Economics Book PDF

Introduction and Chapter 1: Chapter 1 First Principles individual choice — decisions by an individual about what to do and what not to do. -> all economic activities involve individual choices Principles of Individual choice Principle #1: Choices are necessary because resources are scarce ->...

Introduction and Chapter 1: Chapter 1 First Principles individual choice — decisions by an individual about what to do and what not to do. -> all economic activities involve individual choices Principles of Individual choice Principle #1: Choices are necessary because resources are scarce -> Making a choice because you can’t have everything like choosing to spend your money on a nice holiday or a new car ( money is the resource in this case) -> can be limited income or also limited time -> choosing what you spend your time on Principle #2: The True cost of Something is its Opportunity -> what you give up in order to get something else -> either/or -> Example: go to college instead of working so true cost is the money you give up to go to college -> all costs are opportunity costs -> every choice you make forgoing another opportunity -> not just money also lifetime Principle #3 ’’How Much’’ is a decision at the margin ( spielraum) Decision involves a trade-o , comparison of costs and bene ts when you do something Marginal decisions; whether to do a bit more or a bit less Cost of next one = marginal cost e.g. sociolingustics & economics, for which one you learn more the other you learn less Principle #4 People respond to Incentives, exploiting opportunities to make themselves better o —> people exploit opportunities —> basis of all predictions —> will continue to exploit opportunities until they are fully exhausted —> good: substitutes —> bad: taxes, nes Incentive: anything that o ers rewards to people to change their behaviour Interaction: How Economies work each individual makes own choices BUT depend to large extent on choices made by others 1 fi ff ff fi ff  Principles of interaction of individual Choices Principle #5 There are gains from Trade You get more out of a trade than trying to be self-su cient increase in output through specialising in one task Reason for economy not many self-su cient individuals —> gains from trade Gains from trade arise from specialisation Economy as a whole can produce more -> each person specialises Everyones advantage —> individuals specialise Principle #6 Markets move toward Equilibrium Equilibrium is when no individual would be better of doing something different —> Because people respond to incentives, markets move toward equilibrium markets reach equilibrium -> changes prices rise or fall until no opportunities for individuals to make themselves better off remain. —> supply & demand will both tend to meet a sustainable point Example: Supermarket when its busy and a new cash register opens -> checkout lines are the same length would be an equilibrium Equilibrium: an economic situation in which no individual would be better o doing something di erent. —> everytime there is a change situation moves to equilibrium —> markets move towards equilibrium —> depend on them work in predictable way Principle #7 Resources should be used e ciently to achieve society’s goals E cient: is when the economy takes all opportunities to make people better o - without others getting worse —> Resources should be used as e ciently as possible — way to work —> share car with colleague Example: The classroom is too small for too many students even though there are bigger ones available. —> to make everyone better of move lecture to a bigger room only if that room would have been empty -> when economy is e cient —> maximum gains from trade possible given the resources available -> E ciency may class with other society goals —> For example in most societies people care about equity too —> trade-o Example for this trade-o : Disabled-designated parking spaces —> more than people usually use —> con ict equity: making life fairer for disabled and e ciency: all opportunities to make people better o have been fully exploited by not letting close-in parking spaces go unused Principle #8 Markets usually lead to E ciency, in case they don’t government intervention can improve society’s welfare 2 ffi ffi ffi ff ffi ff ffi ffi ffi ffi ffi ff ff fl ff ff  - in most cases the invisible hand does the job - because people usually exploit gains from trade, markets usually lead to e ciency - people normally take opportunities for mutual gain — that is, gains from trade. — >if it doesn’t work —> exceptions market failure, the individual pursuit of self-interest found in markets makes society worse o — that is, the market outcome is ine cient Example: tra c congestion: remedies —> taxing gasoline, public transportation cheaper —> appropriately designed government policy can move society closer to e cient outcome for e.g. by changing how resources are used - At the sector, national and international levels, market principles seem to work - Economists generally believe in ’leaving the market alone’ - Economic downturn — markets can slump or malfunction Government = external force: economy back into growth Quick Review: - Most economic situations involve the interaction of choices, sometimes with unintended results. In a market economy, interaction occurs via trade between individuals. - Individuals trade because there are gains from trade, which arise from specialization. Markets usually move toward equilibrium because people exploit gains from trade. - To achieve society’s goals, the use of resources should be e cient. But equity, as well as e ciency, may be desirable in an economy. There is often a trade-o between equity and e ciency. - Except for certain well-de ned exceptions, markets are normally e cient. When