or consume more. Example: Consumption with and without trade: ● Without trade ○ US consumers get 250 computers and 2500 tons of wheat ○ Japanese consumers get 120 computers and 600 tons of wheat ● US has great advantage ● We will compare consumption without trade to consumption with trade ● First, we need to see how much of each good is produced and traded by the two  countries Example: Consumption Under Trade Suppose US exports 700 tons of wheat to Japan, and imports 110 computers from Japan. (So,  Japan imports 700 tons wheat and exports 110 computers) ● –How much of each good is consumed in the U.S.? Plot this combination on the U.S. PPF. ● –How much of each good is consumed in Japan? Plot this combination on Japan’s PPF. TRADE MAKES BOTH COUNTRIES BETTER OFF Where do these gains come from? Minimizing opportunity costs. Define absolute advantage ­ the ability to produce a good using fewer inputs than another  producer The US has an absolute advantage in wheat: producing a ton of wheat uses 10 labor hours in  the US vs 25 in Japan  ● If each country has an absolute advantage in one good and specializes in that  good, then both countries can gain from trade ● For US, to produce computers, we have to give up wheat (hours to produce  wheat goes to computers instead) Which country has an absolute advantage in computers? ● Producing one computer requires 125 labor hours in Japan, but only 100 in the  US ● The US has an absolute advantage in both goods Why does Japan specialize in computers? Why do both countries gain from trade? Two measures of the cost of a good Two countries can gain from trade when each specializes in the good it produces at lowest cost Absolute advantage measures the cost of a good in terms of the inputs required to produce it Recall ­ another measure of cost is opportunity cost Opportunity cost and comparative advantage Define comparative advantage ­ the ability to produce a good at a lower opportunity cost than  another producer ● Who/where is it cheaper to produce? The opportunity cost of a computer is: ● 10 tons of wheat, 100 hours for 1 computer in US ● 5 tons of wheat, 125 hours for 1 computer in Japan Japan has a comparative advantage in computers LESSON: Absolute advantage is not necessary for comparative advantage ● Specialization is one way to capitalize.


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