Introduction to Economics
Introduction to Economics ECON 101
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This 40 page Class Notes was uploaded by Erna Gislason on Sunday October 25, 2015. The Class Notes belongs to ECON 101 at University of North Carolina - Chapel Hill taught by Tat Sekhposyan in Fall. Since its upload, it has received 10 views. For similar materials see /class/228689/econ-101-university-of-north-carolina-chapel-hill in Economcs at University of North Carolina - Chapel Hill.
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Date Created: 10/25/15
Aggregate Demand and Aggregate Supply The model of Aggregate Demand and Aggregate Supply will help us review the long run analysis and address the short run fluctuations Key facts about the business cycles 9 economic fluctuations or business cycles are irregular and unpredictable 0 most macroeconomic quantities fluctuate together 9 as output falls unemployment rises Most economists believe that classical theory describes the world in the long run but not in the short run I W wimss H June12 2007 1 5 Business Cycle Properties Billions of Billions of 2000 Dollars 2000 Dollars 10000 9000 1500 8000 7900 Real GDP 1000 6000 Investment 5000 Spending 4000 500 3000 2000 IiiiiiiiiHiiiiiiiliiiiHulHHl 0 iiiiiiiiiiiimiiiiiiiHiliiiiiiiiiiiiiil 195 1970 1975 19K 19 1993 19 201 2005 1956 1970 1975 1983 1985 1993 1995 2003 2005 a Real GDP b Investment Percent of Labor Force 12 Unemployment Rate ziiiiiiimilmiiu i Klllllllllllllllllll 1965 1970 1975 19m 1985 1993 1995 2000 2005 c U nemployment Rate Tatevik Sekhposyan UNC Chapel Hill Introduction to Economics Lecture 15 June 122007 Aggregate Demand AD AD a curve that shows the quantity of goods and services that households firms the government and customers abroad want to buy at each price level YCGNX Why does AD curve slope downwards a wealth effect A lower price level increases real wealth which encourages spending on consumption 0 interest rate effect A lower price level reduces the interest rate which encourages spending on investment 0 exchange rate effect A lower price level causes the exchange rate to depreciate which encourages spending on net exports What shifts the AD curve I 451 H June122007 3 5 Aggregate Supply AS A5 a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level In the long run the AS curve is vertical In the short run the AS curve is upward sloping Why is long run AS curve vertical In the long run an economy39s production of goods and services its real GDP depends on its suppliers of labor capital natural resources and on the available technology used to turn these factors 0 production into goods and services We call this the natural rate of output What shifts the long run AS curve in mm H June 12 2007 A 5 Aggregate Supply AS Why is the short run AS curve upward sloping o sticky wage theory An unexpectedly low price level raises the real wage which causes firms to hire fewer workers and produce a smaller quantity of goods and services sticky price theory An unexpectedly low price level leaves some firms with higher than desired prices which depresses their sales and leads them to cut back production misperceptions theory An unexpectedly low price level leads some suppliers to think their relative prices have fallen which induces a fall in production 0 0 Quantity of output supplied Natural rate of output aActual price level Expected price level June122007 55 Markets and Competition The terms supply and demand refer to the behavior of people as they interact with one another in markets 0 Buyers determine demand 0 Sellers determine supply A market is a group of buyers and sellers of a particular good or service A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price I H May 16 2007 15 Perfect Competition More complete definition will appear later in the course What s relevant for now is the following 9 Products are the same 0 Numerous buyers and sellers so that each has no influence over price 0 Buyers and sellers are price takers May 16 2007 2 5 Demand A quantity demanded amount of a good that buyers are willing and able to purchase A law of demand other things being equal the quantity demanded for a good falls when the price of the good rises demand schedule demand curve o price change represents movement along the demand curve 0 income prices of related goods tastes expectations number of buyers shift the demand curve I H May 16 2007 3 5 Supply A quantity supplied amount of a good that sellers are willing and able to sell A law of demand other things being equal the quantity supplied of a good rises when the price of the good rises supply schedule supply curve 0 price change represents movement along the supply curve 0 input prices technology expectations number of sellers shift the supply curve I H May 16 2007 A 5 Equilibrium A equilibrium a situation in which the market price has reached the level at which quantity supplied equals quantity demanded equilibrium price equilibrium quantity A surplus a situation in which quantity supplied