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Economy-"One Chapter who manages a household" Scarcity-the limited nature of society's resources -A society cannot give every citizen the life style they might aspire to. Economics- is the study of how society manages its scarce resources. (The first four principles of economics is how people make decisions) Principle #1: People Face Tradeoffs Giving up one thing you like for another to achieve a goal. Examples How to spend your time. How to spend money. We spend money on national defense (guns) instead of on consumer goods (butter) Society faces the trade between efficiency and equity. Efficiency- the property of society getting the most it can from its scarce resources.(THE PIE) Equity-the property of distributing economic prosperity fairly among the members of society. (HOW THE PIE IS DIVIDED) Government policies of cause these two goals to conflict. Example When government redistributes wealth (graduated income tax motivates people to work less hard) It is less efficient the pie becomes smaller but it become more equitable.
Principle #2 The Cost of Something is what you give up to get it 1. Need to consider all expenditures that would take place with either option 2. Take into consideration the time you are required to spend. You could have been working a job. Opportunity Cost- Whatever must be given up to obtain some item. High school athletes that could go pro or go to college understand how high their opportunity cost of going to college would be and often choose to go pro. Principle #3 Rational People Think at the Margin There are marginal benefits and costs The reason people are willing to pay much more for a diamond than a cup of water. The reason is that a person's willingness to pay for any good is based on the marginal benefit that an extra unit of the good would yield. Marginal benefits depend on how many units a person already has.
Extra water is not very beneficial because it is so plentiful. Rational People-people who systematically and purposefully do the best they can to achieve their objectives. Marginal Changes-small incremental adjustments to a plan of action. Margin means "edge" So marginal changes are adjustments around the edges of what you are doing.
Example The marginal cost of allowing standby customers to buy tickets below the cost of the expense to the airline is the cost of the peanuts and soda they drink. Because Otherwise the airline would just have empty seats.
Principle #4: People Respond to Incentives Incentive- Something that induces a person to act Example A punishment or a reward. Placing a tax on gasoline causes people to drive smaller more fuel efficient cars Bad weather is an incentive to drive more slowly Car safety laws such as seatbelts are an incentive for drivers to drive faster. This incentive has an adverse effect because faster driving= more accidents with less deaths because of the safety. (The next three principles discuss how people interact with each other) Principle 5: Trade can make everyone better off Don't be misled by the idea that competition is bad. You would not be better off to be isolated. You would have inferior products and less variety because you would have to produce everything yourself. Trade allows people to specialize in a specific area and make that product the cheapest and fastest they can. It allows for people to obtain a variety of goods. 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 guided by prices and self interest. 1776 Adam Smith wrote the book An inquiry into the Nature and Causes of the Wealth of Nations. Prices guided by the invisible Hand.
Prices are the instrument with which the invisible hand directs economic activity. When the government prevents prices from adjusting naturally it impedes the invisible hand's ability to coordinate the millions of households and firms that make up the economy. Principle 7: Governments can sometimes improve market outcomes Governments are needed to maintain a good environment for a free market to flourish. The invisible hand counts on our ability to enforce our rights. Property rights- The ability of an individual to own and exercise control over scarce resources. Government's goal and sometimes success is when they produce more equity and efficiency in the market. Sometimes the market system can fail. Market failure- A situation in which a market left on its own fails to allocate resources efficiently. Externalities can cause market failures Externality-The impact of one person's actions on the well being of a bystander. Ex. Pollution Market power can also cause a market failure. Market Power- the ability of a single economic actor (or small group of actors (cartel)) to have a substantial influence on market prices The Invisible hand is not equitable because it rewards people who are able to produce things other people are willing to pay for. The government uses programs such as income tax and welfare to redistribute wealth more evenly. (the next three principles concern the workings of the economy as a whole) Principle 8: A country's standard of living depends on its ability to produce goods and services Productivity- The quantity of goods and services produced from each hour of a worker's time. Almost all variations in living standards is attributable to differences in countries' productivity. Don't credit labor unions or minimum wage laws for good standards of living
Don't blame competition for slow growing incomes in the 70's and 80's\ If policy makers want to improve standards of living they should focus on boosting productivity by ensuring that workers are well educated, have the tools needed and have the best available technology. Principle 9: Prices rise when the government prints too much money Inflation- An increase in the overall level of prices in the economy. More money = higher prices Principle 10: Society faces a short-run trade-off between inflation and unemployment Government can produce quick fixes. Injecting money into the economy induces more spending and which creates a higher demand for goods and services. Higher demand over time may cause prices to increase but in the meantime it encourages them to increase productivity (more goods) and to hire more workers More workers = less unemployment Policy makers can push unemployment and inflation in opposite directions. More inflation = less unemployment and vise versa. Business Cycle- fluctuations in economic activity, such as employment and production. Government can influence inflation and employment by how much it spends, taxes, and money it prints. These issues are subject to continuing debate. Questions for Review 1. Tradeoffs- sleep or work Study accounting or economics Eat or exercise 2. The opportunity cost of seeing a movie is the money I spend on a ticket and the time I spend watching the movie in which I could be doing something more productive. 3. Marginal Cost of a glass of water is small because it is so abundant. 4. Policy makers should think about incentives because their policies can produce negative and positive incentives. 5. Because everyone is better off when you trade. Specialization allows higher quality and higher quantity. 6. Set the price at which buyers wish to buy and sellers wish to sell. 7. Externalities- Trade between two people causes affects to a third party pollution. Market Powers- Monopolies or cartels control the price of a product
