lecture 1 handouts

(1)

Perspectives in Economics

Lecture 1:

Introduction

(2)

1

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Perspectives in Economics



2 nd

Term, 2013-2014



Monday 8:30am-11:15am ELB LT4



Instructor:

Shuaizhang Feng

[email protected]



Teaching Assistant:



Yujie Han [email protected]

(3)

Perspectives in Economics



Required Textbook



Mankiw, N. Gregory (2012),

Essentials of Economics

,

6 th

_{edition, Thomson South-Western. [Mankiw]}



We will follow the textbook closely



It is highly advised that you own a copy of the textbook



You can buy one from the bookstore



Other references listed on syllabus are not required



Course handouts will be posted on the following website:



https://sites.google.com/site/shuaizhangfeng/econ1010k

(4)

3 Perspectives in Economics

Week

Date

Topics

Textbook

Chapter

1 13-Jan

Rationality, What, When, How, Whom

1 & 2

2 20-Jan

Demand and Supply: Theory

4

3 27-Jan

Demand and Supply: Elasticity

5

4 3-Feb

Public Holiday (no Class)

5 10-Feb

Demand and Supply: Government policy

6 & 7

6 17-Feb

Welfare Economics [Quiz #1]

8

7 24-Feb

International Trade

3 & 9

8 3-Mar

Production and competitive firms

12 & 13

9 10-Mar

GDP & CPI

15 & 16

10 17-Mar

Unemployment [Quiz #2]

20

11 24-Mar

Monetary system

21

12 31-Mar

Inflation

22

13 7-Apr

Aggregate Demand and Supply

23

14 14-Apr

Final exam

(5)

Perspectives in Economics



Assessments



Your final grade is awarded according to the

following methods and percentages:



Class participation 10%



Two Quizzes

40%



Final examination

50%



NOTE: Final Exam will be taken on April 14,

2014, the last regular class day.

(6)

1 Ten Principles of

Economics

PowerPoint

Premium

Slides by

Ron Cronovich

2012 UPDATE

N. Gregory Mankiw

E

conomics

Essentials of

(7)

In this chapter,

look for the answers to these questions:

• What kinds of questions does economics

address?

• What are the principles of how people make

decisions?

• What are the principles of how people interact?

• What are the principles of how the economy as

a whole works?

(8)

7 What Economics Is All About



Scarcity

: the limited nature of society’s

resources



Economics

: the study of how society manages

its scarce resources, e.g.



how people decide what to buy,

how much to work, save, and spend



how firms decide how much to produce,

how many workers to hire



how society decides how to divide its resources

between national defense, consumer goods,

(9)

What is Economics?



Economics is the study of how people choose to

use resources.



"Economics is the study of people in the ordinary

business of life."

--

Alfred Marshall

,

Principles of economics; an

introductory volume

(London: Macmillan, 1890)



"Economics is the science which studies human

behavior as a relationship between given ends

and scarce means which have alternative uses."

(10)

The principles of

HOW PEOPLE

MAKE DECISIONS

(11)

PRINCIPLE #1:

People Face Tradeoffs

All decisions involve tradeoffs.

(There is no free lunch)

Examples:



Going to a party the night before your midterm

leaves less time for studying.



Having more money to buy stuff requires working

longer hours, which leaves less time

for leisure.



Protecting the environment requires resources

that could otherwise be used to produce

(12)

11 PRINCIPLE #1:

People Face Tradeoffs



Society faces an important tradeoff:

efficiency vs. equality



Efficiency

: when society gets the most from its

scarce resources



Equality

: when prosperity is distributed

uniformly among society’s members



Tradeoff: To achieve greater equality,

could redistribute income from wealthy to poor.

But this reduces incentive to work and produce,

shrinks the size of the economic “pie.”

(13)

PRINCIPLE #2:

The Cost of Something Is

What You Give Up to Get It



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.

(14)

13 PRINCIPLE #2:

The Cost of Something Is

What You Give Up to Get It

Examples:

The opportunity cost of…

…going to college for a year is not just the tuition,

books, and fees, but also the foregone wages.

…seeing a movie is not just the price of the ticket,

(15)

PRINCIPLE #3:

Rational People Think at the Margin

Rational people



systematically and purposefully do the best they

can to achieve their objectives.



make decisions by evaluating costs and benefits

of

marginal changes

, incremental adjustments

to an existing plan.

(16)

15 PRINCIPLE #3:

Rational People Think at the Margin

Examples:



When a student considers whether to go to

college for an additional year, he compares the

fees & foregone wages to the extra income

he could earn with the extra year of education.



When a manager considers whether to increase

output, she compares the cost of the needed

(17)

PRINCIPLE #4:

People Respond to Incentives



Incentive

: something that induces a person to

act, i.e.

the prospect of a reward or punishment.



