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ECN 104
Tsogbadral Galaabaatar

Chapter 1: Ten Principle of Economics 1/11/2013 9:55:00 AM The word economy comes from the Greek work for “one who manages a household” A household faces many decisions  It must decide which members of the household do which tasks and what each members gets in return  The household must allocate its scarce resources among its various members, taking into account each member‟s abilities, efforts, and desires Like a household, a society faces many decisions  A society must decide what jobs will be done and who will do them  It needs some people to grow food, other people to make clothing, and still others to design computer software  Once society has allocated people (as well as land, buildings, and machines) to various jobs, it must allocate the output of goods and services that they produce Economics is about…  Scarcity: the limited nature of society‟s resources  The management of society‟s resources (e.g., people, land, buildings, machinery) is important because resources are scarce  Natural resource, land and worker‟s time are all limited in its availability  Economics is about how the society manages its limited resources  In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms  Economists study how people make decisions: o Firms: what to produce, how much to produce, how many workers to hire, etc. o Individuals: what to purchase, how to save, how many hours to work, etc.  Economists also study how people interact with one another o They examine how the multitude of buyers and sellers of a good together determine the price at which the good is sold and the quantity that is sold  Economist analyze forces and trends that affect the economy as a whole, including the growth in average income, the fraction of population that cannot find work, and the rate at which prices are rising How People Make Decisions Principle #1: People Face Tradeoffs  To get one thing that we like, we usually have to give up another thing that we like  Making decisions requires trading off one goal against another  Think of the allocations of your time and money etc. o If you buy a new iPhone today, you have to wait before buying a new laptop. o If you invest in a stock, you are giving up other forms of investments, such as RESP and bonds. o For every hour you spend on studying, you could have worked.  When people are grouped into societies, they face different kinds of tradeoffs.  The classic tradeoff is between “guns and butter”. The more we spend on national defence (guns) to protect our shores from foreign aggressors, the less we can spend on customer good (butter) to raise our standard of living at home.  The modern tradeoff is between a clean environment and a high level of income. While pollution regulations give us the benefit of a cleaner environment and the improved health that come with it, they have the cost of reducing the incomes of the firms‟ owners, workers, and customers.  Society faces the tradeoff between efficiency and equity.  Efficiency: the property of society getting the most it can from its scarce resources  Equity: the property of distributing economic prosperity fairly among the members of society  Efficiency can be referred to the economic pie, and equity to how the economic pie is divided among society‟s members Principle #2: The Cost of Something is What You Give Up to Get It  Opportunity cost: whatever must be given up to obtain some item o Decision makers should be aware of the opportunity costs that accompany each possible action o To become a doctor, you need to go to medical school. In addition, you are giving up other career paths. o Waiting in a long line for a free item costs your time. o “There is no such thing as a free lunch” Principle #3: Rational People Think at the Margin  Rational people: people who systematically and purposefully do the best they can to achieve their objectives, given the opportunities they have  In economics, we usually assume that firms‟ objective is to maximize its profit and consumers‟ objective is to achieve the highest level of satisfaction.  Marginal changes: small incremental adjustments to an existing situation or plan of action o “marginal” means “edge”, so marginal changes are adjustments around the edges of what you are doing  Rational people make decision by comparing marginal benefits and marginal costs. o Suppose you have already eaten 3 tacos. Whether to have an extra taco depends on price of the taco (marginal cost) and the extra satisfaction it gives (marginal benefit). o To study one more hour the night before the exam has benefits and costs (less sleep).  A rational decision maker takes an action if and only if the marginal benefit of the action exceeds the marginal cost Principle #4: People Responds to Incentives  Incentive: something, such as a punishment or reward, that induces a person to act  Rational people respond to incentive o “People respond to incentives. The rest is commentary.” o Incentives are crucial to analyzing how markets work  If price of gasoline rises, people drive less.  If a neighboring country let people visit without a visa, the number of tourists will increase.  If a famous food critic is waiting for a dinner, the chef is trying her/his best.  