Modern Economics PDF

Modern Economics Stiglitz, Walsh Economics Chapter MI1 What is Economics? ◼ Economics studies how individuals, firms, the government, and other organizations make choices and how those choices determine society’s use of its resources. Modern Economics l...

Modern Economics Stiglitz, Walsh Economics Chapter MI1 What is Economics? ◼ Economics studies how individuals, firms, the government, and other organizations make choices and how those choices determine society’s use of its resources. Modern Economics lecture by Veronika Miťková 2 Thinking Like an Economist Five Core Concepts ◼ trade-offs ◼ incentives ◼ exchange ◼ information ◼ distribution Modern Economics lecture by Veronika Miťková 3 Thinking Like an Economist Trade-off ◼ All choices involve trade-offs. ◼ Trade-offs stem from scarcity. ◼ limited money, time and resources Modern Economics lecture by Veronika Miťková 4 Thinking Like an Economist Incentives ◼ Incentives are benefits that motivate a decision maker in favor of a particular choice. ◼ Prices reflect incentives: rewards and costs. ◼ Incentives also are affected by the return people expect to earn from different activities. Modern Economics lecture by Veronika Miťková 5 Thinking Like an Economist Exchange ◼ Exchange is the trade of goods and services. ◼ Voluntary exchange in markets determines which goods and services to produce. ◼ A market is any situation in which an exchange takes place. Modern Economics lecture by Veronika Miťková 6 Thinking Like an Economist Information ◼ Making informed choices requires information. ◼ Information is like any other good or service. ◼ Information is unlike any other good or service. Modern Economics lecture by Veronika Miťková 7 Thinking Like an Economist Distribution ◼ Markets determine who gets which goods according to the demand and supply of goods, labor, and capital. ◼ For whom are goods produced. Modern Economics lecture by Veronika Miťková 8 Thinking Like an Economist The Three Major Markets ◼ The product market ◼ where final goods and services are exchanged ◼ The labor market ◼ where workers sell labor and firms hire workers ◼ The capital market ◼ where households, firms, and government save and raise funds Modern Economics lecture by Veronika Miťková 9 Thinking Like an Economist The Three Major Markets consumers workers investors Modern Economics lecture by Veronika Miťková 10 Thinking Like an Economist The Two Branches of Economics ◼ Microeconomics: focuses on the decisions of households and firms and the detailed study of prices and production in specific industries. ◼ Macroeconomics: focuses on the behavior of the economy as a whole and the behavior of aggregate variables. Modern Economics lecture by Veronika Miťková 11 Thinking Like an Economist The Science of Economics ◼ Economics is a social science. ◼ Economic theory is composed of: ◼ Assumptions or hypotheses and the conclusions derived from them. ◼ Theories are logical exercises that lead from assumptions to conclusions. ◼ If the assumptions are correct, then the results follow. Modern Economics lecture by Veronika Miťková 12 Thinking Like an Economist Positive and Normative Economics ◼ Positive economics is the study of how the economy works, it describes facts. ◼ uses word BE ◼ Normative economics deals with the questions. There are no right answers. ◼ uses word SHOULD BE Modern Economics lecture by Veronika Miťková 13 Thinking Like an Economist Thinking Like an Economist Stiglitz, Walsh Economics Chapter MI2 The Basic Competitive Model ◼ Rational consumers ◼ Profit-maximizing firms ◼ Competitive markets ◼ Government is ignored for now Modern Economics lecture by Veronika Miťková 15 Thinking Like an Economist Rational Individuals ◼ Scarcity forces us to make choices. ◼ Economists assume individuals and firms make choices rationally: ◼ what they see as their own self-interest ◼ weigh costs and benefits as they see them ◼ if benefits > costs, take the action ◼ different people have different interests ◼ Economists do not judge people's preferences, they take them as given. Modern Economics lecture by Veronika Miťková 16 Thinking Like an Economist Competitive Markets ◼ Many firms sell identical products to many consumers. ◼ Firms and consumers are price takers. ◼ Firms provide as much output as consumers will buy. ◼ Each firm can sell as much as it wants. ◼ the size of the firm is small compared to the size of the market ◼ If firms charge a price higher than the market price, they lose all their customers. ◼ All firms in the industry charge the same price - the market price. Modern Economics lecture by Veronika Miťková 17 Thinking Like an Economist The Basic Competitive Model as a Benchmark ◼ Combines self-interested consumers, profit-maximizing firms, and competition. ◼ This model can provide answers to the four basic questions: 1. What is produced, and in what quantities? 