Econ_112_Spr08_012308 - 1-23-08 Econ 112:013 Principles of...

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Unformatted text preview: 1-23-08 Econ 112:013 Principles of Microeconomics Professor: Dennis Heffley Grad Assistants: Fei Fei (013D, 014D) Maura Williams (015D, 019D) Leshui He (016D, 017D, 022D) Jennifer Skiba (020D, 021D) Parag Waknis (018D, 023D, 024D) Agenda Course syllabus Text (Microeconomics: A Contemporary Introduction, 7th ed., William A. McEachern, Thomson/South-Western, 2006) Aplia demo by Matt Genaway (Cengage) Readings, assignments & exams posted in Aplia "Course Outline"; other items in "Course Materials" "Graded" exercises or quizzes in Aplia have strict deadlines with no make-ups; normally due Sunday evenings at 11:45 pm. More things to note... In-class exams: First Exam (25%): W 2/27, Chapters 1-6 plus lectures, sections, Aplia, handouts, and additional readings. Second Exam (25%): W 4/9, Chapters 7-10 plus lectures, Aplia, handouts, and additional readings. Make-up Exam: W 4/23 (6-8 pm). Final Exam (35%): Mon 5/5, Chapters 1-12 and 15-18, plus lectures, Aplia, handouts, and additional readings. Improvement will be rewarded (see "Grading Policy") Aplia assignments (10%) Discussion sections (5%) I reserve the right to make other assignments and adjust grading weights depending on material covered in each exam and the number of other assignments. A Word About Cheating... Don't University's policy on cheating or other forms of academic misconduct at: Other stuff... My office hours: MW 8 - 10 am, Monteith 348 GAs' office hours: To be announced in sections Aplia website: Payment options and registration instructions at end of syllabus, but Matt Genaway (Cengage) will further review these and demonstrate Aplia. Economics: a quick, cheap tour What economics isn't Much broader than most people imagine Some examples from the Am. Economic Review: "Superstition and rational learning" "The quiet revolution that transformed women's employment, education, and family" "The evolution of a global climate change agreement" "Israel, the Palestinian factions, and the cycle of violence" "Did Medicare induce pharmaceutical innovation?" "Point-shaving: corruption in NCAA basketball" "White-collar crime writ small: a case study of bagels, donuts, and the honor system" The Economic Problem Virtually unlimited wants or desires Scarce resources or "inputs" (physical and human capital, natural resources, entrepreneurship) available to produce the goods and services needed to satisfy these wants This "clash" of desires and productive capabilities forces individuals, institutions and societies to make hard choices about: what goods and services to produce, how to produce them, and who will receive them. Raises natural questions about how these choices are made (rational vs. arbitrary), and how to organize this process (markets vs. planning). Not Always Popular The focus on difficult choices often leads to conclusions that someone doesn't want to hear. Economics and economists display the full range of political views...from radical to ultra-conservative. But we do attempt to separate fact from opinion by distinguishing between positive and normative economic statements: Positive: supported or rejected by factual evidence "The unemployment rate increased last month." Normative: opinion that cannot be proved or disproved "Government ought to play a larger role in funding education." Evaluation of Positive Statements Requires Analysis Observation of individual behavior, markets, etc. Statement of the question and relevant variables Assumptions (often takes the form of a model) Formulation of the hypothesis (often implied by the model) Hypothesis testing (often involves econometrics) Reject the hypothesis and modify approach, or... Use the hypothesis until a better one is presented Two Common Pitfalls... Caution: association is not necessarily causation. Towns with more doctors have higher doctors' fees. Seems to violate the notion that increased supply ought to lower prices, but... Doctors could simply be attracted to wealthy areas where fees are higher. (Note: more docs are not causing higher fees.) Additional doctors may reduce average wait-times, allowing them to raise their fees. (Here the "causation" is more complex.) Fallacy of composition: what holds for the individual may not hold for all. An increase in income results in higher consumption of goods and services. True for the individual, but if all incomes rise, prices may increase and limit the ability of individuals to consume more goods and services. ...and Another Complication Secondary effects can lead to unintended consequences Example: State grants to a town may initially allow local officials to reduce the local property tax rate, easing the burden on residents. But lower tax rates boost the demand for development in a community, bidding up the value of housing and possibly the amount of taxes paid. Changes in revenue from grants and taxes also affect the level of spending on schools and other public services, which also affects the value of housing. Partial equilibrium analysis tends to ignore secondary effects or feedback effects; general equilibrium analysis tends to incorporate such effects. So, What Do Economists Do? Business: management, strategic behavior, market analysis Government: management, policy formulation, program evaluation, education. Graduate school: MBA Economics Law Even medicine Self-employment: you name it. Median Annual Earnings of 35- to 44-Year-Olds, Bachelor's Highest Degree by Major (1993) Some of the Basics Constraints and opportunity costs Sunk costs: water under the bridge Unequal opportunity costs: absolute versus comparative advantage Production possibilities ("technology") Inefficient, efficient, and unattainable outcomes Increasing opportunity cost Economic growth Economic systems Specialization, exchange, and gains from trade Constraints and Choices Limited resources create constraints Limited ability to earn results in an income constraint. Finite time leads to a time constraint. Constraints force us to make choices Given a certain income (Y), a family must decide how much to spend on different goods or services (pi = price of good i, and Xi = quantity of good i). Ignoring borrowing or saving for the moment, the income constraint is: Income = Spending Y = ( p1X1 + p2X2 + .... + pNXN ) More than one bundle of goods (X1, X2,....,XN) will satisfy this constraint. Economics treats this as a rational decision, rather than a random act. Choosing more X1 requires that the family pay a price -- could be the dollar price (p1) of the extra unit, but we also can think of the opportunity cost of this unit as the amount of some other good(s) that must be given up. If p1 = 10 and p2 = 5, family must give up 2 units of X2 to get one more X1. (Overly) Simple Example Family can spend $100 on eggs (E) and bacon (B) Eggs are $1 per carton (pE = 1) and bacon is $2 per package (pB = 2) Budget constraint: 100 = pE E + pB B To graph this constraint: 100 = E + 2B or B = 50 - (1/2)E B 100 50 B/E = -1/2 To have one more carton of eggs, must give up 1/2 package of bacon. 