8. Productivity is important because higher productivity produces higher standards of living and higher average incomes. 9. Inflation is when money goes down in value. Increased money supply causes deflation. 10. Inflation and unemployment are related in the short term. Injecting money into the economy stimulates spending which creates a higher demand which causes companies to produce more and higher more employees. Injecting the money into the economy decreases the value of the money. Problems and applications. Chapter 2 The Circular Flow-Diagram- a visual model of the economy that shows how dollars flow through markets among households and firms. There are two types of decision makers in this model households and firms. In the markets for goods and services households are buyers and firms are sellers In the Markets for factors of Production households are the sellers and firms are the buyers. Factors of production- (Inputs) labor, land, capital (buildings and machines) The Production Possibilities Frontier Graph p. 24 The production possibilities frontier shows the combinations of out put that the economy can produce. The economy can produce any combination on or inside the frontier. Points outside the frontier are not feasible given the economy's resources. This most relate to one of the ten principles of economics- People face tradeoffs. You can produce more computers but you will have to produce less cars. People look at the opportunity costs. The opportunity costs are the highest at the ends of the graph as they approach they approach the axis because you would be trading off workers that are best in that industry to have them go do something else they are not as good at. Maybe your super duper nerd can make five computers a day but could only make half a car a day, whereas the regular car guy could make a whole car but could only make one computer. A Shift in the Production Possibilities Frontier- a technological advance in an industry enable the economy to produce more of a product fro any given number of another. As a result the production possibilities shift outward. Page 26 If advances in production are made so that a single worker can produce more products then this expands society's set of opportunities.
Microeconomics-The study of how households and firms make decisions and how they interact in markets. Macroeconomics- the study of economy-wide phenomena, including inflation, unemployment, and economic growth. Positive Statements- Claims that attempt to describe the world as it is. Normative Statements-Claims that attempt to prescribe how the world should be Chapter 3 pg. 48-58 Production Possiblities- People trade with each other because they want variety and because they can specialize and produce a mass of one thing at a cheaper cost than trying to make everything they need. Example- Potato Farmer and the Cattle Rancher. They want to trade so they can have steak and potatoes. The production frontier is straight lined in this example and greatly depends on the tastes of the farmer and rancher. Example- Robinson Crusoe can spend time fishing or collecting coconuts. What happens if he can trade with natives and specialize in collecting coconuts. He would collect lots more coconuts and probably get better at it. He could let they native fishermen focus their efforts on fishing and they can catch more fish and they can both have more of what they want. Comparative Advantage: The Driving Force of Specialization. Absolute Advantage- the ability to produce a good using fewer inputs than another producer. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. Opportunity cost- whatever must be given up to obtain some item. Comparative Advantage- The ability to produce a good at a lower opportunity cost than another producer. It is possible for one person to have an absolute advantage in both goods. It is impossible for one person to have a comparative advantage in both goods. The opportunity cost of one good is the inverse of the opportunity cost of the other. If the opportunity cost of one good is relatively high the opportunity cost of the cost of the other good must be relatively low. Comparative advantage and trade
When each person specializes in producing the product that they have a comparative advantage in the whole economic pie increases (efficiency). The price at which they trade must lie between the two opportunity costs. As long as the trading price lies somewhere in this range each party will benefit by buying a good at a price that is lower than his or her opportunity cost. Example page 54 quick quiz muy buien. Adam Smith knew about comparative advantage. David Ricardo was inspired by Adam Smith's book and became an economist. In 1817 he wrote the book Principles of Political Economy and Taxation. Ricardo developed the principle of comparative advantage as we know it today. Applications of Comparative Advantage Examples Should Tiger Woods mow his lawn? He can do it faster than anyone else he has the absolute advantage. But the boy next door has a lower opportunity cost and has the comparative advantage. Because tiger could spend the same time he would be mowing his lawn shooting commercials or promoting products. Imports- goods produced abroad and sold domestically. Exports- goods produced domestically and sold abroad. the Should United States Trade with other Countries? Japan and America can produce cars at the same rate. But an American worker can produce two tons in the same time it takes a Japanese worker to produce one. Each country has a comparative advantage in the product for which they have a lower opportunity cost. The U.S. has a comparative advantage producing food and Japan has a comparative advantage producing cars. Trade with other countries is sometimes make some people in the country worse off as it makes both countries better off as a whole.
