class1 micro

7/28/2019 Class1 Micro

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Jihoon Lee

Northeastern University


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for the individual choice

for the choice interaction

for the economy-wide interaction


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Individual choice: the decision by an individual ofwhat to do, or what not to do

Basic principles Resources are scarce

The real cost of something is what you must give up toget it

How much? is a decision at the margin

People usually take advantage of incentives

3Basic Concepts ofEconomics


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A resource is anything that can be used toproduce something else

Ex.: land, labor, capital

Resources are scarce: unlimited needs withlimited resources

Ex.: fossil fuels, lumber, (clean) water/air, intelligence



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The real cost of an item is its opportunity cost: what youmust give up in order to get it

Opportunity cost is crucial to understanding individualchoice Ex.: The cost of attending the economics classSleep? Coffee at

Starbucks with friends? Work?

I would rather be are referring to the opportunity cost

Its all about what you have to forgo, but remember its

the forgone value of the best alternative activity only,not the sum of all



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Trade-off b/w costs and benefits of doingsomething

Marginal benefit-cost analysis: making trade-off at the margin

comparing the costs and benefits of doing a little bitmore of an activity vs. doing a little bit less

Ex.: Eating one more slice of pizza, studying one morehour, sleeping one more hour, hiring one more worker,etc.



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An incentive is anything that offers rewards topeople who change their behavior

Ex.1: wage increase more people want to work

Ex.2: price of gasoline increase more peopledemand fuel-efficient vehicles

People respond to these incentives (or,

disincentives)



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Interaction of choices: my choices affect yourchoices, and vice versa

Basic principles There are gains from trade

Markets move toward equilibrium

Efficient usage of resources is a good thing for thesociety

Markets usually lead to efficiency

When markets fail, government intervention can

improve social welfareBasic Concepts ofEconomics 8


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Due to specialization Each person specializes in

the task that he or she isgood at performing

The economy, as a whole,can produce and consumemore

Basic Concepts ofEconomics

9

Trade in a market economy: provide goods and servicesto others and receive other g/s in return

Gains from trade: get more of what they want throughtrade than they could under self-sufficiency

I hunt and she gathers otherwise we couldntmake ends meet. The New Yorker Collection 1991 Ed Frascino from cartoonbank.com.


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Equilibrium in an economic sense is a situationwhen no individual would be better off doingsomething different

Any time there is a change, the economy willmove to a new equilibrium

Ex.: What will happen to the price of gas when oilproducing countries decide to produce more barrels ofoil per day?


10


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An economy is efficient if all opportunities are taken tomake some people better off w/o making other peopleworse off

Then, is economic efficiency always the best policy goal?

issue of efficiency vs. equity Equity: everyone gets his/her fair shareWhat is fair?

Ex.: Handicapped-designated parking spaces in a busy parking lot

Equity side: making life fairer for the handicapped people

Efficiency side: letting several parking spaces left unused

How far should we go?


11


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The incentives built into a market economy helpresources be used efficiently

Prices are set where buyers and sellers agree with

No opportunities are left unexploited

Exceptions: market failure

The individual pursuit of self-interest in the markets canmake society worse off

The market outcome is inefficient


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Negative externalities: when producers (sellers) shiftcosts to others Pollution, for example, is a by-product of manufacture

Total cost = sellers production cost + pollution cost

When pollution costs are shifted, supply is greater than sociallyoptimal, and so is the pollution

Positive externalities: when consumers (buyers) maycreate benefits for others

Vaccinations, for example, can prevent neighbors from getting flue Total benefit = individual benefit + benefits to others

When more people want to enjoy free ride, the aggregate

demand for vaccinations is less than socially optimal


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The market outcome is socially optimal (socially efficient)only when The sellers pay the full costs of production, and

The buyers capture the full benefits of g/s

Government can help the market achieve the sociallyefficient level of outcome with regulations, taxes, andfines (for negative externalities) or subsidies (for positive

externalities) More discussion in detail are coming in later chapters!


14


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Basic Principles One persons spending is another persons income

If you spend less at a grocery store, the store employees mayeither lose their jobs, or take pay cuts

Overall spending may exceed or fall below the economysproduction capacity (or potential output)

If spending exceeds potential output, inflation is likely

If spending falls below potential output, economic recessionand increase in unemployment are likely

Government policies can change spending

Monetary/fiscal policies


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Comparative Advantage usingProduction Possibility Frontier

Circular-Flow Diagram


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A model is a simplified representation of realitiesthat is used to better understand real-lifesituations

Ex.: a model showing how much income people spendfor purchasing g/s;

C = + Y

Other things equal

This assumption means that all other relevant factorsremain unchanged for simplicity

Basic Concepts ofEconomics 17


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The production possibility frontier (PPF)

It illustrates the trade-offs facing an economy that

produces only two goods. It shows the maximumquantity of one good that can be produced for anygiven production of the other.



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2820 400

30

9

15

Quantity of coconuts

Production possibility frontier(PPF)

A

B

D

C

Feasible andefficient

in production

Not feasible

Quantity of fish

Feasible but

not efficient


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A

PPF

10 20 30 40 500

35

30

25

20

15

10

5

Producing the first20 fish . . .

requires giving up25 more coconuts

requires giving up5 coconuts

But producing20 more fish . . .


