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Chapter 1

econ ch. 1+2

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Avi Cohen

Chapter 1 – What's in Economics for You? Scarcity, Opportunity Cost and Trade. Economics – is how individuals, businesses, and governments make the best possible choices to get what they want, and how those choices interact in markets Scarcity (basic economic problem) arises because of limited money, time and energy Opportunity cost (most important concept) − because of scarcity, every choices needs a trade off − the true cost of giving up the alternative called opportunity cost − smart choice = value of what you get, greater than the value of what you give up − incentives = rewards and penalties for the choice − actions with rewards (positive incentives) are likely chosen than those actions with negative incentives Where Have All the Men Gone? Women make 60% of undergraduate population, and economists have an explanation for it based on opportunity cost. Even though men and women pay the same fees, they benefit differently from it. Men's alternative of not going to college is higher paying blue-collar jobs (eg. Mechanics, construction workers), while women's alternative is lower paid jobs in retail (eg. Clerks, check out assistants). Women with post secondary education earn 50% to 80% more than those with just high school degree, while the difference for men is 25% to 30% percent. According to the differences in opportunity cost women who do not go to college give up a much bigger gain then men do. For women, the benefits of getting a post secondary education are much better than for men. Only 6% of men go back to receive post secondary education while for women it is 9%. Gains from trade Opportunity cost and comparative advantage are key to understanding why specializing and trading make us all better off − voluntary trade (buyers and sellers are allowed to buy and sell according to their preferences) − absolute advantage: ability to produce a product/service at a lower absolute cost than another producer − comparative advantage: ability to produce a product/service at a lower opportunity cost than another producer Opportunity cost = give up : get The circular flow of economic life − the circular flow diagram of economic life is a map showing how markets connect us all. It illustrates how smart choices by households, businesses, and governments interact in markets − complexity of Canadian economy can be reduced to three sets of players – households, businesses, and governments − in input markets (labour, natural resources, capital equipment and entrepreneurial ability; where businesses buy the inputs they need to produce products / services) = households are sellers and businesses are buyers − in output markets (where businesses sell their products/services) = households are buyers and businesses are sellers − governments (the middle between the markets) set rules and can choose to interact in any aspect of the economy − Microeconomics: analyzes choices that individuals in households, individual businesses, and governments make, and how those choices interact in markets − Macroeconomics: analyzes performance of the whole Canadian economy and global economy, the combined outcomes of all individual microeconomic choices eg. household sells or rents to businesses the labour, resources, capital -> businesses pay wages and other money rewards to households -> businesses produce products/services which they sell to households -> households use money they earned to pay businesses -> people end up with service, businesses end up with the money -> the cycle repeats Weigh marginal benefits and costs: − the three key plan of the core of microeconomics: 1. Opportunity cost rule: choose only when additional benefits are greater than additional opportunity cost 2. Look forward only to additional benefits and additional opportunity costs: count only additional benefits and additional opportunity costs; count only marginal benefits – and marginal opportunity costs MARGINAL=ADDITIONAL 3. Implicit costs and externalities count too: be sure to count all additional benefits and costs, including implicit costs and externalities − Marginal = “additional” − Marginal benefits – additional benefits from next choice − Marginal opportunity costs – additional opportunity costs from next choice − Implicit costs – opportunity costs of investing your own money or time − Negative (positive) externalities – costs (benefits) that affect other external to a choice or a trade STUDY GUIDE QUESTIONS 1. Economics is about how individuals, businesses, and governments make the best possible choices to get what they want, and how those choices interact in markets. TRUE 2. People who win the lottery don't have to make smart choices. FALSE because even people who win the lottery can never satisfy all of their wants, they also face trade offs and have to make smart decisions 3. Opportunity cost is equal to money cost FALSE opportunity cost is value (other benefits that are