2. How are goods produced? 3. For whom are those goods produced? 4. Who decides the answers to the first three questions, and how? ◼ The model is not a perfect representation of actual economies. Modern Economics lecture by Veronika Miťková 18 Thinking Like an Economist Efficiency in the Basic Competitive Model ◼ The basic competitive model is efficient - known as Pareto efficiency. ◼ Scarce resources are not wasted. ◼ It is not possible to produce more of one good without producing less of another good. ◼ It is not possible to make one person better off without making someone else worse off. Modern Economics lecture by Veronika Miťková 19 Thinking Like an Economist Opportunity Sets ◼ Opportunity sets are combinations of goods. ◼ Due to the scarcity of money or time, not all combinations of goods are attainable. ◼ The opportunity set is limited by budget or time constraints. Modern Economics lecture by Veronika Miťková 20 Thinking Like an Economist Budget Constraint ◼ Michelle has $120 to spend on either pens or books. The price of a pen is $10 and a price of a book is $20. PENS PURCHASED books pens 6 0 5 2 4 4 3 6 2 8 1 10 BOOKS PURCHASED 0 12 Modern Economics lecture by Veronika Miťková 21 Thinking Like an Economist Time Constraint ◼ The sum of what an individual spends her time on each day must add up to 24 hours. Modern Economics lecture by Veronika Miťková 22 Thinking Like an Economist The Production Possibilities Curve ◼ A production possibility curve defines a firm’s or society’s opportunity set, representing the possible combinations of goods that it can produce. ◼ Let’s consider guns (military spending) and butter (civilian spending). Modern Economics lecture by Veronika Miťková 23 Thinking Like an Economist The Production Possibilities Curve ◼ PPS is curved, bowed out from the origin. Guns Butter (millions of (millions) tons) 100 0 90 40 70 70 40 90 0 100 Modern Economics lecture by Veronika Miťková 24 Thinking Like an Economist The Production Possibilities Curve ◼ Guns and butter have different inputs and the trade-offs of the society are not fixed. ◼ steel makes great guns, no butter; cows do not make good weapons ☺ Modern Economics lecture by Veronika Miťková 25 Thinking Like an Economist Optimal Production on the PPC ◼ Inside the PPC, a firm can produce more of both goods by moving out to the curve. ◼ So points interior to the curve are inefficient. ◼ Economists want to know the source of these inefficiencies, what resources are unemployed. ◼ The optimal production mix is always on the curve. Modern Economics lecture by Veronika Miťková 26 Thinking Like an Economist Principle of Diminishing Returns ◼ Adding successive units of any input to a fixed amount of other inputs increases the output, or amount produced, but by less and less. ◼ you get more out of the first hour of studying than the tenth Modern Economics lecture by Veronika Miťková 27 Thinking Like an Economist Opportunity Costs ◼ the cost of using any resource ◼ measured by looking at the next-best use to which that resource could be put ◼ Time and budget constraints and production possibilities curves illustrate the cost of one option in terms of the other: opportunity cost. Modern Economics lecture by Veronika Miťková 28 Thinking Like an Economist Opportunity Costs ◼ The cost of an education is: ◼ Tuition ◼ Room and board ◼ Books ◼ Travel expenses ◼ Opportunity cost: lost earnings from not working for three years Modern Economics lecture by Veronika Miťková 29 Thinking Like an Economist Sunk Costs ◼ a past expenditure that cannot be recovered, no matter what choice is made in the present ◼ rational decision makers ignore them Modern Economics lecture by Veronika Miťková 30 Thinking Like an Economist Marginal Costs ◼ the additional cost of producing or consuming one additional unit Modern Economics lecture by Veronika Miťková 31 Thinking Like an Economist Basic Steps of Rational Choice 1. Identify the opportunity sets. 2. Define trade-offs. 3. Calculate the costs correctly, ignoring sunk costs, taking into account opportunity costs and marginal costs. Modern Economics lecture by Veronika Miťková 32 Thinking Like an Economist