Introduction to Economics (PDF)

Part 1 INTRODUCTION TO ECONOMICS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Part 2 SUPPLY AND DEMAND: HOW MARKETS WORK FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 ©...

Part 1 INTRODUCTION TO ECONOMICS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Part 2 SUPPLY AND DEMAND: HOW MARKETS WORK FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 3 THE MARKET FORCES OF SUPPLY AND DEMAND FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Forces of Supply And Demand  Supply and demand are the forces that make market economies work.  Supply and demand determine prices in a market economy and how prices, in turn, allocate the economy’s scarce resources.  The model of the market based on supply and demand, like any other model, is based on a series of assumptions. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Assumptions of The Market Model The terms supply and demand refer to the behavior of people as they interact with one another in markets. A market is a group of buyers and sellers of a particular good or service. A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Assumption for efficient outcomes  The model of supply and demand which leads to this ‘efficient’ outcome is based on the following: ◦ Many buyers and sellers. ◦ Perfect information for all buyers and sellers. ◦ Freedom of entry and exit. ◦ Identical goods. ◦ Buyers and sellers act in self interest. ◦ Clearly defined property rights. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Competitive market  A market in which there are many buyers and many sellers so that each has a negligible impact on the market price.  Characteristics of a perfectly competitive market: ◦ All goods for sale are the same. ◦ No buyer or seller can influence market price on their own.  Because buyers and sellers must accept the market price as given, they are often called "price takers." FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Demand Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand is the claim that, other things equal, «ceteris paribus» the quantity demanded of a good falls when the price of the good rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Demand Curve: The Relationship between Price and Quantity Demanded Demand schedule Price of milk per litre (€) Quantity of milk demanded is a table that (litres per month) shows the relationship 0.00 20 between the price of 0.10 18 the good and the quantity demanded. 0.20 16 0.30 14 0.40 12 0.50 10 0.60 8 0.70 6 Rachel’s Demand 0.80 4 Schedule 0.90 2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Rachel’s Demand Schedule and Demand Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Shifts Versus Movements Along The Demand Curve  Ceteris paribus - other factors affecting demand are held constant so that we can analyze the effect of a change in price on demand. ◦ A shift in the demand curve is caused by a factor affecting demand other than a change in price. ◦ Movement along the demand curve. ◦ Caused by a change in the price of the product. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Changes In Quantity Demanded Price of milk A tax that raises the price milk results in a movement along the B €1.20 demand curve. A €0.60 D 0 4 8 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Terms for Shift vs. Movement Along Curve Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers) Change in the quantity demanded: a movement along a fixed D curve occurs when P changes FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 13 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve A shift in the demand curve, to the left or right. ◦ Caused by any change that alters the quantity demanded at every given price. Shifts caused by factors other than price. 1) Prices of related goods (substitutes and complements) o Substitutes: two goods for which an increase in the price of one good leads to an increase in the demand for the other. o Complements: two goods for which an increase in the price of one good leads to a decrease in the demand for the other. 2) Income ◦ A lower income means that you have less to spend in total, so you would have to spend less on some – and probably most – goods. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve Shifts caused by factors other than price (continued) 2) Income continued. ◦ If the demand for a good falls when income falls or rises as income rises, the good is called a normal good. ◦ If the demand for a good rises when income falls, the good is called an inferior good. 3) Tastes. More people may like something 4) Number of buyers (population). 5) Advertising 6) Expectations of consumers where demand is influenced by expectations of future income and future prices FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Demand Curve Price of milk Increase in demand Decrease in demand Demand curve, D2 Demand curve, D1 Demand curve, D3 0 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 1 Demand Curve Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why? A. The price of iPods falls B. The price of music downloads falls C. The price of CDs falls  ACTIVE LEARNING 1 A. Price of iPods falls Price of music Music downloads and down-loads iPods are complements. A fall in price of iPods shifts the demand curve P1 for music downloads to the right. D1 D2 Q1 Q2 Quantity of music downloads  ACTIVE LEARNING 1 A. Price of music downloads falls Price of music The D curve down-loads does not shift. Move down along curve to a point with lower P, higher Q. P1 P2 D1 Q1 Q2 Quantity of music downloads  ACTIVE LEARNING 1 C. Price of CDs falls Price of music CDs and down-loads music downloads are substitutes. A fall in price of CDs shifts P1 demand for music downloads to the left. D2 D1 Q2 Q1 Quantity of music downloads Supply Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of supply is the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule Price of milk per litre (€) Quantity of milk supplied ◦ The supply (litres per month) schedule is a 0.00 0 table that shows the relationship 0.10 0 between the 0.20 2 price of the good 0.30 4 and the quantity supplied. 