Transcript Topic 1: Basic Economics

Economics 212
Introduction to Macroeconomics
Professor Cotton
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What do economists study?
 Are NBA referees biased in favor of athletes of their own

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race?
How does going to college affect your lifetime earnings?
What do interest groups buy with political contributions?
Which government policies effectively decrease smoking or
obesity?
Why are some countries rich and some countries poor?
What’s the best way to increase employment or fight a
recession?
What do economists do?
 Apply rigorous logical and mathematical techniques to
formally and carefully analyze problems
 Economic Theorists develop models
 A simple model can help us better understand an issue
 Focusing on only the most important aspects of a problem
allows us to develop the greatest intuition
 Empirical Economists test the models
 Use statistical techniques to test the models
 Econometrics
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Most economics questions fit in 1 of 2 categories:
MICROeconomics
MACROeconomics
 Individual behavior (e.g.,
 Aggregate or average


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firms, people, households)
How many employees will
GM lay off?
What characteristics
determine if Joe goes to
college?
Joe’s income or GM profit
How much of the “pie” do
you get?



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behavior (e.g., country)
Total unemployment in the
economy?
What policies determine
the average level of
education?
Gross Domestic Product
How big is the entire “pie”?
How do we make it bigger?
Macroeconomics
Deals with the classic issues in economics:
 Unemployment
 Inflation
 National Output & National Income
 Population Growth
 Economic Growth
 Bond Prices
 Money & Banking
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Which questions are Macro?
 Are NBA referees biased in favor of athletes of their own