Chapter 4 The Market Forces of Supply and Demand pgs 64-83 Markets and Competition Market- a group of buyers and sellers of a particular good or service. Buyers determine the demand Sellers determine the supply Competitive Market- a market in which there are many buyers and many sellers so that each has a negligible impact on the market price. Sellers have limited control over the price of their product because other sellers are offering similar products. No buyer has control over the price of ice cream because each buyer purchases only a small amount. TWO characteristics necessary to have a perfectly competitive market are 1. the goods offered for sale must be the same 2. the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Price takers buyers and sellers accept the price the market determines. One seller = monopoly Demand The Demand Curve: The Relationship between Price and Quantity Demanded. Quantity demanded- the amount of a good that buyers are willing and able to purchase. The price of a good is a central role in determining Demand. Law of Demand- the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises. Demand Schedule- a table that shows the relationship between the price of a good and the quantity demanded. Price is always on the vertical axis Demand is always on the horizontal axis
Demand Curve- a graph of the relationship between the price of a good and the quantity demanded.
Variables that factor Demand Incomemore money equals higher demand less money less demand Normal Good- a good for which other things equal, and increase in income leads to a increase in demand. Inferior Good- a good for which, and increase in income leads to a decrease in demand. If you lose you job these things would be in higher demand. (bus rides) As income falls you are more likely to buy these. Price of Related GoodsExample- if the price of frozen yogurt drops the demand for ice cream drops and the demand for frozen yogurt rises. The frozen yogurt is a substitute for ice cream because they are both frozen creamy deserts. Substitutes- Two goods for which an increase in the price of one leads to a decrease in the demand for the other. Examples Hot dogs-Hamburgers, sweaters-sweatshirts, movie tickets- movie rentals Complements-two goods for which an increase in the price of one leads to a decrease in the demand for the other or decrease in the price of on leads to a increase in the demand for another. ExamplesHot Fudge-Ice Cream, gasoline-automobiles, computers-software, peanut butter-jelly TastesIf people like something more they will buy it more. Economists don't try and explain tastes but they do examine what happens when tastes change. ExpectationsIf you expect to earn more next month you will probably be more willing to spend and not save. If you expect the price of something to drop you probably won't buy it until it does. Number of BuyersDemand changes depending on the Number of Buyers. Important summary stuff
When there is a change in price you move along the demand curve. If there is a change in one of the variables just listed there is Shift to the left or right of the entire curve. Page 70 graph of smoking cigarettes illustrates this very well.
Supply The Supply Curve: The Relationship between Price and Quantity Supplied Quantity supplied- the amount of a good that sellers are willing and able to sell Price plays a special role. When the price of something is high it is profitable to produce that product so the quantity supplied is large. Because the quantity supplied rises as the price rises and falls as the price falls, we say that the quantity supplied is positively related to the price of the good. Law of Supply-the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. When the price falls the supply falls Supply Schedule-a table that shows the relationship between the price of a good and the quantity supplied. Supply Curve- a graph of the relationship between the price of a good and the quantity supplied. Market supply is the sum of the supplies of all sellers. Shifts in the Supply Curve Any change that raises the quantity that sellers wish to produce at a given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at a given price shifts the supply curve to the left. Example- Decrease in the price of sugar causes shift to the right because making ice cream becomes more profitable and more people will want to do it. Variables that shift the Supply Curve Input PricesExample for ice cream Prices of cream, sugar, flavoring, ice cream machines, buildings If an input decreases in price the product becomes more profitable to make. Vice versa Decrease input price shift to the right more suppliers
Increase input price- shift to the left less suppliers TechnologyAdvances in technology can raise supply because firms can produce a product at a cheaper price. ExpectationsIf a firm expects the price of a product to rise in the future it will put some of its current production into storage and supply less. Number of SellersIf there are more sellers there is more supply. Less sellers=less supply If Ben and Jerry's retired there company. The supply would decrease Remember that a curve shifts only when there is a change in a relevant variable that is not named on either axis.