Public policymakers should never forget about incentives, because many policies change the cost or benefits that people face and, therefore, alter behaviour o When government changes a rule or regulation, it gives an incentive to (some) people to change their action.  When policymakers fail to consider how their policies affect incentives, they often end up with results they did not intend o When the government didn‟t think thoroughly about all the incentives, unintended consequences can happen. o Seat belt law changes how people drive. As result, there were no change in the number of driver deaths. o Some say, to decrease the number of concussions in the NFL, you need to stop the use of helmets. Principle #5: Trade can Make Everyone Better Off  Trade allows each individual to specialize in the activities she or he does best and to enjoy a greater variety of goods and services. By doing so, everyone will be better off (than being self sufficient).  Similarly, countries benefit from trade and specialization. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity  Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services  In a market economy, firms and households make self-interested decisions guided by the market price. o Firms decide whom to hire and what to make o Households decide which firms to work for and what to buy with their incomes  Price reveals the buyer‟s valuation of the good and the seller‟s cost of producing it.  Usually, prices adjust to guide the economy to the outcome that maximizes society‟s economic well-being (resources allocated efficiently).  In his famous book, Wealth of Nations (1776), Adam Smith wrote: “Every individual…neither intends to promote the public interest, nor knows how much he is promoting…He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” Principle #7: Government Can Sometimes Improve Market Outcomes  We all rely on government-provided police services and courts to enforce our rights over the things we produce-and the invisible hand counts on our ability to enforce our rights  We need government because the invisible hand is powerful, but is not omnipotent  Market failure refers to a situation in which a market left on its own fails to allocate resources efficiently. It can happen if there is: o Externality: the impact of one person‟s actions on the well- being of a bystander. Example: Pollution o Market power: the ability of a single economic actor (or a small group of actors) to have a substantial influence on market prices. Example: Monopoly o In the presence of externalities or market power, well- designed public policy can enhance economic efficiency  If there is market failure, government can intervene in the economy and improve the market outcome. In this case, government intervention is promoting efficiency.  Government also can take actions that promote equity. Income tax and welfare system are examples of such action.  One of the most important government role is to enforce property right by law. o Property rights: the ability of an individual to own and exercise control over scarce resources Principle #8: A Country‟s Standard of Living Depends on Its Ability to Produce Goods and Services  Living standards vary a lot across countries and over time.  The main determinant of living standard is productivity, the quantity of goods and services produced from each hour of a worker‟s time.  In nations where workers can produce a large quantity of goods and services per unit of time, most enjoy a high standard of living; in nations where workers are less productive, most people must endure a more meager existence o The growth rate of a nation‟s productivity determines the growth rate of its average income  Productivity depends on technology, skills of workers and equipment/machinery. 1. Give three examples of important tradeoffs that face in your life. 2. What is the opportunity cost of a seeing a movie? 3. Water is necessary for life. Is the marginal benefit of a glass of water or small? …. Chapter 2: Thinking Like an Economist 1/11/2013 9:55:00 AM The Economist as Scientist  Scientific Method: the dispassionate development and testing of theories on the workings of the universe.  Since experiment is very difficult to conduct in economics, economists use historical events as natural experiments. o Example: decrease in housing sales after interest rate hike. Assumptions and Economic Models  Assumption is used to simplify complexity of the world. o Example: To study consumption behavior, we may assume there are only two goods. Unrealistic, but will give a valuable insight on consumption behavior.  Economic model is an explanation of workings of an economic phenomenon, based on simplifying assumptions. The Circular-Flow Diagram  Circular-Flow Diagram is a visual model of the economy that shows how dollars flow through markets among households and firms  There are two types of decision makers. o Households: own the factors of production and consume all the goods and services that the firms produce o Firms: produce goods and services using inputs (labour, land/natural resources, and capital/buildings and machines)  There are two markets. o Market for goods and services o Market for factors of production  Factors of production are the inputs that are necessary for production such as land, labor and capital.  