lost in addition to money when given up to path, action or activity 4. In 2007 the Government of Canada announced $1000Apprenticeship Incentive Grant to cover the costs of tuition, travel, and tools for apprentices in the sealing trades. This will eliminate the opportunity cost of being an apprentice for those who receive the cash grant. FALSE because the grant covers the money costs of getting an apprenticeship but does not cover the opportunity cost – the total value of what the individual gives up by taking an apprenticeship, which includes the money that the individual could have earned in a job that year. 5. According to “Economics Out There” on p.6, men have a larger incentive to get a post- secondary education because not getting a post- secondary education results in a relatively worse outcome compared to women FALSE women are the ones that result in a relatively worse outcome because the gap between the incomes of post secondary graduates and high school gradates is higher for women then for men 6. Traditionally, women have specialized in unpaid work at home and men have specialized in paid work outside the house. One possible explanation for this could be that men held a comparative advantage in performing housework (for example: cooking, cleaning, and child care) FALSE because if men held a comparative advantage in performing housework then traditional gender roles would be reversed because individuals are supposed to specialize in the activity where they hold a comparative advantage. 7. The theories of comparative advantage, specialization, and trade in this chapter are consistent with the belief that “opposites attract” TRUE 8. Sheryl and Darrel are trying to decide who should stay at home to take care of their newborn chid and who should continue to work full time outside the house. Sheryl makes $30 an hour and Darrel earns $26. If both are equally effective at taking care of the child, then based on opportunity costs Sheryl should stay at home to take care of the newborn. FALSE if they are both equally productive when staying with the newborn, then Sheryl should work cause she earns more money 9. The proportion of families with both parents working outside the home and sharing child care responsibilities has risen in recent decades. This indicates that specialization and the traditional division of gender roles are becoming much less common in Canada. TRUE 10. Government programs that make child care more affordable, such as Quebec's $7 – a day child-care program, would likely increase the proportion of parents who work outside home. TRUE 11. The labour market – where employers demand labour and employees supply labour – is an output market. FALSE this is an input market because households are sellers, and businesses are buyers 12. In input markets, households are sellers and businesses are buyers, in output markets, households are buyers and businesses are sellers TRUE 13. Decisions to go to college or take out a loan are macroeconomic choices. FALSE, it's microeconomic choices because they focus on individuals making decision, whenever macro focuses on a bigger picture country or global wise 14. Implicit costs are the opportunity costs of investing your own money or time TRUE 15. Negative externalities are benefits that affect others external to a choice or a trade FALSE they are the costs that affect others 1. You can't get everything you want because you are limited by: (d) time, money, energy 2. Scarcity is: (d) a challenge for everyone 3. Economics does not focus on: (b) animals 4. Opportunity cost includes: (d) time you give up, energy you spend, money you spend 5. In deciding wether to study or sleep for the next hour, your decision should consider all of the following except: (a) how much tuition you paid, (b) how tired you are (c) how productive you will be in that hour (d) how much value you place on sleeping in that hour over 6. From 1991 to 2001, the proportion of 25 – to 29 year old women with university degrees rose from 21 percent to 34 percent, while the proportion of 25 to 29 year old men with degrees rise from 16 percent to 21 percent. There is a similar trend for college diplomas. More women than men are getting post secondary eduction because: (d) the gap in pay between post secondary and high school graduates is higher for women than it is for men, the cost of not going to post-secondary education is higher for women, the opportunity cost of going to post secondary education is lower for women 7. According to the table all of the following statements are true except: Median Annual Earnings Men Women College Diploma $51,000.00 $43,000.00 High-School Diploma $37,000.00 $32,000.00 (a) people with college diplomas earn more than people with high school diplomas (b) men with high school diplomas earn more than women with high school diplomas (c) men with college diplomas earn more than women with college diplomas (d) women with high school diplomas earn more than men with high school diplomas 8. If the resource-rich sector of Alberta's