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race?
How does going to college affect your lifetime earnings?
What do interest groups buy with political contributions?
Which government policies effectively decrease smoking or
obesity?
Why are some countries rich and some countries poor?
What’s the best way to increase employment or fight a
recession?
Consider Econ if you’re interested in:
 Business including Marketing and Finance
 Government / Political Science
 Law
 International studies
 Sociology
 Psychology
 Statistics / Applied Mathematics
 Some books to read, if interested:
 The Logic of Life by Tim Hartford
 Freakonomics by Steven Levitt and Stephen Dubner
 Super Crunchers by Ian Ayres
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About Me
 Prof. Christopher Cotton
 My research involves game theory and competitions
 Interest groups compete for policy reform
 Individuals compete for raises and promotions
 I’m a Microeconomist, not a Macroeconomist
 Why do I want to teach Intro Macroeconomics?
 The material is essential for understanding current events
 The first macro class that I took as an undergraduate student…
 I will focus on the topics that will help you carry on a
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conversation about the current state of the US economy
Goals of class
 Understand trade off between inflation and unemployment
 Assess different fiscal and monetary policies
 Why does a downturn in one sector hurt the entire
economy?
 Prepare for future economics and finance classes
 Be able to read economic policy articles in the Wall Street
Journal or The Economist
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What you need
 Textbook: Parkin’s “Macroeconomics” ninth edition
 Another book: Wheelan’s “Naked Economics”
 Subscription to MyEconLab.com (comes with new Parkin)
 You must be willing to keep up on the material. It is
challenging, and the lectures will help but only if you
understand the material from the previous lecture.
 Good skills in Algebra, and the ability to draw and interpret
graphs given data.
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Topic 1: Basic Economic Principals
Law of Diminishing Returns
Production Possibilities Frontier
Opportunity Costs
Absolute & Comparative Advantage
Supply and Demand
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Factors of Production
Factors of production are the inputs used to create outputs
(goods and services) for consumption
Land
2. Labor
3. Capital (“produced means of production”)
4. Entrepreneurship
1.
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What if we increase all of the factors of
production by the same amount?
+
=
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+
What if we increase all of the factors of
production by the same amount?
+
+
+
+
=
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???
+
What if we increase all of the factors of
production by the same amount?
+
+
+
+
=
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+
What if we increase all of the factors of
production by the same amount?
 Question:
Suppose 1 farmers working 10 acres of land with 1 tractor
and 1 bag of seeds can produce 1 ton of corn.
Then how many tons of corn can be produced by 2 equally
competent farmers working 20 equally productive acres of
land with 2 tractors and 2 bags of seeds?
 Answer:
At least 2 tons. (Maybe more, if the farmers benefit from
working as a team. i.e., Economies of Scale)
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What if we increase only of of the
factors of production?
+
+
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+
= ????
What if we increase only of of the
factors of production?
+
+
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=
+
What if we increase only one of the
factors of production? Example 1
 Question:
Suppose 1 farmers working 10 acres of land with 1 tractor and 1
bag of seeds can produce 1 ton of corn.
Then how many tons of corn can be produced by 2 equally
competent farmers working the same amount of land with the
same number of tractors and seeds?
 Answer:
Maybe 2 tons or more, if there are benefits of working together
(Economies of Scale). But not necessarily. Maybe there is only so
much work to do, and the new farmer adds nothing
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What if we increase only of of the
factors of production?
+
+
20
+
= ????
What if we increase only of of the
factors of production?
+
+
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+
<
What if we increase only one of the
factors of production? Example 2
 Question:
Suppose 1 farmers working 10 acres of land with 1 tractor
and 1 bag of seeds can produce 1 ton of corn.
Then how many tons of corn can be produced by 200 equally
competent farmers working 10 acres of land with 1 tractor
and 1 bag of seeds?
 Answer:
Definitely not 200 tons of corn. (Maybe not ever 1 ton if the
additional 199 workers are just getting in the way.)
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Law of Diminishing Returns
 If one factor of production is increased, while the other