0.40 6 0.50 8 0.60 10 0.70 12 0.80 14 Richard’s Supply 0.90 16 Schedule 1.00 18 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Richard’s Supply Schedule and Supply Curve Supply Curve ◦ The supply curve is the graph of the relationship between the price of a good and the quantity supplied. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Supply versus Individual SupplySupply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs) Change in the quantity supplied: a movement along a fixed S curve occurs when P changes FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 25 9781473725331 © CENGAGE EMEA 2017  Supply schedule Price of milk S C €1.50 A rise in the price milk results in a movement along the supply curve. A €0.60 Quantity of milk 0 1 5 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Shifts in the Supply Curve The supply curve shows how much producers offer for sale at any given price, holding constant all other factors that may influence producers’ decisions about how much to sell.  When any of these other factors change, the supply curve will shift. ◦ These are shown on the next slide. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Supply Curve ① Profitability of other goods in production and prices of goods in joint supply. ② Technology. ③ Natural/Social Factors such as the weather and changing attitudes. ④ Input prices – the prices of the factors of production. ⑤ Expectations of producers about the future state of the market. ⑥ A change in the number of sellers in the market. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Shifts in the Supply Curve Price of milk Supply curve, S3 Supply curve, S1 Supply Decrease curve, S2 in supply Increase in supply 0 Quantity of milk FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Variables That Influence Sellers Copyright©2004 South-Western ACTIVE LEARNING 2 Supply Curve Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide. ACTIVE LEARNING 2 A. Fall in price of tax return software Price of tax return S1 S curve does software not shift. Move down along the P1 curve to a lower P and lower Q. P2 Q2 Q1 Quantity of tax return software ACTIVE LEARNING 2 B. Fall in cost of producing the software Price of tax return S1 S2 software S curve shifts to the right: P1 at each price, Q increases. Q1 Q2 Quantity of tax return software  ACTIVE LEARNING 3 C. Professional preparers raise their price Price of tax S1 This shifts the demand return curve for tax preparation software software, not the supply curve. Quantity of tax return software Supply And Demand Together Equilibrium Price ◦ The price that balances quantity supplied and quantity demanded. ◦ On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity ◦ The quantity supplied and the quantity demanded at the equilibrium price. ◦ On a graph it is the quantity at which the supply and demand curves intersect. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Supply And Demand Together Demand Schedule Supply Schedule price quantity price quantity At €2.00, the quantity demanded is equal to the quantity supplied in this example. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Equilibrium of Supply and Demand FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Not in Equilibrium (a) Excess Supply Price of milk Supply Surplus € 0.70 0.60 Demand 0 4 7 10 Quantity of milk Quantity Quantity demanded supplied FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Equilibrium Surplus ◦ When price > equilibrium price, then quantity supplied > quantity demanded. ◦ There is excess supply or a surplus. ◦ Suppliers will lower the price to increase sales, thereby moving toward equilibrium. Shortage ◦ When price < equilibrium price, then quantity demanded > the quantity supplied. ◦ There is excess demand or a shortage. ◦ Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cones € 2.00 1.50 Shortage Demand 0 4 7 10 Quantity of Quantity Quantity Ice-Cream supplied demanded Cones FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Equilibrium Law of supply and demand ◦ The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Three Steps to Analyzing Changes in Equilibrium ① Decide whether the event shifts the supply or demand curve (or both). ② Decide whether the curve(s) shift(s) to the left or to the right. ③ Use the supply and demand diagram to see how the shift affects equilibrium price and quantity. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  How an Increase in Demand Affects the Equilibrium Price of milk 1. Hot weather increases the demand for milk... Supply € 0.80 New equilibrium 0.60 2.... resulting Initial in a higher equilibrium price... D D 0 7 10 Quantity of 3.... and a higher milk quantity sold.  