Supply and Demand Together Equilibrium- a situation in which the market price has reached the level at which quantity supplied equals quantity demanded. Equilibrium Price- the price that balances quantity supplied and quantity demanded. Equilibrium Quantity-the quantity supplied and the quantity demanded at the equilibrium price. Surplus- a situation in which quantity supplied is greater than quantity demanded. People don't want to pay the price so the supplier has lots of inventory Shortage- a situation in which quantity demanded is greater than quantity supplied. Sometimes called excess demand The supplier's price is so low there is not enough of the product to satisfy the demand of everyone that wants it. Customers have to wait a long time to get there desired product because so little is available. Law of Supply and Demand- the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. Three Steps to Analyzing Changes in Equilibrium The equilibrium depends on the positions of the supply and demand curves. Steps 1. We decide whether the event shifts the supply curve, the demand curve or both.
2. We decided whether the curve shifts to the left or right. 3. We us the supply-and-demand curve to campare the initial and new equilibrium which shows how the shift affects the equilibrium price and quantity.
Example change in demand Hotter summer so more people demand more ice cream This shifts the demand curve to the right. For a higher price and higher quantity. Shifts in Curves versus Movements along Curves Referring to the example when the hot weather comes it changes the demand and the demand curve moves to the right essentially up the supply curve. A shift in the supply curve is called change in supply and shift in demand is called change in demand A movement a long a fixed supply curve is called change in quantity supplied A movement a long a fixed demand curve is called change in the quantity demanded Example of change in supply A hurricane destroys sugar cane crops and drives up the price of sugar. The change in price affects the supply curve because it cost more to make the ice cream. ( the inputs cost more) The hurricane doesn't change how much ice cream consumers wish to buy so the demand curve stays put. The supply curve is shifted to the left because at every price the total amount firms wish and are able to sell is reduced. The equilibrium price is raised and the quantity is lowered. Example of change in both supply and demand Heat wave and a hurricane The inputs increase as well as demand. The supply curve moves to the left and the demand moves to the right There are two possible out comes from this event. Both will create higher prices. The quantity depends on the size of the supply decrease and the size of the demand increase. Summary of chapter 4 When you go to the store to buy something you contribute to demand When you look for a job you are contributing to the supply of labor services Markets are usually a good way to organize economic activity. Markets harness the forces of supply and demand to determine prices which in turn allocate scarce resources. This decentralized system works well and doesn't break into chaos because of prices which are guided by the invisible hand.
Chapter 5
Elasticity-a measure of the responsiveness of quantity demanded or quantity supplied. Price Elasticity of Demand- a measure of how much the quantity demanded of a good responds to a change in the price of that good computed as the percentage change in quantity demanded divided by the percentage change in price. Total Revenue-the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold. Income elasticity of demand-a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income. Cross-Price Elasticity of demand-a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good. Price elasticity of supply- a measure of how much the quantity supplied divided by the percentage change in price
Chapter 6
Controls on Prices Price ceiling- a legal maximum on the price at which a good can be sold. Price Floor- a legal minimum on the price at which a good can be sold. When a ceiling is placed above the market equilibrium it is not binding. If the ceiling is set below the equilibrium price it is a binding constraint on the market. A ceiling intended to help the buyers can actually hurt the buyer buy making an ice cream shortage if the ceiling is set below the equilibrium point. When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and the sellers must ration the scarce goods among the number of potential buyers. Rent Control is the best way to destroy a city other than bombing. In the short run rent control reduces the cost of rent
But in the long run it creates a large shortage. It takes a while to reach this large shortage because the market for apartments in inelastic. Remember People Respond to Incentives if you take away the incentive for a land lord to keep his apartments nice he won't. Incentives induce action. Undesirable Landlord behavior is a result of price ceiling that imposes a binding restraint on the market. Less laws are necessary and prices control the behavior in the market. How Price Floors affect Market outcomes If a floor is set above the equilibrium it will cause a surplus. At the higher price more sellers are willing to sell. But less people are willing to pay the higher price set by the floor. Just like a ceiling it causes undesirable ration mechanisms, so can price floors and surpluses. Sellers able to appeal to the personal bias of the buyer due to race, family ties, are better able to sell their goods. The Key is that in a free market the price serves as a rationing mechanism and sellers can sell all they want at the equilibrium price.
Evaluating Price Controls Markets are usually a good way to organize economic activity is the principle why most economists appose price controls. When policy makers set prices they obscure the signals (prices) that usually guide the allocation of scarce resources. Another principle Governments can sometimes improve market outcomes. But price controls usually hurt those they are trying to help. In the example of rent it causes the landlords to not maintain their buildings, be nice to tenants, and it also caused a shortage of apartments. One thing government can do to not affect the supply and demand curve is to offer rent subsidies to the poor. Tax Incidence- the manner in which the burden of a tax is shared among participants in a market. Recommend