markets fail to achieve e ciency, government intervention can improve society’s welfare. Economy-Wide Interactions - economy ups and downs: good economic time ( recoveries) & bad economic times ( recessions) —> cycle 7 to 10 years Principles of economy-Wide Interactions Principle #9 One Person’s spending is another person’s income - a chain reaction of changes in spending behaviour -> repercussions spread economy- wide - Market economy -> people make a living selling things ( including their labor) to other people -> if group in economy decides to spend more income group of other people will rise and other way round Principle #10 Overall Spending Sometimes Gets Out of Line with the Economy’s Productive Capacity; When It Does, Government Policy Can Change Spending Example: if the spending is too high, economy experiences in ation, rise of prices when demand outstrips supply 3 ffi ffi ffi ffi fi ffi ffi ffi fl ff ffi ffi ff  If that happens: government policies can be used to address the imbalances - Modern governments deploy macroeconomic policy tools -> balance overall spending in economy -> steer it between perils of recession and in ation Principle #11 Increases in the Economy’s Potential Lead to Economic Growth Over Time - changes due to economic growth -> increase living standards - Growth can happen through: emergence new technologies & increases resources available for production —> economy potential rises Example: tractors (new technologies) have changed the agriculture sector enormously - Unequally -> increase in economical potential —> winners & losers Example Winner & Loser: alternative energy sources solar and wind power -> pollute less than older sources such -> coal, bene t economy & environment (winners) BUT reduced demand coal hurt communities mining primary source of employment (losers) Summary: - how people make choices - How do these choices interact - How economy functions overall —> Individual choice is the basis of economics —> resources are scarce —> all costs are opportunity costs economics: is the social science that studies the production, distribution, and consumption of goods and services market economy: an economy in which production and consumption are the result of decentralized decisions by rms and individuals invisible hand: to refer to the way a market economy harnesses the power of self-interest for the good of society. microeconomics: The study of how individuals make decisions and how these decisions interact is called market failure: which happens when the individual pursuit of one’s own interest, instead of promoting the interests of society as a whole, actually makes society worse of -> Example air pollution in Indian cities, Water pollutions macroeconomics: which is concerned with the overall ups and downs of the economy 4 fi fi fl  Resource: anything used to produce something else -> like land, labor (the time of workers), capital (machinery, buildings, and other man-made productive assets), and human capital (the educational achievements and skills of workers Scarce: Not enough of resource available satisfy all ways society wants to use it Opportunity Cost: What you must give up in order to get something Marginal decisions: A decision made at the ’’margin’’ of an activity to do a bit more or less of that activity Marginal analysis: Study of marginal decisions Interaction: (of choices) my choices a ect your choices, and vice versa; a feature of most economic situations. The results of this interaction are often quite di erent from what the individuals intend Trade: the practice, in a market economy, in which individuals provide goods and services to others and receive goods and services in return. Gains from trade: gains achieved by dividing tasks and trading; in this way people can get more of what they want through trade than they could if they tried to be self-suf cient. Specialisation: the situation in which each person specialises in the task that they are good at performing. Equity: fairness; everyone gets their fair share. Since people can disagree about what’s “fair,” equity isn’t as well defined a concept as efficiency. Invisible hand: How market economy harnesses power of self-interest for good of society Economic Models: trade-o s and trade Model as simpli ed representation of a real situation that is used to understand real-life situations better Other things equal assumption, all other relevant factors remain unchanged Models are important -> simplicity allows economists focus on e ects of only one change at a time Other things equal assumption: in the development of a model, the assumption that all other relevant factors remain unchanged. most e ective form of economic modelling is the construction of “thought experiments”: simpli ed, hypothetical versions of real-life situations 5 fi ff fi ff ff fi ff ff  Trade-o s: The Production Possibility Frontier -> Dreamliner example illustrates the trade-o s facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given quantity produced of the other. idea of the model: improve understanding of trade-o s by considering a simpli ed economy that produces only two goods. This simpli cation enables us to show the trade-o graphically. —> 40 small jets no Dreamliner or 30 Dreamliner and no jets —> 20 small jets and 15 Dreamliners point A —> 28 small jets and 9 Dreamliners point B FIGURE 1 The Production Possibility Frontier ( Grenze der Produktionsmöglichkeit) The production possibility frontier illustrates the trade-o s Boeing faces in producing Dreamliners and small jets. It shows the maximum quantity of one good that can be produced given the quantity of the other good produced. Here, the maximum quantity of Dreamliners manufactured per year depends on the quantity of small jets manufactured that year, and vice versa. Boeing’s