is greater than quantity demanded A shortage a situation in which quantity demanded is greater than quantity supplied excess demand excess supply Price of any good adjusts to bring the market to equilibrium l H May 16 2007 5 5 Outline 1 Math Review a How to read a graph ofa line b How to graph a linear equation c Slope of a curve 2 Production possibilities frontier PPF shows combination of output that the economy can possibly produce given the available factors of production and available production technology PPF highlights the ideas of scarcity efficiency tradeoffs opportunity cost and economic growth Refer to the graphs in the lecture for the details 539quot Gains from Trade absolute advantage the ability to produce a good using fewer inputs than another producer comparative advantage the ability to produce a good at a lower opportunity cost than another producer A producer can still benefit from trade if heshe has no absolute advantage in any of the products produced Comparative advantage is what matters I ll May 16 2007 11 Externalities Outline externaity the uncompensated impact of one person s actions on the well being of a bystander 0 negative leads markets to produce a larger quantity than is socially desirable 0 positive leads markets to produce a smaller quantity than is socially desirable Private Solutions to Externalities a moral codes and social sanctions b charities d selfinterest of relevant parties Coase Theorem private economic agents can solve the problem of externalities among themselves Whatever the initial distribution of rights the interested parties can always reach a bargain in which everyone is better off and the outcome is efficient Public Policy Solutions to Externalities 0 Regulation law patent franchise 0 Market based policies gt corrective taxes and subsidies gt tradable pollution permits I 39ll May 29 2007 12 Public Goods Outline eXcudabiity the property of a good whereby a person can be prevented from using it rivalry in consumption the property of a good whereby one person s use diminishes other people s use private goods public goods common resources natural monopolies 0 public goods free rider a person who receives the benefit of a good but avoids paying for it 0 common resources tragedy of the commons common resources get used more than is desirable form the standpoint of society as a whole In case of common resources and public goods the markets fails to allocate resources efficiently because property rights are not well established In this case the government can potentially improve the market outcome I H May 29 2007 2 2 Outline Elasticity a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants 1 Elasticity of demand a Price elasticity of demand at How to calculate it midpoint elasticity Elasticity along a deman curve at Variety of demand curves Determinants of price elasticity at Total Revenue TR and price elasticity b Other demand elasticities Income elasticity at Crossprice elasticity 2 Elasticity of supply gt Price elasticity of supply at How to calculate it midpoint elasticity Variety of supply curves at Determinants of price elasticity I May 182 2007 1 l Some Normative Issues Outline 1 Price Controls gt price ceiing a legal maximum on the price at which a good can be sold binding vs nonbinding examples gt price floor a legal minimum on the price at which a good can be sold binding vs nonbinding examples gt The effect of price controls on market outcomes gt Evaluating price controls 2 Taxes tax incidence the manner in which the burden of a tax is shared among participants in a market Taxes on buyers and taxes on sellers are equivalent gt elasticity and tax incidence gt elasticity and the effect of taxes on market activity I May 22 2007 11 Monopolistic Competition Outline A market structure is called monopolistic competition if there are 9 many sellers of the good product differentiation each firm produces a product that is at least slightly different from those of other firms 0 free entry Consider a monopolistically competitive firm in the 9 short run 0 long run Monopolistically competitive firm and the welfare of the society Effects of advertisement on monopolistically competitive firms H June 5 2007 12 Oligopoly Outline Oligopoly is a market structure in which only a few sellers offer similar of identical products Collusion an agreement among firms in a market about quantities to produce or prices to charge cartel a group of firms acting in unison Analyze oligopoly based on game theory the study of how people behave in strategic situations Nash equilibrium a situation in which economic participants interacting with one another each choose their best strategy given the strategies that all the others have chosen Oligopoly and the welfare of the society I m mm H June 5 2007 2 2 Market and Welfare welfare economics the study of how the allocation of resources affects economic wellbeing a consumer surplus the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it b producer surplus the amount a seller is paid for a good minus