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ECON 101 Lecture Notes

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Gordon Lee

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ECON 101 12/12/2013 6:44:00 PM Tuesday, September 10 , 2013 1) Definitions 2) Economics as a science 3) Production possibilities frontier 1. Definitions: economics: the study of the choices people make and the actions they take to make the best of scare resources in meeting their wants and needs  a study of people and their actions  scarcity is always a present issue - eg. time, money, resources o Q: How do I allocate my (resources) ? microeconomics: the study of the choices and actions of individual economic units such as households, firms, consumers, etc. macroeconomics: the study of the behavior of the aggregate economy, including issues like unemployment, inflation, and changes in the level of national income Economic Choices: Let x = some activity.  if benefits of x > cost of x, do activity  if benefits of x < cost of x, do not do activity eg. Set the speed limit on the highway from Edmonton to Calgary at 10 km/hr. Cost vs. Benefits Comparison Chart Costs Benefits  travel time ↑  severity of vehicular accidents ↓  fuel costs ↑  deaths ↓  travel fatigue ↑  damage ↓  pollution ↑  injuries ↓  travel & tourism ↓  shipping costs ↑  enforcement costs ↑  change road signs Q: What is the value of a human life? Can this “value” be fairly enumerated? Judging Economic Allocations the allocation of resources can be evaluated on the basis of: 1. Efficiency  Pareto efficiency  equal distribution to all; we cannot benefit someone without hindering somebody else  eg. splitting money equally to all parties as opposed to favoring/discriminating against people to justify who deserves what  occurs when the net benefits are maximized (net benefit = benefit – cost)  when benefits are maximized, we have an efficient outcome 2. Equity  distributing goods and services in a manner considered fair by society;  economists provide multiple efficient outcomes (often the catch lies in the equity) and a politician chooses one of the options based on what they think is best for society 3. Moral & Political Consequences Positive vs. Normative Economics: Positive:  involves statements about “what is”, or “what will be” and can be tested by checking the statement against observed facts  objective  eg. If the price of coffee rises, people will buy less coffee. Normative:  “what ought to be”  depends on values or beliefs and cannot be tested  biased  eg. Taxes should be used to redistribute income from high income groups to low income groups. Economics as a Science:  social science that seeks to explain how people act  uses theories, assumptions, and models to explain how people behave  model: simplified description of the way things work  models and theories provide an understanding and explanation; they try to predict behavior  Ockham’s Razor  assumptions are made in the formulation of all models o simplify complexities o true test of a model is not the realism of the assumptions it uses, but rather the ability of the model to explain and predict behavior o the model used in this course is called the Neoclassical Paradigm  empirical science, measureable against a real-world observation Caution in observations: I. Correlations Fallacy: the incorrect belief that correlations implies causation eg. increase in ice cream sales during the summer months are correlated with an increase in crime rates  the truth is: it’s a statistical coincidence – warm weather drives both the sales of ice cream as well as the rates for crime II. The Post Hoc Fallacy: a mistake in reasoning that the relative occurrence of one event preceding another must be the impetus for the second event eg. shopping increases in the months before Christmas, therefore Christmas comes as the result of shopping  post hoc ergo pronter hoc: (Latin) after this, therefore because of this III. Fallacy of Composition: when an individual’s beneficial actions are replicated by the group, and the beneficial component becomes counterproductive as a result  if one person stands up at a baseball game, they can see better – therefore if everyone stands up, they can all see better  if one person takes the earlier bus, then it will be less crowded – doesn’t work if everyone takes the morning bus  if one person raises their voice to be heard, and then everyone raises their voice causing no one to be heard th Thursday, September 12 , 2013 1) Production Possibilities Frontier 2) Markets 3) Demand 1) Production Possibilities Frontier (PPF)  shows all the combinations of goods and services that a society is capable of producing given its resources and its technological capacity  eg. Freddonia - watch “Duck Soup” documentary for history of the nation, if interested - only produces two goods: i. bottled water (BW) ii. CD’s PPF of Freedonia as of Sept. 12 , 2013 Notes:  combinations A, B, C, D, E are all attainable  combination G (and all other combinations that lie outside the frontier) are unattainable  combinations on the edge of the frontier are efficient  combination F (and others within, but not on the edge) are possible, but inefficient  most economies are representative to some degree of “F” because there always exists unemployment, and hence, inefficiency  the concept of scarcity (lack of resources) forces us to make choices → ties into the larger theme of this course Opportunity Cost:  forgone benefits that arise when the resources