How a Decrease in Supply Affects the Equilibrium Price of milk 1. An increase in the animal feed reduces the supply of milk.. S2 S1 New € 0.80 equilibrium 0.60 Initial equilibrium 2.... resulting in a higher price of milk Demand 0 4 7 Quantity of milk 3.... and a lower quantity sold. Table: What Happens to Price and Quantity When Supply or Demand Shifts? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION FOR USE WITH 9781473725331 MANKIW AND TAYLOR, ECONOMICS © CENGAGE 4TH EDITION EMEA 2017 9781473725331 © CENGAGE EMEA 2017 EXAMPLE: The Market for Hybrid Cars P price of hybrid cars S1 P1 D1 Q Q1 quantity of hybrid cars FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 1: A Shift in Demand EVENT TO BE ANALYZED: P Increase in price of gas. S1 STEP 2: 3: 1: P2 D shifts Thecurve shifts shiftright causes an because price increase high in of gas gas price price P1 affects makes and demand hybrids quantity for of more hybrid hybrids. relative to attractive cars. other cars. S curve does not shift, because price of gas D1 D2 does not affect cost of Q producing hybrids. Q1 Q 2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 1: A Shift in Demand Notice: When P rises, producers P supply S1 a larger quantity of hybrids, even though P2 the S curve has not shifted. P1 Always be careful to distinguish b/w a shift D1 D2 in a curve and a movement along the Q Q1 Q2 curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 2: A Shift in Supply EVENT: New technology reduces cost of producing P hybrid cars. S1 S2 STEP 1: S curve shifts because STEP 2: event affects P1 cost of production. S shifts right P2 D curve 3: does because STEP eventnot shift, reduces because production cost,shift causes The price D1 technology makes to is not one fall production moreof the factorsatthat affect Q profitable and quantity anyrise. to given Q1 Q2 demand. price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 3: A Shift in Both Supply and Demand EVENTS: price of gas rises AND P new technology reduces S1 S2 production costs STEP 1: P2 Both curves shift. P1 STEP 2: Both shift to the right. STEP 3: D1 D2 Q rises, but effect Q on P is ambiguous: Q1 Q2 If demand increases more than supply, P rises. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 EXAMPLE 3: A Shift in Both Supply and Demand EVENTS: price of gas rises AND P new technology reduces S1 S2 production costs STEP 3, cont. P1 But if supply increases more P2 than demand, P falls. D1 D2 Q Q1 Q2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 Shifts in supply and demand Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. Event A: A fall in the price of CDs Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. Event C: Events A and B both occur. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 A. Fall in price of CDs The market for STEPS P music downloads 1. D curve shifts S1 2. D shifts left P1 3. P and Q both fall. P2 D2 D1 Q Q2 Q1 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 B. Fall in cost of royalties STEPS The market for P music downloads 1. S curve shifts (Royalties are part of sellers’ costs) S1 S2 2. S shifts right P1 3. P falls, Q rises. P2 D1 Q Q1 Q2 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 ACTIVE LEARNING 3 C. Fall in price of CDs and fall in cost of royalties STEPS 1. Both curves shift (see parts A & B). 2. D shifts left, S shifts right. 3. P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Summary ① Economists use the model of supply and demand to analyse competitive markets. ② In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price. ③ The demand curve shows how the quantity of a good depends upon the price. ◦ According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward. ◦ In addition to price, other determinants of how much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers. ◦ If one of these factors changes, the demand curve shifts. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Summary ④ The supply curve shows how the quantity of a good supplied depends upon the price. ◦ According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward. ◦ In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. ◦ If one of these factors changes, the supply curve shifts. ⑤ Market equilibrium is determined by the intersection of the supply and demand curves. ⑥ At the equilibrium price, the quantity demanded equals the quantity supplied. ⑧ To analyse how any event influences a market, we use the supply and demand diagram to examine how the even affects the equilibrium price and quantity. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 1 WHAT IS ECONOMICS? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 What is Economics? …is NOT the study of money or getting rich. ….is NOT the stock market. What is Economics? …is an 20 year old girl who is deciding whether to work or go to university and how that affects her future income. …is a company deciding whether to produce smartphones or tables and how that’s influenced by what we consumers want to buy. …is the government deciding whether to increase its spending when there is a recession and if it is worth going into debt. No matter who you are, you will be using economics! Economy...... The word economy comes from a Greek word for “one who manages a household.” The Economy and Economic Systems In the economy we are faced with many decisions; many of them involves an exchange sometimes using money as the medium. Households purchase final goods and services for final consumption and also provide the inputs into production – land, labor and capital The organizations which buy these factors and use them to produce goods and services are referred to collectively as firms. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Economy and Economic Systems The economy is all the production and exchange activities that take place every day (all the buying and selling). Economic activity is how much buying and selling goes on in the economy over a period of time. The economy exists at different scales Local, İstanbul National e.g. the UK, Turkey International e.g. EU FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Economic Problem The four big questions are: ◦ What goods and services should be produced? ◦ How should it be produced (see resources)? ◦ Who should get the goods and services produced? ◦ At what price should the goods be sold? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Scarcity and Choice Society and Scarce Resources: ◦ The management of society’s resources is important because resources are scarce. ◦ Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. ◦ If everybody could reach whatever they want: then there will be no need to economics ◦ Economics is the study of how society manages its scarce resources. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 What is Economics? Economics is a social science that aims at the study of production, distribution, consumption and accumulation of wealth in society.  What is Economics? Production: What to produce? How much? Which technology do we need and how to produce? Distribution: Who gets what portion of total production? How to distribute total income amongst different social groups (religion, region, gender, etnical) Consumption: How individuals get consumption and saving decisions? What type of goods and services are consumed by individuals? Accumulation: How fast can wealth be accumulated (economic growth)? What factors cause rapid growth? Why economic crises ocur? How can individuals living conditions be improved? FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 E ECONOMY AS A WHOLE WORKS Macroeconomics and Microeconomics Microeconomics Branch of economics that deals with the behavior of individual economic units—consumers, firms, workers, and investors— as well as the markets that these units comprise. Macroeconomics. Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Economic Agents Households/Individuals: the decisions of consumption, savings and labor supply ◦ Households: All persons living under one roof or occupying a separate housing unit – co-consumption decisions Firms: the decisions of production, investment and labor demand Government: economic policies (fiscal, monetary, social, development plans, macroeconomic targets) FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 How People Make Decisions ◦ People face tradeoffs. ◦ The cost of something is what you give up to get it. ◦ Rational people think at the margin. ◦ People respond to incentives. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Principle #1: People Face trade-offs Principle Tradeoffs. “There is no such thing as a free lunch!” FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 People Face trade-offs To get one thing, we usually have to give up another thing. ◦ Food v. clothing ◦ Leisure time v. work ◦ Efficiency v. equity Making decisions requires trading off one goal against another.  People Face trade-offs Society and Scarce Resources: The management of society’s resources is important because resources are scarce. Consumers Consumers have limited incomes, which can be spent on a wide variety of goods and services, or saved for the future. Workers Workers also face constraints and make trade-offs. First, people must decide whether and when to enter the workforce. Second, workers face trade-offs in their choice of employment. Finally, workers must sometimes decide how many hours per week they wish to work, thereby trading off labor for leisure. Firms Firms also face limits in terms of the kinds of products that they can produce, and the resources available to produce them. People Face trade-offs Efficiency v. Equity ◦ Efficiency means society gets the most that it can from its scarce resources. ◦ Equity means the benefits of those resources are distributed fairly among the members of society. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Principle #2: The Cost of Something Is What You Give Up to Get It. Opportunity Cost Decisions require comparing costs and benefits of alternatives. ◦ Whether to go to university or to work? ◦ Whether to study or go out on a date? ◦ Whether to go to class or sleep in? The opportunity cost of an item is what you give up to obtain that item. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 The Cost of Something Is What You Give Up to Get It. LA Laker basketball star Kobe Bryant (former basketball player) chose to skip college and go straight from high school to the pros where he has earned millions of dollars. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Principle #3: Rational People Think at the Margin. Marginal changes are small, incremental adjustments to an existing plan of action. People make decisions by comparing costs and benefits at the margin. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Principle #4: People Respond to Incentives Marginal changes in costs or benefits motivate people to respond. The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs! Public policies can create incentives or disincentives that alter behaviour. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Can Be a Good Way to Organize Economic Activity Market a shorthand expression for the process by which … households’ decisions about consumption of alternative goods firms’ decisions about what and how to produce and workers’ decisions about how much and for whom to work … are all reconciled by adjustment of prices. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Economic agents of society and their economic decisions 1. Households / Individuals as consumers and suppliers of labor ◦ a household (HH): group of individuals living under the same roof and hence sharing a common budget 2. Firms (the private sector) as producers; employers of labor; and investors, users of technology and capital 3. The Government (the public sector) as decision-maker on legal framework and policies (fiscal, monetary, industrial and social welfare policies, macro programs, development plans, etc.) 4. Rest of the world (the international sector) Markets Can Be a Good Way to Organize Economic Activity Prices and Markets How prices are determined? The price is an important factor for resource allocation. Resource allocation is crucial for a society and is handled in different ways in different societies, e.g.: Central planned economy Mixed economy Free market economy FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Can Be a Good Way to Organize Economic Activity Prices and Markets How prices are determined? The price is an important factor for resource allocation. Resource allocation is crucial for a society and is handled in different ways in different societies, e.g.: Central planned economy: by government Mixed economy Free market economy: by economic agents FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Can Be a Good Way to Organize Economic Activity Efficiency or Equity? In market economies, efficiency is more of a concern whereas the planned economies gives more emphasis on equity. Since the prices are not free in the planned economies a central office decides the prices and the production. A heavy bureaucracy is required for this process. Lack of competition decreases the productivity and quality in planned economies.  Markets Can Be a Good Way to Organize Economic Activity Market Orientation China Sweden USA Hungary Cuba United Kingdom Free Market Central Planned Economy Economy FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Can Be a Good Way to Organize Economic Activity Pure market economy has no government intervention. Centrally planned economy is where those in charge guide economic activity. ◦ They have failed because they did not allow the market to work. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Markets Can Be a Good Way to Organize Economic Activity Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.” ◦ Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. ◦ As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Market Structures Market characteristics that determine the economic environment in which firms and individuals operate ◦ Number & size of firms in market ◦ Degree of product differentiation ◦ Likelihood of new firms entering market Market Structures Perfect Competition: ◦ Large number of relatively small firms ◦ Homogeneous product ◦ No barriers to entry Monopoly: ◦ Single firm ◦ Produces product with no close substitutes ◦ Protected by a barrier to entry Monopolistic Competition: ◦ Large number of relatively small firms ◦ Differentiated products ◦ No barriers to entry Oligopoly: ◦ Few firms produce all or most of market output ◦ Homogeneous or heterogeneous products ◦ Actions by any one firm will affect sales & profits of the other firms  Governments Can Sometimes Improve Market Outcomes Market failure occurs when the market fails to allocate resources efficiently. When the market fails government can intervene to promote efficiency and equity. Market failure may be caused by ◦ an externality, which is the impact of one person or firm’s actions on the well-being of a bystander. ◦ market power, which is the ability of a single person or firm to unduly influence market prices. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 An Economy’s Standard of Living Depends on its ability to produce goods and services Economic growth - the increase in the amount of goods and services in an economy over a period of time. Gross domestic product per head - the market value of all final goods and services produced within a country in a given period of time divided by the population of a country to give a per capita figure FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 An Economy’s Standard of Living Depends on its ability to produce goods and services Standard of living - a measure of welfare based on the amount of goods and services a person’s income can buy. ◦ Usually measured by the inflation adjusted (real) income per head of the population. ◦ Most variations in living standards are explained by differences in countries’ productivities. Productivity is the amount of goods and services produced from each hour of a worker’s time. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Summary ① When individuals make decisions, they face trade-offs among alternative goals. ② The cost of any action is measured in terms of foregone opportunities. ③ People often make decisions by comparing marginal costs and marginal benefits. ④ People change their behavior in response to the incentives they face. ⑤ Government can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable. ⑧ Productivity is the ultimate source of living standards. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017