the seller s cost of providing it c rotasurplus consumer surplus producer surplus Free markets a allocate the supply of goods to the buyers who value them most highly as measured by their willingness to pay b allocate the demand for goods to the sellers who can produce them at least cost c produce the quantity of goods that maximizes the total surplus Applications a cost of taxation gt deadweight loss the fall in total surplus that results from a market distortion b international trade 1 H May 23 2007 11 Monopoly A firm is considered a monopoly if 0 it is the sole seller of its product 0 its product does not have close substitutes 0 there are barriers to entry As a result the monopoly is not a price taker but a price maker examples monopolies of resources government created monopolies natural monopolies May31 2007 13 Profit Maximization Note the cost structure is the same but the revenue side is different Suppose a firm is faced with the following demand schedule Q PTR AR MR DONOU39Ibwwb O wbmo Profit is still maximized at MRMC competitive firm P MR MC monopoly firm gtMR MC May31 2007 23 Outline of the Rest o No market supply curve for the monopoly o Deadweight loss associated with a monopoly firm a Public policy towards monopolies gt antitrust laws gt regulation gt public ownership gt do nothing A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources No real economy meets the exact conditions of the theorem and all real economies will fall short of the ideal economy a difference called quotmarket failure In my view however the degree of quotmarket failure for the American economy is much smaller than the quotpolitical failure arising from the imperfections of economic policies found in real political systems George Stigler l H May 31 2007 3 3 The Monetary System What is money money the set of assets in an economy that people regularly use to buy goods and services from other peop e Money has the following functions a medium of exchange an item that buyers give to sellers when they want to purchase goods and services a unit of account the yardstick people use to post prices and record debts 0 store of value an item that people can use to transfer purchasing power from the present to the future commodity money money that takes the form of a commodity with intrinsic value fiat money money without intrinsic value that is used as money because of government decree I ma June11 2007 18 The Federal Reserve System central bank an institution designed to oversee the banking system and regulate the quantity of money in the economy Organization of the Fed 1 a Federal Reserve Board a Federal Reserve Banks 12 regulate banks and ensure the health of the banking system gt monitor each banks financial conditions gt facilitate bank transactions by check clearing gt lender of last resort 0 FOMC Federal Open Market Committee conducts monetary policy monetary poicy the setting of the money supply by policymakers in the central bank 39 fmoney available in the economy 1httpVININIstloulsfed orgabout V 451 H June11 2007 2 s Banks and the Money Supply reserve deposits that banks have received but have not loaned out Money supply in two cases 0 100 reserve banking o fractional reserve banking reserve ratio the fraction of deposits that banks hold as reserves When banks hold only a fraction of deposits in reserve banks create money However they do not create wealth but provide liquidity money mutipier the amount of money the banking system generates with each dollar of reserves Money multiplier is the reciprocal of the reserve ratio I in mm H June112007 3 8 Monetary Policy The Fed has 3 tools to implement a monetary policy a open market operations the purchase and sale of US government bonds by the Fed o reserve requirements regulations on the minimum amount of reserves that banks must hold against deposits 0 discount rate the interest rate on the loans that the Fed makes to banks Outline of other issues 9 problems in controlling the money supply a importance of the soundnessdevelopment of the financial sector a federal funds rate the short term interest rate that banks charge one another for loans I m mm H June11 2007 A 8 Money Growth and Inflation As Milton Friedman once put it quotInflation is always and everywhere a monetary phenomenonquot quantity theory of money a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate Outline 9 determinants of money supply a determinants of money demand In the long run the overall level of prices adjusts to the level at which the demand for money equals the supply I W V w H June11 2007 5 s Money Neutrality in the Long Run Classical Dichotomy o nominal variables a real variables money neutrality the proposition that changes in the money supply do not affect real variables aAustn39a hHungary Pnce level Muneysupply Money Supply 1000 1000 100 100 1921 1922 1923 1924 1925 1921 1922 1923 1924 1925 c Germany 1 Poland Ind Index Jan 1921 100 Jan 1921 100 100 000 000 000 000 7 10 000 000 1 000 000 000 000 7 1 00000 000 7 l 000 000 00 000 000 7 100 000 may 1 