feasible production is shown by the area inside or on the curve. Production at point C is feasible but not e cient. Points A and B are feasible and e cient in production, but point D is not feasible. —> distinction between points inside/on the PPF (shaded area) & outside —> production point inside/ on frontier —> C (Boeing produces 20 small jets & 9 DLs a year) —> feasible HOWEVER —> production point outside the frontier —> D isn’t feasible E ciency - key element —> no missed opportunities in production —> no way to produce more of one good without producing less of other goods - E ciency in production and allocation needed too be e cient for the economy - Must also produce mix of goods people want & deliver them to the right people 6 ffi ffi ff ff ffi fi ff ffi ff fi ff ffi  When something ine cient in allocation it means that other amounts of something are produced than society would need —> plane example how many planes do we need from which one Opportunity Cost De nition: what must be given up in order to get that good Example: Boeing decides to change its production from point A to point B, it will produce 8 more small jets but 6 fewer Dreamliners. So the opportunity cost of 8 small jets is 6 Dreamliners — the 6 Dreamliners that must be forgone in order to produce 8 more small jets. This means that each small jet has an opportunity cost of 6/8 = 3/4 of a Dreamliner. - whenever we assume that the opportunity cost of an additional unit of a good doesn’t change regardless of the output mix, the production possibility frontier is a straight line - the slope of a straight-line production possibility frontier is equal to the opportunity cost — speci cally, the opportunity cost for the good measured on the horizontal axis in terms of the good measured on the vertical axis - Production possibility frontier constant slope —> Boeing faces constant opportunity cost - production possibility frontier model can also be used to examine situations in which opportunity costs change as the mix of output changes. FIGURE 2 Increase The bowed-out shape of the production possibility frontier re ects increasing opportunity cost. In this example, to produce the rst 20 small jets, Boeing must forgo producing 5 Dreamliners. But to produce an additional 20 small jets, Boeing must forgo manufacturing 25 more Dreamliners. - opportunity costs are typically increasing - When only small amount of good produced —> opportunity cost is low —> increasing opportunity cost —> more small jets produced the more costly it is to produce yet another jets -> forgone production in DL —> more Dreamliners Boeing produces, the more costly it is to produce yet another Dreamliner -> forgone production of small jets —> producing 20 SJ forgo producing 5 DL -> opportunity cost of 20 SJ is 5 DL 7 fi fi ffi fi fl  Economic Growth De nition: the growing ability of the economy to produce goods and services —> economic growth fundamental features of an economy —> expansion of the economy’s production possibilities; that is, the economy can produce more of everything. FIGURE 3 Economic Growth Economic growth results in an outward shift of the production possibility frontier because production possibilities are expanded. The economy can now produce more of everything. For example, if production is initially at point A (25 Dreamliners and 20 small jets), economic growth means that the economy could move to point E (30 Dreamliners and 25 small jets). —> economy initially produces at point A —> growth —> moves point E —> E outside original frontier —> PPF model growth outward shift of frontier What leads the PPF to shift outward shift 1. Increase in economy’s factors of production: the resources used to produce goods and services. —> refer to source not used up in production —> main factors: labor (pool of workers), land (resource supplied by nature) physical (machines)& human capital ( education) Example: airplane manufacture —> workers used riveting machines connect metal sheets when constructing a plane’s fuselage —> workers & riveters —> factors of production —> can be used again —> rivets & sheet metal are not —> cannot be used again How leads to economic growth Boeing builds another hanger —> increase number of planes (hanger is a factor of production) -> ressource can be used over and over again 2. Progress in Technology —> Composite example: —> more e cient —> do more with any given resources —> pushing out PPF 8 fi ffi Comparative Advantage and Gains from Trade —>based on lower opportunity cost - it makes sense to produce the things ur good at - Buy the things that you are not good at Comparitive advantage - it’s between two countries/economics the one with the lower opportunity cost in producing has a comparative advantage Specialisation & Trade - makes both sides produce & consume more than if they were self-su cient FIGURE 4 Production Possibilities for 2 Countries Here, both the United States and Brazil have a constant opportunity cost of small jets, illustrated by a straight-line production possibility frontier. For the United States, each small jet has an opportunity cost of 3/4 of a large jet. Brazil has an opportunity cost of a small jet equal to 1/3 of a large jet. Example: -each choose to make their own large and small jets, not trading any of them and consuming only what each produced within its own country -absence of trade, the United States produces and consumes 16 small jets and 18 large jets per year -Brazil produces and consumes 6 small jets and 8 large jets per year. Specialisation & Trade —> Example USA and Brazil with big & small jets - makes both sides produce and consume more as if they were self - su cient 9 ffi ffi  FIGURE 5 Comparative Advantage and Gains from Trade By specializing and trading, the United States and Brazil can produce