In the market for goods and services, households are buyers and firms are sellers.  In the market for factors of production, households are sellers and firms are buyers.  If you trace a loonie in the economy for period of time, it will be used in transactions in the above two markets repeatedly.  see figure on slide 6 Production Possibilities Frontier  Production Possibilities Frontier (PPF) is a graph that shows the combinations of outputs that the economy can possibly produce given the available factors of production and the available production technology  We assume that there are two goods.  Since the factors of production are limited in quantity, not every combination of goods is feasible.  See figure + explanation on slide 8 PPF and opportunity cost  Opportunity cost is what you have to give up in order to obtain something.  If economy moves from one efficient point to other on PPF, it faces a trade-off. Increasing the production of one good means, we need to decrease the production of the second good.  The slope of the PPF is opportunity cost of one good in terms of the other.  See figure + explanation on slide 10 Shape of PPF  Generally, the shape of PPF is bowed out. But, sometimes, it can be a straight line.  If the PPF is straight line, then that means the opportunity cost (in terms of other good) of a good is constant regardless of output.  Bowed out PPF implies opportunity cost of a good increases as economy produces more of it.  See figure + explanation on slide 12 and 13 PPF and the Economic Growth  The production possible frontier shows the tradeoff between the outputs of different goods at a given time, but the tradeoff can change over time  Society can move production from a point on the old frontier to a point on the new frontier  The production possible frontier simplifies a complex economy to highlight and clarify some basic but powerful ideas  See figure + explanation on slide 14 The Economists as Policy Advisors  As a scientists, an economist makes a positive statement (descriptive). Positive statement is a description of the world as is  As a policy advisor, an economist makes a normative statement (prescriptive). Its is a statement that expresses the economist‟s view on how things should be.  Confirm or refute positive statements by examining evidence.  Evaluating normative statements involves values as well as facts. Positive and Normative Statements  Is the following a positive and normative statement? o “We should increase the interest rate in order to cool the housing market”. o Normative, involves judgment. o “Price decrease of iPhone decreases the number of Galaxy S3 sold.” o Positive, describes a relationship. Chapter 3: Interdependence and the Gains from Trade 1/11/2013 9:55:00 AM Interdependence  Every day you reply on many people from around the world, most of whom you‟ve never met, to provide you with the goods and services you enjoy.  One of the Ten Principles from Chapter 1: Trade can make everyone better off.  We now learn why people - and nations – choose to be interdependent, and how they can gain from trade. Example  Two countries: Canada and Japan  Two goods: computers and wheat  One resource: labour, measured in hours  We will look at how much of both good each country produces and consumes o If the country chooses to be self-sufficient o If it trades with the other country Production Possibilities in Canada  Canada has 50,000 hours of labour available for production, per month  Producing one computer requires 100 hours of labour  Producing one ton of wheat requires 10 hours of labour Canada‟s PPF: Canada has enough labour to produce 500 computers, or 5000 tons of wheat, or any combination along the PPF Canada Without Trade: Suppose Canada uses half its labour to produce each of the two goods. Then it will produce and consume 250 computers and 2500 tons of wheat. Active Learning 1: Derive Japan’s PPF Use the following information to draw Japan‟s PPF  Japan has 30,000 hours of labour available for production, per month  Producing one computer requires 125 hours of labour  Producing one ton of wheat requires 25 hours of labour Japan‟s PPF: Japan has enough labour to produce 240 computers, or 1200 tons of wheat, or any combination along the PPF Japan Without Trade: Suppose Japan uses half its labour to produce each good. Then it will produce and consume 120 computers and 600 tons of wheat. Consumption With and Without Trade  Without trade, o Canadian consumers get 250 computers and 2500 tons of wheat o Japanese consumers get 120 computers and 600 tons what  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 Active Learning 2: Production under trade 1. Suppose Canada produces 3400 tons of wheat. How many computers could Canada be able to produce with its remaining labour? Draw the point representing this combination of computers and wheat on Canada PPF 2. Suppose Japan produces 240 computers. How many tons of wheat would Japan be able to produce with its remaining labour? Draw this point on Japan‟s PPF U.S. Production With Trade: Producing 3400 tons of wheat requires 34,000 labour hours. The remaining 16,000 labour hours are used to produce 160 computers. Japan‟s Production With Trade: Producing 240 computers requires all of Japan‟s 30,000 labour hours. So, Japan would produce 0 tons of wheat. Basic International Trade Terms  Exports: goods and services produced domestically and sold abroad o To export means to sell domestically produced goods abroad.  