factors of production remain unchanged, then eventually, the
marginal increase in output from an additional unit of input
will be lower than the marginal increase in production from
the previous unit of input.
 e.g., the benefit of adding the 101st worker is less than the
benefit of adding the 100th worker. (Assuming the other
factors of production are fixed.)
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Law of Diminishing Returns
 Graph:
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A scary interpretation
 Thomas Malthus (1798): food production and population
growth
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Malthusian Theory of Pop Growth
 The world cannot support a population above a certain level
 Therefore, world population will be kept in line through
“positive” and “preventative” checks.
Positive checks – Increase the death rate
 War
 Famine & Disease
Preventative checks – Decrease the birth rate
 Increased use of contraception
 Increased age of marriage
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World Population – graph it
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Year
Population
10,000 BC
1 million
950 AD
250 million
1600
500 million
1804
1 billion
1927
2 billion
1961
3 billion
1974
4 billion
1987
5 billion
2000
6 billion
2011
7 billion
Note that data and graph are from Wikipedia’s entry on World Population. Just because I use
Wikipedia for lecture data, does not mean you should use it as a main source for your papers.
However, you should always give credit to your sources, even if it is Wikipedia.
World Population – graph it
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So, what happened?
 What didn’t Malthus account for?
 Changes in technology
 What happened around the major kink in the graph?
 Mid-1700s = Industrial Revolution
 Better access to food, medicine, shelter
 Better water supply, sewage
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Another example – US Output
30
Year
Total Output
($ billions)
Population
(millions)
1935
73
127
1950
295
152
1965
719
194
1980
2,784
227
1995
7,265
263
Total output is US Gross Domestic Product, as provided by the BEA. Population figures come
from the US Census
Increase in population also…
+
+
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+
came with increases in technology
+
+
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came with increases in technology
+
+
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+
came with increases in technology
+
+
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+
+
came with increases in technology
+
+
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+
+
+
Important Questions:
 What are the four factors of production?
 What is the law of diminishing returns?
 Why is technology important?
 Why was Thomas Malthus wrong? Might he still be proven
correct?
Next concept: Opportunity Costs & Productions Possibilities
Frontier
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Opportunity costs
 Definition: The (value of the) next-best alternative we forgo,
or give up, when choosing an action.
 What’s the opportunity cost of studying for your test on a
Saturday night?
 Is it higher or lower than the opportunity cost of studying for
your test on a Tuesday night?
 We can refer to opportunity costs in terms of items forgone,
or in terms of the monetary value of the items forgone.
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Production Possibilities Frontier (PPF)
 Definition: the maximum level of production in an economy,
given its factors of production
 Graph an example for an economy that can only produce 2
goods (e.g., guns & butter)
 If the economy is producing along its PPF, it cannot produce
more of one good without giving up some production of
another good.
 If the economy is inside its PPF, it can do better
 Can’t be outside of the PPF
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Opportunity Cost of
 Illustrated by movement along the PPF.
 What’s the opportunity cost of producing 1000 tubs of
butter?
 What’s the opportunity cost of making one more tub of
butter?
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French Colony of Louisiana, 1750
 You’re the “economic” advisor. Suppose you have 1000 workers
with equal sized farms spread across the colony. Your workers can
either farm rice or corn.
 If you put all of your inputs into corn production, then you
produce 10,000 bushels of corn
 If you put all of your inputs into rice production, then you
produce 3,000 bushels of rice
 What happens if you devote 900 workers to corn production, and
the rest to rice production? Which workers should produce corn?
 What about a 50-50 split?
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Rainfall in Louisiana
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Opportunity costs
 What is the opportunity cost of producing 100 bushels of
corn?
 What is the opportunity cost of producing 100 additional
bushels of corn?
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What happens to the PPF when…
 A fleet of ships land on the shore with 500 new farmers