50 100 E Opportunity Cost In the bacon and eggs example: Opportunity cost of a carton of eggs is 1/2 a package of bacon. Opportunity cost of a package of bacon is 2 carton of eggs. In a more general sense, the opportunity cost of an item or activity is the value of the best foregone opportunity. What's the opportunity cost of: getting up for an 8 AM class? vacationing in Alaska? choosing to major in Economics? attending graduate school? Opportunity Cost is a Forward-Looking Concept In choosing an appropriate course of action, future consequences may be more important than past ones. Sunk costs are those that have already been incurred and are not affected by the choice you're making--therefore irrelevant to the decision at hand. Example 1: Choosing the lowest-cost route from Storrs to Boston depends on current road conditions, not the way you last traveled from here to there. (But your past experience in traveling different routes might affect your current evaluation or expectations about road conditions.) Example 2: Self-employed persons often undervalue their own time; failure to accurately evaluate the (current or future) opportunity cost of working in their business. What you used to make is not particularly relevant. Economies Also Face Opportunity Costs in Making Constrained Choices Fixed stock of resources (land, labor, capital, etc.) and the existing "technology" of production imply a production possibilities set. The outer boundary of this set is the production possibilities frontier (PPF). Combinations outside the PPF are unattainable. Combinations on the PPF are efficient. Combinations inside the PPF are Inefficient. Y Unattainable Ef fic ie n t Inefficient 0 X Shape of the PPF Tells Us Something About the Nature of Opportunity Costs Slope of the PPF reflects the opportunity cost of producing an additional unit of one good in terms of another good. An outward-bowed PPF implies increasing opportunity costs. In the graph, each extra unit of X requires the economy to forego more and more Y. Y 0 1 2 X What Do These PPFs Tell Us About Opportunity Costs? Y Y Increasing, Constant, or Decreasing? Increasing, Constant, or Decreasing? X X Economic Growth Outward shift of the PPF If resources (land, labor, reflects economic growth. Y capital, etc.) are fixed, improvements in technology can produce growth. Even if technology is static, additional resources will permit economic growth. 0 X How Do Economies Choose an Output Combination on the PPF? Fundamental economic questions that all economies must answer: What will be produced? How will it be produced? Who will consume the outputs? Questions Are Answered Differently by Different Economic Systems Capitalist Economies Private ownership Strong enforcement of property rights Reliance on markets to determine prices and distribute goods and services Limited economic role of government Command Economies Public or communal control of property Weak enforcement of property rights Reliance on central planning to determine prices and distribute goods and services Government plays major role in the economy Most Economies Are Mixed More accurate to think about a continuous spectrum of economic systems ranging from pure market to pure command. Most economies lie somewhere in the middle: mixed economies. Transitional economies have been moving from command to market-oriented systems. Some economies strongly influenced by custom or religion. U.S. economy may be less market-oriented than commonly thought. Some Questions What role have historical events played in determining a country's current economic system? What are the potential advantages of a command economy? What are the potential advantages of a market economy? Why do you think mixed economies are so common? How has the distribution of economic systems changed over the last several decades? Would you like to see the U.S. economy become more market-oriented or more centrally planned? Even Planned Economies Rely on Specialization and Trade Differences in opportunity costs, among individuals and among economies, provide the basis for specialization and trade. Lower opportunity costs result in a comparative advantage. Even economies (or persons) that have no absolute cost advantage will normally have a comparative advantage. Normally it's advantageous to specialize in the good or service for which you have a comparative advantage, provided you can then trade this item for other goods and services. Later we'll show how this process of specialization and trade benefits both parties in the trading process. The Players Microeconomics focuses on the decisions of those involved in the process of production, consumption, and exchange: Households or consumers Businesses or firms Governments or other institutions Understanding how these decisions are made helps us to understand how markets price and allocate goods and services, and how the outcomes are affected by government policies. Circular Flow Model helps to see the roles of these economic agents Goods & Services Product Markets Expenditure Revenue Households Income Firms Wages, Interest, Rent, Profit Resource Markets Labor, Capital, Land, Entrepreneurship Government's Role Federal, state, and local governments influence these product and resource markets in various ways: Taxation Federal income taxes State income taxes and sales taxes Local property taxes Provision of public goods and services National defense State highways Local public education Laws to establish and enforce "rules of the game" Regulation, market intervention, and redistribution ...
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