Imports: goods and services produced aboard and sold domestically o To import means to purchase goods produced in other countries. Active Learning 3: Consumption under trade Suppose Canada 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 Canada? Plot this combination on Canada PPF.  How much of each good is consumed in Japan? Plot this combination on Japan‟s PPF.  See slide 18 and slide 20 Trade Makes Both Countries Better Off see slide 20 Where Do These Gains Come From?  Absolute advantage: the comparison among producers of a good according to their productivity  Canada has an absolute advantage in wheat: producing a ton of wheat uses 10 labour hours in Canada 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  Which country has an absolute advantage in computers?  Producing one computer requires 125 labour hours in Japan, but only 100 in Canada  Canada has an absolute advantage in both goods! 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 o Opportunity cost: whatever must be given up to obtain some item  In our example, the opportunity cost of a computer is the amount of wheat that could be produced using the labour needed to produce one computer Opportunity Cost and Comparative Advantage  Comparative advantage: the comparison among producers of a good according to their opportunity cost  Which country has the comparative advantage in computers?  To answer this, must determine the opp. cost of a computer in each country.  The opp. cost of a computer is o 10 tons of wheat in Canada, because producing one computer requires 100 labour hours, which instead could produce 10 tons of wheat o 5 tons of wheat in Japan, because producing one computer requires 125 labour hours, which instead could produce 5 tons of wheat  So, japan has a comparative advantage in computers. Lesson: Absolute advantage is not necessary for comparative advantage! Comparative Advantage and Trade  Gains from trade arise from comparative advantage (differences in opportunity costs).  When each country specializes in the good(s) in which it has a comparative advantage, total production in all countries is higher, the world‟s “economic pie” is bigger, and all countries can gain from trade  The same applies to individual producers (like the farmer and the rancher) specializing in different goods and trading with each other.  NOTE: for both parties, to gain from trade, the price at which they trade must lie between the two opportunity costs Active Learning 4: Absolute & comparative advantage Argentina and Brazil each have 10,000 hours of labour per month. In Argentina,  Producing one pound coffee requires 2 hours  Producing one bottle wine requires 4 hours In Brazil,  Producing one pound coffee requires 1 hour  Producing one bottle wine requires 5 hours Which country has an absolute advantage in the production of coffee? Which country has a comparative advantage in the production of wine? Answers Brazil has an absolute advantage in coffee:  Producing a pound of coffee requires only one labour-hour in Brazil, but two in Argentina. Argentina has a comparative advantage in wine:  Argentina‟s opp. cost of wine is two pounds of coffee, because the four labour-hours required to produce a bottle of wine could instead produce two pounds of coffee.  Brazil‟s opp. cost of wine is five pounds of coffee. Active Learning 5: Constructing PPF Suppose your factory has 3 workers and it produces chairs and tables. A workday has 8 working hours.  In each hour, Tom can produce 2 chairs or 2 tables.  In each hour, Jim can produce 4 chairs or 1 table.  In each hour, John can produce 4 chairs or 2 tables.  See slide 30  Who has absolute advantage and who has comparative advantage in chair? o Absolute - Jim and John o Comparative – Jim  If everyone makes chair, how many chairs can the factory produce in one day? o 80 chairs.  If everyone makes table, how many tables can the factory produce in one day? o 40 tables.  See slide 32  Suppose Jim and Tom are making only chairs and John is making only tables. Is this production plan efficient?  Not efficient. 48 chairs and 16 tables - point E in the graph.  How do you increase productions of tables and chairs? (We want to find a production plan that produces more than 48 chairs and 16 tables.)  Make Tom spends only 1.5 hours in table production and John only 1 hour in chair production. (As result, chairs will be produced by Jim (8 hours), Tom (6.5 hours) and John (1hour). Tables will be produced by Tom (1.5 hours) and John (7 hours).)  See slide 34 Unanswered Questions…  We made a lot of assumptions about the quantities of each good that each country produces, trades, and consumes, and the price at which the countries trade wheat for computers.  In the real world, these quantities and prices would be determined by the preferences of consumers and the technology and resources in both countries. (next chapter)  For now, though our goal was merely to see how trade can make everyone better off. Chapter Summary  Interdependence and trade allow everyone to enjoy a greater quantity and variety of goods & services.  