are not used in the next best alternative way (professor’s definition)  the difference in benefits between the current choice of action versus the next best alternative eg. Opportunity cost of this lecture (ie., what we could have been doing instead of being at the lecture)  sleeping (valued at: $20/75 min.)  studying (valued at: $15/75 min.)  working (valued at: $17/75 min.)  socializing (valued at: $5/75 min.)  playing video games (valued at: $25/75 min.) The opportunity cost of the next best option would be $25/75 min. – NOT the sum of the opportunity costs, only the next best (highest valued) option. eg. Opportunity cost of earning a 4-year undergrad degree. a) Going to school:  tuition: $7000/year  books: $1500/year TOTAL: $8500/year x 4 years = $34,000/4 years b) Working full-time:  $50,000/year x 4 years = $200,000/4 years Possibility Bottles of Water CDs (millions) (millions) A 0 15 B 1 14 C 2 12 D 3 9 E 4 5 F 5 0 Calculating the opportunity cost: Bottles of Water CDs (millions) Opportunity cost (of (millions) one bottle of water) 0 15 N/A 1 14 1 CD 2 12 2 CDs 3 9 3 CDs 4 5 4 CDs 5 0 5 CDs eg. Opportunity cost of one bottle from making 3M, as opposed to 2M? = (12M CDs – 9M CDs)/(3M bottles – 2M bottles) = 3M CDs/1M bottles = 3 CDs/1 bottle The opportunity cost of one bottle is 3 CDs. eg. Opportunity cost of five bottles from making 3M, as opposed to 2M? = opportunity cost of one bottle x 5 = (3 CDs/1 bottle) x 5 = 15 CDs/5 bottles The opportunity cost of five bottles is 15 CDs. Notes:  Watch the wording of the third column: opportunity cost of one bottle of water, or opportunity cost of five bottles of water; read closely.  scarcity implies choice, and choice implies opportunity cost  calculating opportunity costs are relative to some standard (eg. the difference in y between choosing x v1. x ) 2 o always be mindful of what numbers you plug in Law of Increasing Cost:  in order to produce extra amounts of one good, society must give up ever-increasing amounts of the other good  the higher the relative quantity of one type of good produced, the larger the trade-off to obtain that increase in production What would cause a PPF to shift out? Positive PPF Shift Negative PPF Shift Acquisition/discovery of new Depletion or loss of resources resources Technological innovation or Negative change to working process, methodical improvement less efficient Workers are more productive (eg. Decrease in worker efficiency mastery, incentives, happiness, etc.) Increase in population Decrease in population (war, migration, etc.) Positive two-variable PPF Shift  Movement from inefficient production to efficient production (eg. removing restrictions to be able to work at full capacity)  does not have to be a parallel shift (eg. better firearms technology will not impact the production of butter)  no money involved in this graph – only provides production capabilities Market  a place where buyers and sellers meet and make exchanges  the rationality assumption: individuals do not intentionally make decisions that will leave them worse off  economy can be controlled (in part) by the market (government, mixed economy, etc.)  eg. Government of Albania shut down borders, so the government controlled pretty much everything  mixed economy: government regulates, but consumers guide the hand of the market  Players: 1. Households (consumers):  individuals who demand goods and services  supply factors/labor  objective: maximize satisfaction 2. Firms:  supply goods and services  demand factors  objective: maximize profits 3. Government:  the referee; ensures the “game” is being played fairly  objective: ? (questionable; never certain) Tuesday, September 17th, 2013 1) Market Economies 2) Demand 3) Supply Main Characteristics of Market Economies 1. Self-Interest: Individuals pursue their own self-interest, buying and selling what seems to be best for them and their families. 2. Incentives: People respond to incentives (eg. changes in prices, profit, etc.) 3. Market prices and quantities: Prices and quantities are determined in open markets where would-be sellers compete to sell their products to would-be buyers. 4. Institutions a. Individualist Institutions of Property and Decision Making: Before people can begin to think about making an exchange, they must be clear about what belongs to whom. For decentralized exchange to take place, people must have individually held private property which is the ownership of assets by non-governmental economic agents. o private property rights b. Social institutions of trust: Trust must exist between buyers and sellers. This trust may be established through cultural norms, though direct one-to-one relationships or through the establishment of contracts. o trust c. Infrastructure for the smooth flow of goods and services: This refers to the physical infrastructure of transportation and storage. d. Money as a medium for exchange: To facilitate the flow of exchange, we need a generally accepted form of payment. The natures of private property and contractual obligations are defined by legislature and enforced by the courts. Circular Flow Diagram: Demands for Goods and Services Supply of Factors Households Payment for Goods Income and Services Factors Goods and Market Services Market Monetary Costs Revenue Demands for Firms Supply of Goods factors and Services 2) Demand and Supply x Q D = D xP x …) Q Dx= quantity that consumers wish to purchase D x [need to clarify with the prof
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