000 000 7 10000 5 pr 10000 7 100 7 1000 1 l l l l l l l l 1921 1922 1923 1924 1925 1921 1922 1923 1924 1925 Tatevik Sekhposyan 39 UNCChapel Hill 39 39 i Jun 114 2007 68 Money Neutrality in the Long Run cont Nominal interest rate In a on 0 l l l l l l l l l 1960 1965 1970 1975 1980 1985 1990 1995 2000 Tatevik Sekhposyan 39 NCChapel Hillj lntroductian to Economics Lecture 14 Costs of Inflation inflation tax the revenue the government raises by creating money The inflation tax is like a tax on everyone who holds money Other costs of inflation o A falling in purchasing power The inflation fallacy o Shoeleather costs a Menu costs a Relative price variability and misallocation of resources Inflation induced tax distortions o Confusion and inconvenience o A special cost of unexpected inflation arbitrary redistribution of wealth I H June11 2007 8 8 Measuring the Cost of Leaving How do we compare incomes across time and various countries inflation increase in the overall price level of the economy deflation decrease in the overall price level of the economy inflation rate percentage change in the price level from previous penod Percent per Year 15 U1 GDP deflator Tatevik Sekhposyan UNC Chapel Hill introduction llzo39EGQ mail 17quotquot June 7 2007 l ll Consumer Price Index CPI consumer price index a measure of overall costs of goods and services bought by a typical consumer What does the Bureau of Labor Statistics BLS do Fix the basket Find the prices Compute the basket39s cost Compute the CPI Compute the inflation rate wewzve producer price index PPI a measure of the cost of a basket of goods and services bought by firms I m June 7 2007 2 11 What39s in the CPI39s Basket 17 Transportation 42 Housing Education and communication Medical care Other goods Recreation AP parel and services Inter nation to Eman ilt ls CPI a good measure for the cost of living 0 Substitution bias 0 Introduction of new goods 0 Unmeasured quality changes Beginning 1994 environmental regulations have required that gasoline contain a new additive to reduce air pollution This requirement raised the cost of gasoline The BLS decided that this increase in cost represented an improvement in quality Given this decision did the increased cost of gasoline raise the CPI Ju39nje 7 2007 4 11 CPI vs GDP Deflator a different quot basketsquot thus different weights 0 CPI accounts for imports bought by consumers o the quotbasketquot for GDP deflator is automatically adjusting Some examples for a wrapup 0 In 1931 President Hoover s salary was 75000 How does that compare to President George W Bush s salary of 400000 in 2005 CPI was 152 in 1931 and 195 in 2005 0 Henry Ford paid his workers 5 5 a day in 1914 If the CPI was 10 in 1914 and 195 in 2005 how much is the Ford paycheck worth in 2005 dollars indexation the automatic correction of a dollar amount for the effects of inflation by law or contract I W V H June 12007 511 Nominal vs Real Interest Rates Real interest rate 2 Nominal interest rate Inflation rate example You borrowed 1000 for one year Nominal interest rate was 15 During the year inflation was 10 Real interest rate is Interest Rates 7 Nominal interest rate Real interest rate m EllJquot 1965 1970 1975 1950 1985 1990 1995 27000 2005 Tatevik Sekhposyan UNCChapel Hill introduction to Economics June 7912007 3961 11 Unemployment Labor Force 10 7 nempluyment rate 8 6 A A V 4 7 Natural rate of unemployment l l l l l 1960 1965 1970 1975 1980 1985 1990 I I 995 2000 2005 natural rate of unemployment the normal rate of unemployment around which the unemployment rate fluctuates cyclical unemployment the deviation of unemployment from its natural rate Juner7I 2007 711 Unemployment How is it calculated BLS calculates data on unemployment based on Current Population Survey of 60000 households Labor force Number of employed Number of unemployed LI I L rate Number of unemployed 100 r Labor force 39 39 39 7 Labor force Labor force partClpatlon rate 7 Adult population gtr 100 Ju39nje 7 2007 8 11 Unemployment the extent LaborForce Demographic Group Unemployment Rate Participation Rate Adults ages 20 and older White male 44 762 White female 4 2 59 7 Black male 9 9 7O 9 Black female 89 642 Teenagers ages 1 6 1 9 White male 163 474 White female 136 467 Black male 356 300 Black female 282 328 C L Tatevik Sekhposvan UNCChapel Hill Infr ductibi39n ta Emnorn39 June 12907 9 11 Labor force participation LaborForce Participation Rate in percent Men 50 50 40 Women 20 o 1950 1955 1950 1955 1970 1975 1980 1985 1990 1995 2000 2005 Natural Rate of Unemployment frictional unemployment unemployment that results because it takes time for workers to search for the jobs that best suit their tastes and skills structural unemployment unemployment that results because the number ofjobs available in some labor markets is insufficient to provide a job for everyone who wants one Reasons 9 job search a minimum wage laws 0 unions and collective bargaining a theory of efficiency wages I H June 7 2007 11 11
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