Comparative advantage means being able to produce a good at a lower opportunity cost. Absolute advantage means being able to produce a good with fewer inputs.  When people – or countries – specialize in the goods in which they have a comparative advantage, the economic “pie” grows and trade can make everyone better off. Chapter 4: The Market Forces of Supply and Demand 1/11/2013 9:55:00 AM Markets and Competition  A market is a group of buyers and sellers of a particular good or service o The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product  A competitive market is a market in which there are many buyers and many sellers so that each has a negligible impact on the market price o Price and quantity are determined by all buyers and sellers as they interact in the marketplace  In a perfectly competitive market: o Goods offered for sale are all exactly the same o Buyers & sellers are so numerous that no single buyer or seller has any influence over the market price – each is a “price taker”  NOTE: for this chapter, we assume markets are perfectly competitive Demand  the quantity demanded of any good is the amount of the good that buyers are willing and able to purchase  law of demand: the claim that, other things equal, when the price of a good rises, the quantity demanded of the good falls, and when the price falls, the quantity demanded rises Demand Schedule  Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded, holding constant everything else that influences how much consumers of the good want to buy o Example: see slide 5 + 6 (demand curve)  Demand curve: a graph of the relationship between the price of a good and the quantity demanded Market Demand vs. Individual Demand  The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price  Market demand: Sum of all individual demands for a particular good service  Qd = quantity demanded  see slide 7 The Market Demand Curve  The market demand curve shows how the total quantity demanded of a good varies as the price of the good varies, while all the other factors that affect how much consumers want to buy are held constant  see slide 8 Demand Curve Shifters  The demand curve shows how price affects quantity demanded, other things being equal  These “other things” are non-price determinants of demand (i.e., things that determine buyers‟ demand for a good, other than the good‟s price)  Changes in them shift the D curve… o an increase in demand; any change that increases the quantity demanded at every price, shifts the demand curve to the right o an decrease in demand; any change that reduces the quantity demanded at every price, shifts the demand curve to the left Demand Curve Shifters: # of Buyers  Increase in # of buyers increases quantity demanded at each price, shifts D curve to the right  Suppose the number of buyers increases. Then, at each P, Qd will increase. (see slide 11) Demand Curve Shifters: Income  Demand for a normal good is positively related to income o A good for which, other things equal, an increase in income leads to an increase in demand, shifts D curve to the right  Demand for an inferior good is negatively related to income o A good for which, other things equal, an increase in income leads to a decrease in demand, shifts D curves to the left  for the inferior good=> income decreases, shift right  The impact of changes in wealth on both the amount and composition of goods that individuals consume is called the wealth effect (demand curve changes like income) Demand Curve Shifters: Prices of Related Goods  Two goods are substitutes if an increase in the price of one leads to an increase in demand for the other o Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right. o Other examples: Coke and Pepsi, laptops and desktop computers, CDs and music downloads  Two goods are complements if an increase in the price of one leads to a decrease in demand for the other o Example: computers and software. If price of computer rises, people buy fewer computers, and therefore less software. Software demand curve shifts left. o Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon Demand Curve Shifters: Tastes  Anything that causes a shift in tastes toward a good will increase demand for that good and shifts its D curve to the right o Example: The Atkins diet became popular in the „90s, caused an increase in demand for eggs, shifted the eggs demand curve to the right. Demand Curve Shifters: Expectations  Expectations about the future affect consumers‟ buying decisions o Examples: If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now. o If the economy sours and people worry about their future job security, demand for new autos may fall now. Summary: Variable That Influence Buyers  see table 4.1 Activity Learning 1: Demand Curve Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?  A. The price of iPods falls o Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right.  B. The price of music downloads falls o The D curve does not shift. Move down along curve to a point with lower P, higher Q.  C. The price of CDs falls o CDs and music downloads are substitutes. A fall in price of CDs shifts demand for mu
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