- Broad Principleso There are gains from tradeo Markets move toward equilibriumo Resources should be used as efficiently as possible to achieve society’s goals There is a trade-off between efficiency and equityo Markets usually lead to efficiencyo When markets don’t achieve efficiency (see e.g.’s below), gov’t. intervention can improve society’s welfare Monopolies Public goods Externalitieso One person’s spending is another’s incomeo Overall spending sometimes gets out of line w/the economy’s capacityo Gov’t. policies can change spending- Positive vs. Normativeo Positive: Factual: what is Objective “Verifiable” Descriptiveo Normative: Value-oriented Subjective Not verifiable Prescriptive: what should/ought to be done- Scientific methodo Observationo Simplifying assumptions model building (this is the theory of economics)o Testable hypotheses (these are the fields of economics)o Empirical testing (this is econometrics, using statistics and computers)- Data (2 types)o Cross sectional data: is collected at one point in time (e.g. your home town)o Time series data: is collected at multiple points in time (e.g. income)- Issueso Bad datao Sampling error (the sample must be representative of the population)o Time series: choosing bad beginning & end pointso Population distortion E.g. China’s GDP is way bigger than the US’s because their population is larger, but if you look at GDP per capita you get a better idea of the data, and you get meaningful numberso Inflation distortion E.g. with time series data on income, the data isn’t meaningful unless you adjustfor inflation (you use constant dollars instead of current dollars)o Slope distortion/misleading data presentation The axes of a graph can be stretched or contracted to change how steep the slope looks- Opportunity cost (OC) is the production (or consumption) foregone when we make decisions to produce (or consume) something elseo E.g. going to college & getting a degree:Accounting Cost Opportunity costTuition X X (could use the money for other things)Books X XRoom XBoard XSalary X- A PPF is the path of points showing the maximum amount of 2 goods that can be produced w/a given level of resources, technology & timeo Properties: Downward sloping Bowed outward (due to specialization of resources) Slope represents OC of getting one more unit of X- Slope = rise/run = ΔY/ΔX = (Y2-Y1)/(X2-X1)- If ΔX = 1 then ΔY must be the slopeo Vocabulary Feasible, obtainable points- All points on the PPF or inside it (between the axes and the PPF) Not feasible, not obtainable points- All points beyond/outside of the PPFYX Efficient points- All points on the PPF Inefficient points- All points on the inside the PPFo PPF represents/illustrates: OC - When going from one point to another, the difference in X or in Y represents how much of a good you are giving up to gain more of the other (e.g. X2-X1) Scarcity (points beyond the PPF are unobtainable) Trade-offs (more of good X requires less of good Y and vice versa; trade-offs imply choices) Under-/unemploymento The law of increasing OC states that as you produce more units of one good, the OC of producing more of it increases E.g. if you are building bridges and writing books, there are some people who are better at one task than the other. If you begin by having everyone build bridges, and you move the best book-writer over to writing books, there is a small opportunity cost because they weren’t good at producing bridges. However, once you move the last bridge-builders over to writing books, there is a large opportunity cost because they were the good bridge-builders.o Economic growth of PPF- it shifts outward Shifts in a PPF are due to:- New resources- New technology- Decisions this time period affect new time periods o E.g. on a PPF with capital goods/yr and consumer goods/yr, a production bundle with more capital goods will spur more economic growth in the long run than a production bundle with more consumer goodso Current consumption vs. future consumption- Absolute and comparative advantageo Absolute advantage: a person/country has an absolute advantage when they can produce more output from a given amount of input than another person/countryo Comparative advantage: The ability to produce a good/service at a lower opportunity cost than other producerso *Specialization and free trade will benefit all trading parties even when some are absolutely more efficient producers than others!o E.g.: James and Rebecca produce guns and butter; assume they have linear PPFs James can produce 0 guns and 40 butter; he can produce 40 guns and 0 butter Rebecca can produce 0 guns and 40 butter; she can produce 20 guns and 0 butterRebeccaJames40204040 James’ PPF: - slope = -1- G = 40 - B- OC of 1B = 1G- OC of 1G = 1B Rebecca’s PPF: - slope = -1/2- G = 20 – (1/2)B- OC of 1B = (1/2) G- OC of 1G = 2B James should make guns and Rebecca should make butter Why it makes sense to specialize with the given current production: James makes 20 guns and 20 butters, Rebecca makes 10 guns and 20 butters- If James increases towards his specialization and produces 21 guns and 19 butters, and Rebecca makes 9 guns and 22 butters, there is a net gainof 1 butter from- On the other hand, if James and Rebecca move away from their specializations and James makes 19 guns and 21 butters, and Rebecca makes 11 guns and 18 butters, there is a net decrease from the original values of 1 butter Range of trading prices:- For 1 butter: James is willing to trade 1 gun or less, Rebecca is willing to trade ½ a gun or more, therefore fair trading prices would be between ½ a gun to 1 gun- For 5 guns: James is willing to trade 2 butters or less for 1 gun, and Rebecca is willing to trade 1 butter or more for 1 gun; therefore the range of fair trading prices for 5 guns (multiply times 5) is 5 to 10 butters Joint PPF- Plot the point where all producers produce only guns- Plot the point where all producers only produce butter- Plot the point where both specialize (James makes only guns and Rebecca makes only butter)- Market failureo Inefficiencies: public goods, externalities, monopoly market correctiono Income distribution redistributiono Inflation & unemployment stabilization- Supply & demando Demand is a function of: (+ = positive correlation, - = negative correlation) Price of a good (-)
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