Week 1 Lecture Notes
Week 1 Lecture Notes EC 110
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This 9 page Class Notes was uploaded by Matt Owens on Friday January 16, 2015. The Class Notes belongs to EC 110 at University of Alabama - Tuscaloosa taught by Kent O. Zirlott in Spring2015. Since its upload, it has received 414 views.
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Date Created: 01/16/15
Matt Owens Principles of Microeconomics January 13 2015 Chapter 1 Notes Today s notes consist of a large amount of vocabulary and covers very basic concepts of Microeconomics What Economics is All About Scarcity The limited nature of society s resources Economics The study of how society manages its scarce resources 0 How people decide what to buy how much to work save and spend 0 How firms decide how much to produce how many workers to hire 0 How society decides to divide its resources between national defense consumer goods protecting the environment and other needs I Roughly 40 of the United States federal budget goes towards national defense 0 Economics is not just the study of money or business however those are pieces of the subject How People Make Decisions All decisions involve tradeoffs 0 Examples I Going to a party the night before your midterm leaves less time for studying I Having more money to buy stuff requires working longer hours which leaves less time for leisure I Protecting the environment requires resources that could otherwise be used to produce consumer goods Society faces an important tradeoff o Efficiency vs equality Efficiency When society gets the most from its scarce source 0 Bang for your buck Equality When prosperity is distributed uniformly among society s members 0 We all get an equal share Tradeoff of efficiency and equality To achieve greater equality we could redistribute income from wealthy to poor But this reduces incentive to work and produce shrinks the size of the economic quotpiequot Making decisions requires comparing the costs and benefits of alternative choices The Opportunity Cost of any item is whatever must be given up to obtain it o What is your opportunity cost for coming to this class I Working The opportunity cost of going to college for a year is not just the tuition books and fees but also the foregone wages o The Opportunity cost of seeing a movie is not just the price of the ticket but the value of the time you spend in the theater 0 Opportunity Cost is measured as the highest valued alternative given up It is the relevant cost for decision making Rational people 0 Systematically and purposefully do the best they can to achieve their objectives I Rational model only does that which makes us better I According to a COMPLETELY rational model Nobody would smoke Nobody would have unprotected sex 0 Make decisions by evaluating costs and benefits of marginal changes 0 Marginal Changes incremental adjustments to an existing plan Examples 0 When a student considers whether to go to college for an additional year he compares the fees and foregone wages to the extra income he could earn with the extra year of education 0 When a manager considers whether to increase output she compares the cost of the needed labor and materials to the extra revenue Incentive Something that induces a person to act ie the prospect of a reward or punishment Rational people respond to incentives Examples 0 Amari Cooper Star football player for University of Alabama leaving college football early to go into the NFL 0 When gas prices rise consumers buy more hybrid cars and fewer gas guzzling SUVs 0 When cigarette taxes increase smoking falls o What is the incentive for having a playoff system in college football January 2015 I Increase revenue and increase ratings 0 You are selling your 1996 Mustang You have already spent 1000 on repairs At the last minute the transmission dies You can pay 600 to have it repaired or sell the car as isquot In each of the following scenarios should you have the transmission repaired I Blue book value is 6500 if transmission works 5700 if it doesn t Benefit of fixing the transmission is 800 so fix the transmission I Blue book value is 6000 if transmission works 5500 if it doesn t You would lose 100 if you fixed the transmission before selling it So sell it as is Rather than being selfsufficient people can specialize in producing one good or service and exchange it for other goods Countries also benefit from trade and specialization 0 Example Apple makes products in China for VERY cheap yet sells them in US for hundreds of dollars 0 Get a better price abroad for goods they produce 0 Buy other goods more cheaply from abroad than could be produced at home Market A group of buyers and sellers need not be in a single location Organize economic activityquot means determining o m goods to produce 0 How to produce them 0 How much of each to produce 0 Who gets them A Market Economy allocates resources through the decisions of many households and firms as they interact in markets The invisible hand works through the price system 0 Adam Smith The Bible of Economics 0 The interaction of buyers and sellers determines prices 0 Each price re ects the goods value to buyers and the cost of producing the good 0 Prices guide selfinterested households and firms to make decisions that in many cases maximize society s economic wellbeing Important role for government enforce property rights with police courts People are less inclined to work produce invest or purchase if large risk of their property being stolen Market Failure When the market fails to allocate society s resources efficiently Causes 0 Externalities When the production or consumption of a good affects bystanders eg pollution 0 Market Power A single buyer or seller has substantial in uence on market price eg monopoly In such cases public policy may promote efficiency Example Government restricted ATampT and TMobile from merging because they would control over 60 of that market and therefore have a monopoly in the cellular field Government may alter market outcome to promote equity equality If the market s distribution of economic wellbeing is not desirable tax or welfare policies can change how the economic quotpiequot is divided The most important determinant of living standards Productivity Productivity the amount of goods and services produced per unit of labor