Rational people respond to incentives.

Examples:



When gas prices rise, consumers buy more

hybrid cars and fewer gas guzzling SUVs.



When cigarette taxes increase,

(18)

The principles of

HOW PEOPLE

INTERACT

(19)

PRINCIPLE #5:

Trade Can Make Everyone Better Off



Rather than being self-sufficient,

people can specialize in producing one good or

service and exchange it for other goods.



Countries also benefit from trade and

specialization:



Get a better price abroad for goods they

produce



Buy other goods more cheaply from abroad

than could be produced at home

(20)

19 PRINCIPLE #6:

Markets Are Usually A Good Way to

Organize Economic Activity



Market

: a group of buyers and sellers

(need not be in a single location)



“Organize economic activity” means determining



what goods to produce



how to produce them



how much of each to produce



who gets them

(21)

PRINCIPLE #6:

Markets Are Usually A Good Way to

Organize Economic Activity



A

market economy

allocates resources through

the decentralized decisions of many households

and firms as they interact in markets.



Famous insight by Adam Smith in

The Wealth of Nations

(1776):

Each of these households and firms

acts as if “led by an invisible hand”

(22)

21 PRINCIPLE #6:

Markets Are Usually A Good Way to

Organize Economic Activity



The invisible hand works through the price

system:



The interaction of buyers and sellers

determines prices.



Each price reflects the good’s value to buyers

and the cost of producing the good.



Prices guide self-interested households and

firms to make decisions that, in many cases,

maximize society’s economic well-being.

(23)

PRINCIPLE #7:

Governments Can Sometimes

Improve Market Outcomes



Important role for govt:

enforce property rights

(with police, courts)



People are less inclined to work, produce,

invest, or purchase if large risk of their property

being stolen.

(24)

23 PRINCIPLE #7:

Governments Can Sometimes

Improve Market Outcomes



Market failure:

when the market fails to allocate

society’s resources efficiently



Causes of market failure:



Externalities

, when the production or consumption

of a good affects bystanders (e.g. pollution)



Market power

, a single buyer or seller has

substantial influence on market price

(e.g. monopoly)

(25)

PRINCIPLE #7:

Governments Can Sometimes

Improve Market Outcomes



Govt may alter market outcome to

promote equity

.



If the market’s distribution of economic well-being

is not desirable, tax or welfare policies can

(26)

The principles of

HOW THE

ECONOMY

AS A WHOLE

(27)

PRINCIPLE #8:

A Country’s Standard of Living Depends

on Its Ability to Produce Goods & Services



Huge variation in living standards across

countries and over time:



Average income in rich countries is more than

ten times average income in poor countries.



The U.S. standard of living today is about

(28)

27 PRINCIPLE #8:

A Country’s Standard of Living Depends

on Its Ability to Produce Goods & Services



The most important determinant of living

standards:

productivity

, the amount of goods

and services produced per unit of labor.



Productivity depends on the equipment, skills,

and technology available to workers.



Other factors (e.g., labor unions, competition from

abroad) have far less impact on living standards.

(29)

PRINCIPLE #9:

Prices Rise When the Government Prints

Too Much Money



Inflation

: increases in the general level of prices.



In the long run, inflation is almost always caused

by excessive growth in the quantity of money,

which causes the value of money to fall.



The faster the govt creates money,

the greater the inflation rate.

(30)

29 PRINCIPLE #10:

Society Faces a Short-run Tradeoff

Between Inflation and Unemployment



In the short-run (1–2 years),

many economic policies push inflation and

unemployment in opposite directions.



Other factors can make this tradeoff more or less

favorable, but the tradeoff is always present.

(31)

FYI: How to Read Your Textbook

1 .

Read before class.

You’ll get more out of class.

2 .

Summarize, don’t highlight.

Highlighting is a passive activity that won’t

improve your comprehension or retention.

Instead, summarize each section in your own

words. Then, compare your summary to the one

at the end of the chapter.

(32)

31 FYI: How to Read Your Textbook

3 .

Test yourself.

Try the “Quick Quiz” that follows each section

before moving on to the next section.

Write your answers down, compare them to the

answers in the back of the book. If your answers

are incorrect, review the section before moving on.

4 .

Practice, practice, practice.

Work through the end-of-chapter review questions

and problems. They are often good practice for

the exams. And the more you use your new

(33)

FYI: How to Read Your Textbook

5 .

Go online.

The book comes with excellent web resources,

including practice quizzes, tools to strengthen

your graphing skills, helpful video clips, and other

resources to help you learn the textbook material

more easily and effectively. Visit:

http://academic.cengage.com/economics/mankiw

6 .

Study in groups.

Get together with a few classmates to review each

chapter, quiz each other, and help each other

(34)

33 FYI: How to Read Your Textbook

7 .

Teach someone.

