Econ Notes before Exam 1.pdf

What is Economics? The Science of Choices Scarcity -Resources ○ -Inputs to produce goods and services -Fundamental economic problem: scarcity -Scarcity ○ -Exists when human wants (material and nonmateria...

What is Economics? The Science of Choices Scarcity -Resources ○ -Inputs to produce goods and services -Fundamental economic problem: scarcity -Scarcity ○ -Exists when human wants (material and nonmaterial) exceed available resources Definition Economics is the study of choices we make among our many wants, given our limited resources Wants vs. Needs Economic good: any item that we value or desire (car, food, etc) ○ Tangible (can touch) ○ Intangible (unable to touch) Economic bad: Any items which we would pay to get rid of (pollution, garbage, disease) The Economic Problem “To choose is to lose.” Scarcity necessitates making choices Choices are costly because we must give up other opportunities that we value A famous student from the London School of Economics, Mick Jagger, sings “You can’t always get what you want” Making Choices It can be a risk Choosing convenience over money (Ex: go to 7-Eleven instead of Grocery store) Microeconomics vs. Macroeconomics Microeconomics ○ Individual units that comprise the economy Examples ○ Individual shopping for groceries ○ Firm choosing to open another factory ○ Effect of government intervention on a single market —>  Macroeconomics ○ The study of the broader economy Examples: ○ Inflation ○ Economic growth (more production) ○ Unemployment ○ Interest rates Economic Models Ceteris paribus ○ Latin: “other things being equal” ○ Assumption in which we examine a change in one variable, but hold all other variables constant. ○ Allows us to isolate the effect of a single variable Economists use models to understand the complex real-world economy. Models ○ Simplified versions of reality ○ Built with some assumptions ○ Are considered good if they explain and predict well Economic Analysis Endogenous factors ○ Variables controlled for inside a model ○ Independent variables we freely change in the model equations to study their effect on the dependent variable Exogenous factors ○ Variables that are not accounted for in a model ○ Outside our control Danger of Faulty Assumptions It is necessary to often examine and re-evaluate the assumptions in models Example: ○ Assumption that housing prices always rise ○ Pre-2008 computer models used by banks didn’t have a variable for declining housing prices  Models and Ceteris Paribus What determines a person’s wage rate? W – f (Education - Positive, Age - Positive or Negative Effect?, Experience - Pos, Skills - Pos, Pleasant Conditions - Neg, Female - A Negative effect here may be indicative of discrimination.) ——————————— Wage depends on the endogenous variables. How will a change in the variables affect wage? What might some exogenous variables be? W – f (Education, Age, Experience, Skills, Pleasant Conditions, Female) Ceteris paribus analysis, Economic Analysis Preconceptions ○ People often seen what they expect to see and ignore information that contradicts their preconceptions ○ “Facts” are often influenced by biases ○ CHALLENGE YOUR PRECONCEPTIONS Positive and Normative Analysis Positive statement ○ A claim that can tested to be true or false ○ What “is” Normative statement ○ Statement of opinion; cannot be tested as to whether it is true or false ○ What “ought to be” or “should be” — Examples Positive statement: The unemployment rate rose last month. Normative statement: The government must take action to reduce the unemployment rate. Practice 1. Whenever the NFC team wins the Super Bowl, the U.S. stock market increases the next day. 2. A rise in income levels will result in an increase in car sales. - Positive 3. California should raise tuition at community colleges in order to give professors a salary increase.  Potential Pitfalls When Using Scientific Thinking Confusing correlation with causation ○ Ex. Diet cola drinkers are most likely obese or people are already obese, but drink diet cola ○ Ex. Did Ice cream cause polio? No connection at all with each other The Fallacy of Composition ○ Incorrectly assuming that what is true for the individual is true for the whole Ex. If you get up at 7am to get somewhere, you think there will be less traffic, but what if everyone thinks that? Then you have to wake up even earlier. What’s true for one, isn’t true for everyone Rational Self Interest Individuals select choices that make them happiest, given the information available at the time. ○ Ex. You try looking for shortest line – > Rational ○ Ex. Where would you tip better, tip well at a restaurant in the desert where you will only visit once or somewhere you go every week? ○ Ex. Choose certain majors that will make you more money Is self interest the same as selfishness? Charity: consistent with the pursuit of one’s self interest The Invisible Hand Adam Smith (“The Wealth of Nations, 1776) Individuals pursuing their own self interest can benefit society as a whole. Metaphor describing the self-regulation nature of markets. People Respond to Incentives Incentives (reason to do something whether it be positively or negatively) ○ Factors that motivate you to act or exert effort Positive incentives Negative incentives Unintended Consequences Unintended Consequences An unplanned result (usually negative and unwanted) of an incentive ○ Ex. Seatbelts for everyone, makes you feel safer which can cause injuries or deaths to bicyclists and pedestrians and you might feel more lenient  Opportunity Cost The highest-valued alternative sacrificed ○ Scarcity –> Choice –> Opportunity Cost TINSTAAFL –> There is no such thing as a free lunch Travel from Los Angeles to Las Vegas By plane: 1 hour; airfare = $100 By bus: 5 hours; bus fare = $40 ○ Which is the cheaper mode of transportation for someone who could earn $8 per hour Opportunity cost $8 per hour: ○ Plane: $100 + 1x$8 = $108 ○ Bus: $40 + 5x$8 = $80 Opportunity cost $20 per hour: ○ Plane: $100 + $20 = $120 ○ Bus: $40 + 5x$20 = $140 Indifferent when $100 + 1x$X = $40 + 5+$X X = $15 You have already purchased Car 1. Should you buy Car 2? 