economy starts to slow down, (b) opportunity costs of upgrading to a college diploma will decrease (decrease = less will be gained from choosing to receive a college diploma) 9. Mutually beneficial gains from trade come from: (b) comparative advantage 10. The easiest way to calculate opportunity cost is: (a) to divide what you GIVE UPby what you GET 11. Which of the following is not a microeconomic choice for businesses? (a) what interest rates to set (b) what products/services to supply (c) what quantity of output to produce (d) how many workers to hire 12. Which of the following is not a microeconomic choice for governments? (a) increasing tuition rates (b) taxing automobile emissions (c) increasing the exchange rate of the canadian dollar (d) increasing the number of taxi licences 13. In the circular-flow diagram, (d) households ultimately own all the inputs of an economy, governments set the rules of the game, businesses are sellers and households are buyers in output markets 14. All of the following should be considered when making smart choices, except (a) external costs and benefits (b) past costs and benefits (c) implicit costs (d) additional costs and additional benefits 15. For any activity, failure to consider (d) external costs will result in too much of that activity 1. You're trying to decide whether to go camping with your friends or spend a quiet weekend at home with your significant other. What incentives (think rewards and penalties), if changed, may influence your decision? Weather, cost of trip, if your partner tells you the relationship is over if you go, if your partner offers to cook for you or take you out to dinner if you stay 2. Olga chooses to live at home rather than move into residence during her first year of college. She often brags about the fact that she saves a lot of money by living at home. Provide some examples of what Olga may have given up by choosing to live at home. Meeting new people and making friends (social life), not spending money on transportation (residence is probably located on campus), time (living in residence is convenient because food is provided, rooms are cleaned, and less time needs to be spend on moving around), parties, freedom, privacy, study partners 3. Suppose the government was worried about the decline of young men in post-secondary education. What incentives might encourage more men to pursue further education? Decreasing tuition costs or guaranteeing minimum pay levels for people with degree 4. You friend has an extra ticket to the Calgary Flames – Ottawa Senators game on a Saturday night. He says he will give you the ticket for free if you pay for all the other expenses. You usually work Saturday nights, so if you go you will have to take the night off work. Explain what costs you would include in deciding whether or not to go to the “free” game. The costs of transportation and food, in addition, to the opportunity cost which the loss of the money that could be earned in that night 5. Seat belts save lives. Suppose that a city doubles the penalty for being caught driving without a seat belt in attempt to increase seat belt use among drivers. (a) Explain how this policy will influence driver behaviour More people will start wearing seat belts, because the fine for it is doubled, and their opportunity cost for driving without a seat belt is greater than the opportunity cost for driving with it (b) Now suppose the city evaluates the policy and finds that the number of fatalities actually increased after the policy was introduced. Can you think of a reason why this may have occurred? Drivers begin to drive more dangerously because since wearing the seatbelt is so important it must make them safe. 6. Consider Jacqueline and Samantha from Section 1.3, who specialize and trade to become better off. Suppose that Jack, and person in town, is deciding between specializing )in either bread or wood) and being self-sufficient. Jack's production possibilities are illustrated below: Jack's Production Possibilities (monthly) Bread (loaves) Wood (cords) 70 0 60 15 50 30 40 45 30 60 20 75 10 90 0 105 If Jack chooses to be self-sufficient, he prefers spending his month making 20 loaves of bread and cutting 75 cords of wood. Determine who has the comparative advantage between a) Jack and Jacqueline In order to calculate the opportunity cost we take what we give up and divide (:) by what we get. The opportunity of Jack spending all his time making bread (expressed per unit of what he gets) is 105 (cords of wood that he could make) :70 (loaves of bread that he makes) = 3/2 cords of wood (opportunity cost for producing only bread) The opportunity cost of Jack spending all his time making wood is 70:105 = 2/3 loaves of bread The opportunity cost of Jacqueline spending all her time making bread is 100:50 = 2 cords of wood The opportunity cost of Jacqueline spending all her time making wood is 50:100 = 1/2 loaves of bread From this, Jack has a comparative advantage in making bread and Jacqueline has a comparative advantage in chopping wood b) Jack and Samantha Jack spending all his time making bread: opportunity cost = 3/2 cords of wood Jack spending all his time making cords: opportunity cost = 2/3 loaves of bread Samantha spending all her time making bread: opportunity cost = 20:40 = 1/2 cords of wood Samantha spending all her time making cords: opportunity cost = 40:20 = 2 loaves of bread From this, Samantha has a comparative advantage in producing bread and Jack has a comparative advantage in producing cords. 