The best way to learn something is to teach it to

someone else, such as a study partner or friend.

8 .

Don’t skip the real world examples.

Read the Case Studies and “In The News” boxes

in each chapter. They will help you see how the

new terms, concepts, models, and graphs apply to

the real world. As you read the newspaper or

watch the evening news, see if you can find the

connections with what you’re learning in the

(35)

S U M M A R Y

The principles of decision making are:

• People face tradeoffs.

• The cost of any action is measured in terms of

foregone opportunities.

• Rational people make decisions by comparing

marginal costs and marginal benefits.

(36)

S U M M A R Y

The principles of interactions among people are:

• Trade can be mutually beneficial.

• Markets are usually a good way of coordinating

trade.

• Govt can potentially improve market outcomes if

there is a market failure or if the market outcome

is inequitable.

(37)

S U M M A R Y

The principles of the economy as a whole are:

• Productivity is the ultimate source of living

standards.

• Money growth is the ultimate source of inflation.

• Society faces a short-run tradeoff between

inflation and unemployment.

(38)

2 Thinking Like an

Economist

PowerPoint

Premium

Slides by

Ron Cronovich

2013 UPDATE

N. Gregory Mankiw

E

conomics

Essentials of

(39)

In this chapter,

look for the answers to these questions:

• What are economists’ two roles? How do they differ?

• What are models? How do economists use them?

• What are the elements of the Circular-Flow Diagram?

What concepts does the diagram illustrate?

• How is the Production Possibilities Frontier related

to opportunity cost? What other concepts does it

illustrate?

(40)

39 The Economist as Scientist



Economists play two roles:

1. Scientists: try to explain the world

2. Policy advisors: try to improve it



In the first, economists employ the

scientific method

,

the dispassionate development and testing of

theories about how the world works.

(41)

Assumptions & Models



Assumptions simplify the complex world,

make it easier to understand.



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.

(42)

41 Some Familiar Models

(43)

Some Familiar Models

A model of human

anatomy from high

school biology class

(44)

43 Some Familiar Models

(45)

Some Familiar Models

The model teeth at the

dentist’s office

Don’t forget

(46)

45 Our First Model:

The Circular-Flow Diagram



The

Circular-Flow Diagram

: a visual model of

the economy, shows how dollars flow through

markets among households and firms



Two types of “actors”:



households



firms



Two markets:



the market for goods and services



the market for “factors of production”

(47)

Factors of Production



Factors of production

: the resources the

economy uses to produce goods & services,

including



labor



land



capital (buildings & machines used in

production)

(48)

47 FIGURE 1:

The Circular-Flow Diagram

Households

:



Own the factors of production,

sell/rent them to firms for income



Buy and consume goods & services

Households

Firms

:



Buy/hire factors of production,

use them to produce goods

and services

(49)

FIGURE 1:

The Circular-Flow Diagram

Markets for

Factors of

Households

Firms

Factors of

production

Labor, land,

capital

Spending

G & S

bought

G & S

sold

Revenue

Markets for

Goods &

Services

(50)

49 Our Second Model:

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



Example:



Two goods: computers and wheat



One resource: labor (measured in hours)



Economy has 50,000 labor hours per month

(51)

PPF Example



Producing one computer requires 100 hours labor.



Producing one ton of wheat requires 10 hours labor.

2,500

250 1,000

400 25,000

25,000

10,000

40,000

0

500

0 50,000

C

B

A

Wheat

Computers

Wheat

Computers

Production

Employment of

labor hours

(52)

Point

on

graph

Production

Com-puters

Wheat

A

500

0 B

400 1,000

C

250 2,500

D

100 4,000

E

0 5,000

0 1,000

2,000

3,000

4,000

5,000

6,000

0 100 200 300 400 500 600

Computers

Wheat

(tons)

A

B

C

D

E

PPF Example

51

(53)

The PPF: What We Know So Far

Points on the PPF (like

A

–

E

)



possible



efficient: all resources are fully utilized

Points under the PPF (like

F

)



possible



not efficient: some resources underutilized

(e.g., workers unemployed, factories idle)

Points above the PPF (like

G

)

(54)

53 The PPF and Opportunity Cost



Recall: The

opportunity cost

of an item

is what must be given up to obtain that item.



Moving along a PPF involves shifting resources

(e.g., labor) from the production of one good to

the other.



Society faces a tradeoff: Getting more of one

good requires sacrificing some of the other.



The slope of the PPF tells you the opportunity

cost of one good in terms of the other.

(55)

The PPF and Opportunity Cost

The slope of a line

equals the

“

rise

over the run,”

the amount the line

rises when you

move to the right by

one unit.