GDP Gross Domestic Product Measure of productivity Productivity depends on the equipment skills and technology available to workers Other factors labor unions competition from abroad have far less impact on living standards US has the highest GDP and highest standard of living In ation Increases in the general level of prices In the long run in ation is almost always caused by excessive growth in the quantity of money which causes the value of money to fall 0 Gas prices dominate in ation and de ation The faster the government creates money the greater the in ation rate 0 US is not doing this Most money printed today is used to replace money that is worn out and create new bills to prevent counterfeit bills Phillips Kerr discovered the correlation In the shortrun 12 years many economic policies push in ation and unemployment in opposite directions Other factors can make this tradeoff more or less favorable but the tradeoff is always present Last recession was focused completely on jobs aspect of economy 0 VERY close to becoming a depression Matt Owens Intro to Microeconomics January 15 2015 Chapter 2 Notes Assumptions amp Models Assumption simplify the complex world make it easier to understand 0 Example To study international trade assume two countries and two goods Unrealistic but simple to learn and gives useful insights about the real world Model A highly simplified representation of a more complicated reality 0 Economists use models to study economic issues 0 Supply and demand 0 Game Theory Model 1 The CircularFlow Diagram The CircularFlow Diagram A visual model of the economy shows how dollars ow through markets among households and firms Two types of actors o Households us 0 Firms Two markets 0 The market for goods and services The market for factors of productionquot input 0 Factors of Production The resources the economy Input Basically the uses to produce goods and services including stuff we use to make I Labor us more stuff I Land raw materials Corn Sugar I Capital buildings and machines used in production Machines in a bottling factor in a CocaCola Factory Delivery trucks I Entrepreneurship idea behind the business All businesses started with an idea Households 0 Own the factors of production I Sellrent them to firms for income 0 Buy and consume goods and services Firms 0 Buyhire factors of production use them to produce goods and services 0 Sell goods and services Households 9 Markets for Factors of Production 9 Factors of production 9 Firms Firms 9 Wages rent interest profit 9 Markets for factors of production 9 Income 9 Households Households 9 Spending 9 Markets for goods and services 9 Revenue 9 Firms Firms 9 Goods and services sold 9 Markets for Goods and Services 9 Goods and services bought 9 Households Model 2 The Production Possibilities Frontier 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 The PPF and Opportunity Cost v B 5 c 0 Recall The Opportunity Cost of an item is g what must be given up to obtain that item 3 0 Moving along a PPF involves shifting 2 O D resources eg labor from the production of one good to the other A 0 Society faces a tradeoff Getting more of one good requires sacrificing some of the other 0 The Slope 0fth PPF tells you the ResourceDepletmg melnctmn opportunity cost of one good in terms of the Other Example of a PPF Graph I Slope RiseRun The Shape of the PPF The PPF could be a straight line or bowshaped Depends on what happens to the opportunity cost as economy shifts resources from one industry to the other 0 If opportunity cost remains constant PPF is a straight line Essentially the same resources are equally useful for producing in either industry I Wheat and barley use the same resources Same sunlight Same fields Same water Same farmer I With additional resources or an improvement in technology the economy can produce more barley more wheat or any combination in between F o If opportunity cost of a good rises as the economy produces more of the good PPF is bowshaped Essentially the resources are specialized and not easily adaptable for producing in either industry I Production of beer and bikes use completely different resources Bikes aren t fermented Beer doesn t require tar Etc I As the economy shifts resources from beer to mountain bikes PPF becomes steeper Opportunity cost of mountain bikes increases I So PPF is bowshaped when different workers have different skills different opportunity costs of producing one good in terms of the other I The PPF would also be bowshaped when there is some other resource or mix of resources with varying opportunity costs eg different types of land suited for different uses The PPF Important Notes The PPF shows all combinations of two goods that an economy can possibly produce given its resources and technology The PPF illustrates the concepts of trade off and opportunity cost efficiency and inefficiency unemployment and economic growth A bowshaped PPF illustrates the concept of increasing opportunity cost A straight line PPF illustrates constant opportunity costs Microeconomics and Macroeconomics Microeconomics The study of how households and firms make decisions and how they interact in markets Macroeconomics The study of economywide phenomena including in ation unemployment and economic growth These two branches of economics are closely intertwined yet distinct they address different questions The Economist as Policy Advisor As scientists economists make Positive Statements 0 Positive Statements Attempt to describe the world as it is As policy advisors economists make Normative Statements 0 Normative Statements Attempt to prescribe how the world should be Examples 0 Prices rise when the government increases the quantity of money I Positive describes a relationship could used data to confirm or refute o The government should print less money I Normative this is a value judgment cannot be confirmed or refuted o A tax cut is needed to stimulate the economy I Normative another value judgment 0 An increase in the price of burritos will cause an increase in consumer demand for tacos I Positive describes a relationship The PPF What We Know So Far Points on the PPF 0 Possible 0 Efficient all resources are fully utilized Points under the PPF 0 Possible 0 Not efficient some resources are underutilized eg workers unemployed factories idle Points above the PPF 0 Currently unobtainable