7. Before trade Jack decide that he is best at producing 20 loaves of bread and 75 cords of wood. Since, Jack has a competitive advantage over Jacqueline in making bread that's what he would specialize in. After trading with Jacqueline he would end up with 50 loaves of bread and 20 cords of wood, and that would be worse than what he could achieve by being self-sufficient because for the same amount of bread, he can produce 30 cords. Since Jack has a competitive advantage over Samantha in chopping wood, then he would only specialize in wood.After trading with Samantha he would end up with 20 loaves of bread and 85 cords of wood, in which cases he produces the same amount of bread but gains extra 10 cords of wood. Therefore, Jack would choose to go into partnership with Samantha. 8. Back in the old days, professors and students could smoke in the classrooms. Today, smoking indoors in public places is illegal. (a) provide an example of an “external cost” that indoor smokers fail to consider when deciding to light up inside the classroom Internal cost that they do not consider when lighting up a smoke, is the damage of the health of people who do not smoke and do not want to be exposed to smoke, and the harm it brings to their health, maybe then then they would realize that the cost of smoking inside exceeds the benefit they earn from it over the others (b) Do you think that those who smoked indoors considered the “external cost” in their decision to smoke? Why or why not? No, people do not take external cost as a reason for not doing an activity, and therefore they only care about their needs and wants because they keep on smoking indoors (c) Another way to discourage smoking is to tax the activity. If people respond to incentives, how would we expect smokers to adjust behaviour in response to an increase in a cigarette tax? In response to an increase in a cigarette tax, people would be expected to reduce the amount of cigarette packs they buy because prices would rise but their money would still be limited like it was before they rose. 9. Mrs.And Mr. Singh are encouraging both their son and daughter to get a full-time job right after completing high school. According to what you learned from “Economics Out There” on p. 6, which child should they encourage less to go to work? The daughter should be encouraged less to go to work because the earnings she will make with a high school education are smaller to what their son would make with the same education, and by achieving the college degree she would make way more money, whenever the difference for their son would not be significant if he pursues a college degree. 10. From a social point of view, external costs should be included in making smart decisions, but sometimes they are not. In each of the following examples, determine whether the market economy (in the absence of government policy) would result in too few or too many products/services being produced. Then describe one policy or program that the government has in place to force individuals to consider these costs or benefits when they make decisions. (a) pollution levels – too much pollution – government enforces carbon taxes, fines for cars that do not pass emission tests (b) smoking levels – too high – government enforces cigarette taxes, smoking indoors is prohibited by law (c) education levels – too little education – tuition subsidies, loans for students who are stopped from education because of limited money resources, scholarships to motivate students to do better, sponsoring education centres to be able to supply their students with education Chapter 2 – Making Smart Choices. The Law of Demand. Economics is not about money but rather about how individuals, businesses and governments make the best possible choices to get what they want. Smart choices produce happiness, and help governments to spend their tax dollars wisely. Three Keys to Smart Choices are most important for distinguishing smart choices from not-smart. Economists use the term demand to summarize all of the influences on consumer choice. Weighing benefits, costs and substitutes − willingness to buy a product or service depends on your ability to pay comparative benefits and costs, and the availability of substitutes − Preferences – your wants and their intensities − Demand – consumer's willingness and ability to pay for a particular product/service − for any choice, what you are willing to pay or give up depends on the cost and availability of substitutes −
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