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Chapter 1-6.docx

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Bridget O' Shaughnessy

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Chapter 1 Ten principal of economic September 10 2012 How people make decisions 1. People face trade offs -“ There is no such thing as free lunch” -To get one thing that we like we have to give up another E.g. spending extra dollar on something is a dollar less for something else -“Guns and butter” (Classic example of the trade off in society, when the nation spends more on national defenses (gun) to protect our shores from foreign aggressors, the less we can spend on consumer goods (butter) to raise our standard of living at home.) -Efficiency and equity Efficiency means that society is getting the most it can from its scarce resources (the size of the economic pie) Equity is the property of distribution economic prosperity fairly among the members of society (how pie is divided) 2. The cost of something is what you give up to get it -Opportunity cost: what must be given up to obtain some item  Making decisions 3. Rational people think at the margin -Rational people: people whom systematically and purposefully do the best they can to achieve their objectives given the opportunity they have. -Marginal (edge) changes/benefit/cost Marginal changes are adjustment around the edge of what you were doing. Marginal cost is the cost of the original price  E.g. a man pays 300$ for a $ 500 seat in plane that is about to take off. It’s profitable because it’s better than flying with empty seats. Marginal decision are made if the marginal benefit exceed the marginal cost -Cost at benefits (additional) -All relevant 4. People respond to incentives -Incentive: something that induces a person to act E.g. when a price of an apple increases, people decides to eat more pairs because the cost of buying an apple is higher. “People respond to incentives. The rest is commentary” “ When analyzing any policy, we must consider incentives. Is the policy changes inventive, it will cause people to alter their behaviors.” How people interact 5. Trade can make everyone better off -Trade between two countries can make each better off. 6. Markets tend to increase economic efficiency -Market economy: an economy that allocates resources through the decentralized decision of many firms and households as they interact in markets for goods and services.  Firm decides who to hire and what to make. House hold decides which firms to work for and what to buy with their incomes. “Household and firms interacting in markets as id they are guided by an “invisible hand” that leads them to desirable market outcomes. ” –Adam Smith -Prices are instrument with which the invisible hand directs economic activity.  Buyer looks at the price when determine how much to demand, and the seller look at the price when deciding how much to supply.  Market prices reflect both the value of a good to society of making the goods. Impedes: block, stops -Communism-equity-fairness 7. Sometimes the government can eliminate market inefficiencies (improve market outcomes) -Property rights: the ability of an individual to own and exercise control over scarce resources. E.g. a farmer wont grow food if he expects his crop to be stolen etc. -The invisible hand counts on our ability to enforce our rights. -“Invisible hands” are powerful but its not omnipotent. Therefore, we need government to intervene the economy and change the allocation of resources that people would choose on their own: to promote efficiency and to promote equity (to enlarge the pie or to change how the pie is divided). -Market failure: a situation in which market left on its own fails to allocate resources efficiently. -Externality: exercise on transaction between two people affects a third person. E.g. pollution -Market power: the ability of a single economic actor (a small group actors) to have substantial influences on market prices. -Invisible hand might fail to ensure that economic prosperity is distributed equitably.  An invisible hand does not ensure that everyone has sufficient food, decent clothing, and adequate health care. - -Negative externality: when a person affects a cause on a person How the economy as a whole works 8. A countries standard of living depends on its productivity -Productivity: the quantity of good and services produced from each hour of a worker’s time. -Per capital GDP -Out puts for workers 9. Prices increases when the government prints too much money -Inflation: an increase in the overall level of prices in the economy  High inflations imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world.  What causes inflation? When a government creates large quantities of the nation’s money, the value of the money falls. 10.There is a short run trade off between inflation and unemployment -Long run is where the higher level of prices is. -Short run effects of monetary injection:  Increasing the amount of money in the economy stimulates overall level of spending and thus demands for goods and services  Higher demand may, over time, cause firm to raise their prices, but in the meantime, it also encourages them to increase the quantity of goods and services they produce and hire more workers to produce those goods and services  More hiring means lower unemployment - The short run trade off plays a roll in Business cycle: fluctuations in economic activity, such as employment and productions Macroeconomics Sept 12 20212 Chapter 1, 2 What is more dangerous, a gun or a swimming pool? 1. Why is economics difficult:  Express idea in economics: E.g. When the price of toffee rises people drink less coffee -English language (When the price of toffee rises people drink less coffee) -Algebra/equation (Qd/c=100-0.67Pc) -Diagrams/graphs (demand graphs)  Translate between each different each different form of communication 2. Economic is a social science  Social=people  Science = use of scientific method  Observe  Theorize*  Test theory* *Natural experiment 3. Microeconomics vs. macro economics  Microeconomics: individual household and firms and how they interact  Macroeconomics: economy-wide phenomena such as interest rates, unemployment, money and growth 4. Efficiency vs. equity  Efficiency is the size of the pie (size of the share)  Equity is how the pie is divided (does everyone get the same share?) 5. Positive vs. normative analysis  Positive: the world “as it is”  Normative: the world “as it should be”  Value judgment E.g. The world is flat (a) a. Positive b. Normative Positive statement is always shorter than normative statement M: Markets are usually a good way to improve marker efficiency I: Market tends to increase market efficiency 6. Model=simplification  Diagram or equation  Assumption  Variables (inflation rates, the amount of coffee sold)  E.g. map of a city (it has a smaller scale) 7. Classify variables  Real variables vs. nominal variables  Physical quantities  Stock variables* vs. flow variables^  *Snap shot at a point in time  ^Time element (per year, per minute) -Capital stock means quantities of building used to produce goods and services -Investment is new purchases year add to stock variables Example of a model: circular flow diagram Expenditure Market for good & services $ Firm household Market for factor services Income What is more dangerous, a gun or a swimming pool? “ Freakonomics: a rogue economist explores the hidden side of everything” by Steven d. Levitt and Stephen J. DUBNER “ NUDGE: improving decision about wealth, wealth, and happiness” by Richard H. Thaler and Cass R. Sunstein September 13 2012 Chapter 3 Why doesn’t Sidney Crosby mow his own lawn? The production possibilities frontier (PPF) PPF: the combination of out put that the economy can produce given the available factors of production and production technology. Feasible: a combination that lies on the PPF or inside the PPF Infeasible: a combination that lies above (under) the PPF Efficient: an out come that occurs if the economy can get all it can from its scarce resources September 17 2012 Should you and your roommate divide household chores evenly? Example 1: There are 2 interior decorator that can paint and wallpaper. They have 40hr workweeks. Martha can paint 20 rooms or wallpaper 5 rooms; Stewart can paint 10 rooms or wallpaper 8 rooms. Opportunity cost: whatever must be given up to obtain some item (e.g. Going to university instead of working) Paint Paint Stewart Martha 20 10 5 Wallpaper 8 Wallpaper Absolute advantage: the ability to a produce a good with a smaller quantity of inputs Comparative advantage: the ability to produce a good with a smaller opportunity cost. (The producer who gives up less of other goods to produce good x has smaller opportunity cost of production good x  Can’t have compara
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