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looking to settle in Louisiana?
Someone invents a more efficient plow?
Rice production technology improves?
Disease kills off 500 farmers?
A hurricane increases flooding throughout the colony?
The royal governor outlaws corn production?
Coastal farmers go on strike, refusing to work?
Where on the PPF?
 To be on the PPF, need “full employment” of factors of
production.
 Macroeconomic policy making is often aimed at moving
production as close to the PPF as possible.
 At which point on the PPF does production take place?
 Depends on what people want or need
 Command Economy (government decides, central planner)
 Market Economy (individuals decide own actions)
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Next Concept: Comparative Advantage
Absolute Advantage
Comparative Advantage
Who should produce what in an efficient economy?
Unless told otherwise, assume that there are constant
opportunity costs of production (linear individual PPFs) for
questions of comparative advantage.
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Absolute Advantage
 Someone has an absolute advantage in producing something
when they can do so more efficiently (using fewer factors of
production, e.g., less labor) than someone else.
 The person or group that is “better” at producing a good has
the absolute advantage in doing so.
Who has the absolute advantage?
 Jokes
 Lance Armstrong
 Bikes
 Jerry Seinfeld
 Physics
 Albert Einstein
 Economics
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?
 Prof. Cotton
Comparative Advantage
 Someone has comparative advantage in producing something
when their opportunity costs of doing so are lower than
someone else.
 Compared to someone else, everyone has a comparative
advantage in the production of something.
 Comparative advantage does not imply absolute advantage.
Who has the comparative
advantage?
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 Jokes
 Lance Armstrong
 Bikes
 Jerry Seinfeld
 Physics
 Albert Einstein
 Economics
 Prof. Cotton
Examples – Individuals
 Scotty and Iris can make both sweaters and beer
Sweaters
Beer
Scotty
1000
900
Iris
1300
1000
 Who has the absolute advantage in each product?
 For each person,
 What is the opportunity cost of making a beer?
 What is the opportunity cost of making a sweater?
Examples – Individuals
 Scotty and Iris can make both sweaters and beer
Sweaters
Beer
Scotty
1000
900
Iris
1300
1000
 Scotty has the lower opportunity cost of beer
 So, Scotty has the comparative advantage in beer
 Iris has the lower opportunity cost of sweater
 So, Iris has the comparative advantage in sweaters
Examples – Individuals
 Scotty and Iris can make both sweaters and beer
Sweaters
Beer
Scotty
1000
900
Iris
1300
1000
 Graph the PPF for an economy made up of Scotty and Iris.
Examples – Countries
 The French and Irish can make both wine and beer
Beer
Wine
France
500
1000
Ireland
1000
100
 Who has the absolute advantage in each product?
 For each country,
 What is the opportunity cost of making beer?
 What is the opportunity cost of making wine?
Examples – Countries
 The French and Irish can make both wine and beer
Beer
Wine
France
500
1000
Ireland
1000
100
 France has the lower opportunity cost of wine
 So, France has the comparative advantage in wine
 Ireland has the lower opportunity cost of beer
 So, Ireland has the comparative advantage in beer
Examples
 If Aidan specializes, every week he can brew 12 gallons of
beer, or he can bake 6 pizzas
 If Sally specializes, every week she can brew 6 gallons of beer,
or she can bake 12 pizzas
 Pizza and beer go together, so people must consume 1 gallon
of beer for every 1 pizza they eat.
 Assume constant opportunity costs
 Draw Aidan’s PPF
 Draw Sally’s PPF
Example
 If they produce alone, how many pizzas and how much beer
do they each consume?
 4 pizzas and 4 gallons of beer
 Draw the joint PPF when they work together
 Working together, how many pizzas and how much beer do
they each consume?
 6 pizzas and 6 gallons of beer
 GAINS FROM TRADE
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Examples
 Abby, Bruce and Carlos can make cheese and bread
Cheese
Bread
Abby
500
600
Bruce
200
700
Carlos
600
300
 As always with comparative advantage problems in this class,
assume linear PPFs for each producer.
 Who has the absolute advantage in each product
 Carlos has it in Cheese
 Bruce has it in Bread
Examples
 Abby, Bruce and Carlos can make cheese and bread
Cheese
Bread
Abby
500
600
Bruce
200
700
Carlos
600
300
 Who has the comparative advantage in Cheese?
 Abby v. Bruce?  Abby
 Abby v. Carlos?  Carlos
 Bruce v. Carlos?  Carlos
 Carlos > Abby > Bruce
Examples
 Abby, Bruce and Carlos can make cheese and bread
Cheese
Bread
Abby
500
600
Bruce
200
700
Carlos
600
300
 Graph the PPF for the economy with trade.
Comparative Advantage Summary
 Use the concept of comparative advantage to argue in favor
of companies moving production from US to China or India.
 Who gains?
 On average, US citizens are better off.
 Are all US citizens better off?
 Consider the exchange of goods and services. Which does the
US have comparative advantage in compared to most other
countries?
Next Concept: Supply & Demand
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Auction for a Coke
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
At $0.25, _____ people would like to buy a Coke