0 1,000

2,000

3,000

4,000

5,000

6,000

0 100 200 300 400 500 600

Wheat

(tons)

–1000

100 slope =

= –10

Here, the

opportunity cost of

a computer is

(56)

55 Economic Growth and the PPF

With additional

resources or an

improvement in

technology,

the economy can

produce more

computers,

0 1,000

2,000

3,000

4,000

5,000

6,000

0 100 200 300 400 500 600

Computers

Wheat

(tons)

more wheat,

or any combination

in between.

Economic

growth shifts

the PPF

(57)

The Shape of the PPF



The PPF could be a straight line or bow-shaped



Depends on what happens to opportunity cost

as economy shifts resources from one industry

to the other.



If opp. cost remains constant,

PPF is a straight line.

(In the previous example, opp. cost of a

computer was always 10 tons of wheat.)

(58)

57 Why the PPF Might Be Bow-Shaped

Mountain

Bikes

Be

er

As the economy

shifts resources

from beer to

mountain bikes:



PPF becomes

steeper



opp. cost of

mountain bikes

increases

(59)

Why the PPF Might Be Bow-Shaped

At point

A

,

most workers are

producing beer,

even those who

are better suited

to building bikes.

So, do not have to

give up much beer

to get more bikes.

A

Mountain

Be

er

At

A

, opp. cost of

(60)

59 Why the PPF Might Be Bow-Shaped

At

B

, most workers

are producing bikes.

The few left in beer

are the best brewers.

Producing more

bikes would require

shifting some of the

best brewers away

from beer production,

causing a big drop in

beer output.

B

Mountain

Bikes

Be

er

_At

_B

_{, opp. cost}

of mtn bikes

is high.

(61)

Why the PPF Might Be Bow-Shaped



So, PPF is bow-shaped when different workers

have different skills, different opportunity costs of

producing one good in terms of the other.



The PPF would also be bow-shaped when there

is some other resource, or mix of resources with

varying opportunity costs

(E.g., different types of land suited for

different uses).

(62)

61 The PPF: A Summary



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

tradeoff and opportunity cost,

efficiency and inefficiency,

unemployment, and economic growth.



A bow-shaped PPF illustrates the concept of

increasing opportunity cost.

(63)

Microeconomics and Macroeconomics



Microeconomics

is the study of how

households and firms make decisions and how

they interact in markets.



Macroeconomics

is the study of economy-wide

phenomena, including inflation, unemployment,

and economic growth.



These two branches of economics are closely

intertwined, yet distinct—they address different

questions.

(64)

The Economist as Policy Advisor



As scientists, economists make

positive statements

,

which attempt to describe the world as it is.



As policy advisors, economists make

normative statements

,

which attempt to prescribe how the world should be.



Positive statements can be confirmed or refuted,

normative statements cannot.



Govt employs many economists for policy advice.

E.g.

,

the U.S. President has a

Council of Economic

Advisors

, which the author of this textbook chaired

from 2003 to 2005.

(65)

Why Economists Disagree



Economists often give conflicting policy advice.



They sometimes disagree about the validity of

alternative positive theories about the world.



They may have different values and, therefore,

different normative views about what policy

should try to accomplish.



Yet, there are many propositions about which

most economists agree.

(66)

65 Propositions about Which Most

Economists Agree

(and % who agree)



A ceiling on rents reduces the quantity and quality

of housing available. (93%)



Tariffs and import quotas usually reduce general

economic welfare. (93%)



The United States should not restrict employers

from outsourcing work to foreign countries. (90%)



The United States should eliminate agriculture

subsidies. (85%)

(67)

Propositions about Which Most

Economists Agree

(and % agreeing)



The gap between Social Security funds and

expenditures will become unsustainably large

within the next fifty years if current policies remain

unchanged. (85%)



A large federal budget deficit has an adverse effect

on the economy. (83%)



A minimum wage increases unemployment among

young and unskilled workers. (79%)

(68)

FYI:

Who Studies Economics?



Ronald Reagan, President of the United States



Barbara Boxer, U.S. Senator



Sandra Day-O’Connor, Former Supreme Court Justice



Anthony Zinni, Former General, U.S. Marine Corps



Kofi Annan, Former Secretary General, United Nations



Meg Witman, Chief Executive Officer, eBay



Steve Ballmer, Chief Executive Officer, Microsoft



Arnold Schwarzenegger, Former Gov. of California, Actor



Ben Stein, Political Speechwriter, Actor, Game Show Host



Mick Jagger, Singer for the Rolling Stones



John Elway, NFL Quarterback



Tiger Woods, Golfer



Diane von Furstenburg, Fashion Designer

(69)

S U M M A R Y

• As scientists, economists try to explain the world

using models with appropriate assumptions.

• Two simple models are the Circular-Flow Diagram

and the Production Possibilities Frontier.

• Microeconomics studies the behavior of

consumers and firms, and their interactions in

markets. Macroeconomics studies the economy

as a whole.