Quantity of fish


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Production is initially at pointA(20 fish and25 coconuts), it can move to point E(25

fish and 30 coconuts) due to economicgrowth

A

10 20 25 30 40 500

35

30

25

20

15

10

5

E

NewPPF

OriginalPPF


Quantity of fish


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28 400

30

9

(a)Toms Production Possibilities

Toms consumptionwithout trade

TomsPPF


Quantity of fish


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1060

20

8

HanksPPF


Quantity of fish

(a)Hanks Production Possibilities

Hanks consumptionwithout trade


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Toms OC Hanks OC

One fish 3/4 coconuts 2 coconuts

One coconut 4/3 fish 1/2 fish


Both Tom and Hank are better off when theyeach specialize in what they are good at andtrade

Tom is good at fish: Toms OCf

< Hanks OCf

Tom has comparative advantage in and specializes in catching

fish

Hank is good at coconuts: Toms OCc> hanksOC

c

Hank has comparative advantage in and specializes in


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28 400

30

910

1060

20

810

(a) Toms Production and Consumption

Toms consumption

without trade

30

Hank'sPPF

Quantity of coconuts Quantity of coconuts

Quantity of fishQuantity of fish

Toms consumption

with trade

Toms production

with trade

(b) Hanks Production and Consumption

Hanks production

with trade

Hanks consumption

with trade

Hanks consumptionwithout trade

TomsPPF


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Comparative Advantage Lower opportunity cost to perform a task than the other person

Absolute advantage Lower production cost (or, higher productivity) to perform a task

than the other person

Comparative advantage matters! Tom has absolute advantage in both activities, but still specialize

in fishwhy? Because Tom gains benefits by doing so! (1more coconut & 2

more fish)

Hank also benefits by specializing in coconuts (2 more coco & 4more fish)

Mutual benefits from following comparative advantage!Basic Concepts ofEconomics 26


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0

1,500

1,000

Quantity of aircraft

(a) The U.S. Production Possibilities Frontier

321 0

3,000

2,000

1,500

10.5 1.5

U.S.PPF

CanadianPPF

Quantity of pork (millions of tons)

Quantity of aircraft

(b) Canadian Production Possibilities Frontier

U.S. consumptionwithout trade

U.S. consumptionwith trade

U.S.

productionwith trade

Canadian productionwith trade

Canadian

consumptionwith trade

Canadianconsumptionwithout trade

Quantity of pork (millions of tons)


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U.S. PPF is relatively flat It implies that U.S. has a comparative advantage in pork

production

U.S. specializes In pork production and trade

Canadian PPF is relative steep It implies that Canada has a comparative advantage in aircraft

production

Canada specializes in aircraft production trade

Both countries gain from specialization and trade: bothenjoy more benefits than if they were self-sufficient



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Money

FactorsGoodsand services

Factors

Households

Firms

Factor Markets

Goodsand services

Money Money

Money


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Factor markets: determine income distributionamong factor owners wages, interests, rent

Real-world complications International trade

Transactions b/w firms

Government

Financial markets



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Description, and prediction: positive economics Its about facts, and describes how the economy actually works

Ex.: the average price of gas in May 2008 was higher than in May2007

Prescription: normative economics Its about values, and prescribes how the economy should work

Ex.: Gas prices are too high

A solution to normative economics

Ex.: If policy option A is more efficient that B for achieving thesame goal, then A is better than B



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Opportunity Cost

Marginal Analysis


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Its the sum of explicit cost and implicit cost Explicit cost: actual outlay of money

Implicit cost: forgone value of best alternative activity

Ex.: OC of an additional year of school



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Accounting profit: businesss revenue minus explicit costs

and depreciation

Economic profit: businesss revenue minus OC of its

resources

Ex.: Profits at Babettes Cafe



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Relevant to how much decisions Ex.: how many slices of pizza want to eat, how many workers want

to hire

Its an analysis at the edge, comparing additional benefit

to additional cost of one more unit of consumption (orproduction)

Marginal benefit: the additional benefit earned by

consuming (producing) one more unit of g/s Marginal cost: the additional cost incurred by consuming

(producing) one more unit of g/s



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Marginal benefit curve, MB

Marginal benefit (per wing)

Quantity of chicken wings


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$4.00

3.00

2.00

1.00

Marginal cost (perwing)

Quantity of chickenwings

Marginal cost curve, MC


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Its the quantity that generates the maximum possible

total net gain

And the total net gain is maximized when MB is equal toMC



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76543210

$4.00

3.00

2.00

1.00

MB, MC (per

wing)

Quantity of chickenwings

Optimal point

MC

MB

Optimal quantity

0

1

2

3

4

5

6

7

Total net gain(profit per serving)

Net gain(per wing)

Quantity ofchicken wings

$0

3.50

5.20

5.90

6.30

6.40

6.30

6.10

$3.50

1.70

0.70

0.40

0.10

0.10

0.20


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Sunk cost: a cost that has already been incurred andnon-recoverable

Ex.: You went to Sushi Buffet How many dishes you

want to have? Worth more than (or at least as much as)what you paid? Or, lets say, according to your marginal

analysis?

Sunk cost should be ignored in decisions about futureactions



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What is $x realized tyears in the future worthtoday?

It must satisfy this formula:

$V (1+r)t

= $x, or

$V =$x

(1+r)t

where $Vis the present value of$xrealized tyears inthe future at r, the annual interest rate

Ex.: Ifx = 1, r= 0.1, and t= 2, then V=1

1+0.1 2 0.83



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NPV of a project is the present value of current andfuture benefits minus the present value of current andfuture costs



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What are Free Trade Agreements (FTAs) and the WorldTrade Organization(WTO) Agreement? Explain therelationships between the two.

How many FTAs with how many countries does the U.S.

have in force?

With which countries does the U.S. has recently signedthe FTAs?

Discuss the possible pros and/or cons of having FTAs.

Basic Concepts of

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