1: $30k 2: $24k Total: $54k Price of each car = $25k 2 x $25k = $50k Marginal Thinking “How Much” is a decision at the margin Marginal Benefit = additional benefit Marginal Cost = additional cost Rule of Rational Choice: If the expected marginal benefit > expected marginal cost > Undertake the activity  You have already purchased Car 1. Should you buy Car 2? Value to you 1: $30k Marginal Benefit – > 2: $24k Total Benefit: $54k Marginal Cost Price of each car = $25k Total Cost: 2 x $25k = $50k Factors of Production C-E-L-L Capital ○ Physical (tractors, etc.) ○ Human (factors used to create or help stuff Entrepreneurship Land Labor (Mental & Physical Effort) Production Possibilities Frontier Production Possibilities Frontier ○ Combination of outputs that a society can produce if all of its resources are being used efficiently Assumptions of this model ○ Resources fixed ○ Technology fixed ○ Simplified two-good analysis (picture here) PPF and Opportunity Cost Recall opportunity cost ○ Highest-valued alternative ○ What we give up as a result of an action  Opportunity cost in this case is the slope of the PPF (2nd picture here) Opportunity cost of chicken wings (Horizontal Laws) (picture) Demand Quantity demanded ○ The amount of a good consumers are willing and able to consume at a particular price Law of Demand ○ Ceteris paribus, there is an inverse relationship between price and quantity demanded # of KitKats: (written on paper) Satisfaction (marginal utility): Demand Curve Shows at any given price, how many units of output consumers wish to purchase (picture written) Buyer’s Reservation Price Height of the demand curve Maximum price that consumers are willing to pay for a particular quantity of output Increase in Quantity Demanded Caused by price decrease Decrease in Quantity Demanded Caused by price increase Increase in Demand Entire demand curve shifts to the right Willing to buy more at ANY price Decrease in Demand Entire demand curve shifts to the left Willing to buy less at ANY price Change in Quantity Demanded vs. Change in Demand A Change in Quantity Demanded: ○ Movement along the demand curve caused by a change in the price of the good A Change in Demand:  ○ Shift of the demand curve caused by changes in non-price factors ○ Entire demand curve will shift to the left or right Factors that Shift the Demand Curve (P-I-R-A-T-E-S) -Non-price factors that impact buying decisions will shift the demand curve. Population Income Related Goods Advertising Tastes or Fashion Expectations Season Demand Shifters: Population -number of Buyers go higher -Demand goes higher Demand Shifters: Income Normal Goods ○ As income increases, we buy more - Income and Normal Goods Income goes up Demand goes up Inferior Goods ○ Income goes up ○ Demand goes down Demand Shifters: Related Goods - Substitutes Goods that can be used in place of each other Direct relationship between the price of good X and demand for good Y Ex. Butter and Margarine or Snickers and Milky Way or Cola and Pepsi Substitutes in Consumption Event: price of Coke increases ○ So people would move to pepsi instead or continue to stay at coke Demand Shifters: Related Goods - Complements Goods used together Inverse relationship between the price of good X and demand for good Y ○ Ex. Guac with chips, PB and J, Milk and Cereal Complements in Consumption Event: price of milk increases  ○ Milk: Movement along the demand curve ○ Cereal: A shift in demand Demand Shifters: Advertising Advertising goes up Demand goes up ○ Lebron James drinks Sprite Demand Shifters: Tastes & Preferences Popularity goes down or up Demand goes down or up Demand Shifters: Expectations Price in future goes higher Demand goes up today Demand Shifters: Seasons Winter brings higher demand for coats Summer brings lower demand for coats Supply Quantity supplied ○ The amount of the good or service that producers are willing and able to sell at a particular price Law of Supply ○ Ceteris paribus, there is a positive relationship between price and quantity supplied Supply Curve Shows at any given price, how many units of output sellers are willing to sell Seller’s Reservation Price Height of the supply curve Minimum price that sellers require to be willing to supply a particular quantity of output Increase in Quantity Supplied Caused by a price increase ○ Price goes higher, quality supply goes higher Decrease in Quantity Supplied Caused by a price decrease ○ Price goes down, quality supply goes down Increase in Supply (right is increase on graph) Entire supply curve shifts to the right  Less willing to sell at ANY price Non-Price Factors & Supply Any non-price factors that impact production/selling decisions will shift the supply curve. Resource Cost Other Goods’ Price Technology (Productivity) Taxes, Subsidies, & GOvernment Regulation Expectation of the Producer Number of Sellers Supply Shifters: Resource Cost A change in resource costs (input prices) will shift the supply curve Supply Shifters: Other Goods’ Price Substitutes: ○ Alternative products that can be produced with the same resources (factors of production) ○ An inverse relationship between the price of good X and supply of good Y Ex. Suppose that the price of corn triples: people would move to corn instead of wheat which affects the supply and prices would increase Complements: ○ Products that are produced together ○ A direct (positive) relationship between the price of good X and the supply of good Y Ex. Suppose that the price of beef triples: you send more cows to the market increase the supply of LEATHER Supply Shifters: Technology The cost of production goes down as a result o Supply Shifters: Taxes, Subsidies, & Government Regulation Taxes and increased Government Regulation: ○ Taxes and government regulations imposed on firms tends to increase the cost of production, consequently decreasing supply. Subsidies: A subsidy, the opposite of a tax, is an amount of money given directly to firms by the government to encourage production Supply Shifters: Expectations Suppose that news reports project a much higher price for wine in a few months due to production problems in France. Then they’d keep it stored and release it when it price rises Supply Shifters: Number of Sellers Typically, market supply increases as the number of sellers increases.