At $0.50, _____ people would like to buy a Coke

At $0.75, _____ people would like to buy a Coke

At $1.00, _____ people would like to buy a Coke

At $1.25, _____ people would like to buy a Coke

At $1.50, _____ people would like to buy a Coke

At $1.75, _____ people would like to buy a Coke

At $2.00, _____ people would like to buy a Coke

At $2.25, _____ people would like to buy a Coke

At $2.50, _____ people would like to buy a Coke

At $2.75, _____ people would like to buy a Coke

At $3.00, _____ people would like to buy a Coke

At $3.25, _____ people would like to buy a Coke

At $3.50, _____ people would like to buy a Coke

At $3.75, _____ people would like to buy a Coke
Demand for Coke
 The numbers on the previous slide represent the DEMAND
for Coke at each price
 Graph it
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Supply of Coke
 How much Coke is available (i.e., supplied) at each price
 Usually supply is increasing price. Producers are willing to
sell more of something when the price is high.
 What about in our class? The vending machine down the hall
means that supply is a vertical line at $1.25.
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Supply & Demand
 Key model for analyzing the market economy
 Supply– How much of a good or service firms are willing to
supply at different prices
 Demand– How much of a good or service individuals want
to buy at different prices
 Equilibrium (“market-clearing”) Price– The price at which
the number of goods supplied equals the number of goods
demanded.
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Imagine if….
Each person
on this side of
the classroom
has been given
one set of
coasters each.
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Each person
on this side of
the classroom
hasn’t.
Imagine if….
Each person
on this side of
the classroom
has been given
one set of
coasters each.
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Each person
on this side of
the classroom
hasn’t.
(I like the other
side better)
How much $$$
would you
require to give
up your
coasters?
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How much
would you be
willing to spend
to buy some
coasters?
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Price
Total # of sellers
Total # of buyers
$0.00
0
20
$1.00
2
18
$2.00
4
16
$3.00
6
14
$4.00
8
12
$5.00
10
10
$6.00
12
8
$8.00
14
6
$9.00
16
4
$10.00
18
2
$11.00
20
0
Graph it.
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US Market for Bourbon
 What is the equilibrium price and quantity?
 What happens when the price of bourbon is too high?
 What happens when the price of bourbon is too low?
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US Market for Bourbon
 What happens to the market for bourbon when…
 …the Jack Daniel’s distillery burns to the ground?
 Decreases supply
 …someone invents a more cost-effective way to make bourbon?
 Increases supply
 …a highly publicized study shows that people who drink
bourbon live longer happier lives?

Increases demand
 …Scotch becomes trendy?
 Decreases demand
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US Market for Bourbon
 Assume that the equilibrium price of bourbon is $20 per
bottle
 What happens when…
 …the US government passes a law saying that the price of
bourbon cannot exceed $10 per bottle?

This is a price ceiling, resulting in a shortage
 …the US government passes a law saying that the price of
bourbon cannot fall below $30 per bottle?

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This is a price floor, resulting in a surplus
Details
 Substitutes and complements
 What determines the shape of supply and demand?
 The invisible hand of the market place
 Price ceilings and floors
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Substitutes and Complements
 Substitutes – A good that can be used in place of another
good
 Complements – A good that is used in conjunction with
another good
 Complements can be in either consumption (i.e., pizza &
beer) or production (i.e., dough and cheese)
 Substitutes can also be in either consumption (i.e., pizza or
tacos) or production (i.e., sugar or corn syrup)
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Substitutes and Complements
 What are some substitutes and complements of…
 …Pickup truck?
 …Pen?
 …Movie ticket?
 …Orange?
 …Bourbon?
 …Cigarette?
 …Gasoline?
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Shape of Supply & Demand
 The availability of substitutes determines the shape
(steepness) of the supply and demand curves
 Demand for cigarettes
 Demand for ham
 Demand for gasoline
 Demand for apple juice
 Supply for apples
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The Invisible Hand
 The “invisible hand”
 If the price is above the equilibrium price, there is a surplus.
More people want to sell than buy at that price. In an effort to
sell their goods, suppliers will decrease prices in an effort to
undercut other suppliers so they are not left with a surplus. This
tends to drive the price towards equilibrium
 If the price is below the equilibrium price, there is a shortage.
More people want to buy than sell at that price. Buyers will
increase their price offers in an effort to entice sellers to sell to
them. This tends to drive the price towards equilibrium
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Price Ceilings and Floors
 Price ceilings keep the market price from going above a fixed
level
 Price floors keep the market price from falling below a fixed
level
 Keep the market from achieving equilibrium
 Examples
 Rent ceilings in NYC
 Price gouging laws during a gasoline panic
 Farm price supports
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Shifts in supply and demand
 Market for Coke






Price of Pepsi increases (substitute)
Price of pizza decreases (complement)
New health reports show it’s bad for you
Sugar increases in price
Trade reform make it easier to import soda from Mexico
Government sends stimulus check to all citizens
 Hot dog market when bun price increases
 Miller Beer market when Bud price increases
 Sport coat market when UM requires them in class
 Milk market when price of hay increases
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Shifts in supply and demand
 Shifts in demand
 Complement or substitute price change
 Shifts in taste
 Shifts in income
 Shifts in supply
 Input price change
 Change in technology
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Labor Market
 Supply is made up of many individual workers
 Demand is from firms and organizations
(counterintuitive?)
 Minimum wage laws
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