and consume more of both large jets and small jets. The United States specializes in manufacturing large jets, its comparative advantage, and Brazil — which has an absolute disadvantage in both goods but a comparative advantage in small jets — specializes in manufacturing small jets. With trade, both countries can consume more of both goods than either could without trade. —> everyone has a comparative advantage & disadvantage in something Absolute Advantage Is when the country can produce more output per worker than other ones. ( or just being better at it) —> in that case US has absolute advantage still bene t from Brazil because —> comparative, not absolute, advantage is the basis for mutual gain —> matters for trade for Brazil OC is lower for smaller jets than for US Transactions: The Circular-Flow Diagram Absolute Advantage: Means that a country is simply better ( or can produce more) than another one —> opportunity cost doesn’t matter Barter: trade in the form of the direct exchange of goods or services that people for other goods or services that people want.—> without using money Circular- ow diagram: - represents the transactions in an economy by two kinds of ows around a circle: - ows of physical things: goods, services, labor or raw materials in one direction - ows of money to pay for these physical things in the opposite direction. Households: A person or a group of people that share their income Firms: an organization that produces goods and services for sale. Markets for goods and services: markets in which rms sell goods and services that they produce to households. 10 fl fl fl fi fi fl  Factor markets: ( labor market) Firms buy the resources they need to produce goods and services —> simplest form only two kinds of inhabitants: households and rms —> On the left side there are markets for goods and services —> On the right side there are factor markets Capital market: Market where capital is bought and sold Income distribution: the way in which total income is divided among the owners of the various factors of production in an economy —>in uenced by factor markets Positive economics: about description tries to answer questions about the way the world works, which have de nite right and wrong answers. Stating facts (Analytical judgement) Normative economics: about prescription Analysis that say how the world should work. Giving explanantions (Value judgement) How Graphs work Causal relationship the relationship between two variables in which the value taken by one variable directly in uences or determines the value taken by the other variable. Independent variable the determining variable in a causal relationship -> in uencer Dependent variable the determined variable in a causal relationship -> in uenced The slope of a linear curve Along a linear curve the slope, or steepness, is measured by dividing the rise between two points on the curve by the run between those same two points. The rise is the amount that y changes, and the run is the amount that x changes. Here is the formula: In the formula, the symbol Δ (the Greek uppercase delta) stands for change in. When a variable increases, the change in that variable is positive; when a variable decreases, the change in that variable is negative. 11 fi fl fl fl fi fl  Chapter 3 Supply and Demand A Model of a Competitive Market - people who interact in the market “buyers” and “sellers. Competitive market: a market in which there are many buyers and sellers of the same good or service, the key feature is that none of whom can in uence the price at which the good or service is sold. Example: Of the Uber drivers and consumers in the San Francisco area Supply and demand model: a model of how a competitive market behaves. There are ve key elements in this model: 1. The supply curve 2. The demand curve 3. The set of factors that cause the supply curve to shift and the set of factors that cause the demand curve to shift 4. The market equilibrium, which includes the equilibrium price and equilibrium quantity 5. The way the market equilibrium changes when the supply curve or demand curve shifts The Supply Curve the amount of any good or service a seller wants to provide depends on the price. The higher the price, the more of the good or service sellers want to provide; alternatively, the lower the price, the less of the good or sellers want to provide. The supply schedule and the supply curve Supply schedule: table showing how much of a good or service sellers will want to provide at di erent prices Quantity supplied: the actual amount of a good or service producers are willing to sell at some speci c price. —> The supply curve and the supply schedule re ect the fact that supply curves are usually upward-sloping: other things equal, the quantity supplied rises when the price rises. —> supply curve visual representation of supply schedule Supply curve: a graphical representation of the supply schedule, showing the relationship between quantity supplied and price. 12 fi fl fl ff fi  Shifts of the Supply Curve —> fall of quantity in rides — less drivers willing to drive Shift of the supply curve: a change in the quantity supplied of a good or service at any given price. It is represented by the change of the original supply curve to a new position, denoted by a new supply curve. Movements along the supply curve: a change in the quantity supplied of a good that results from a change in the good’s price. -fall in quantity supplied going from A to B re ects movement along supply curve -->Result of fall in price of good -Fall in quantity supplied going from A to C re ects shift of supply curve —> Result of fall in quantity supplied at any given price Understanding Shifts of the Supply Curve -reduces supply shifts -> supply curve to the left —> re ecting fall in quantity supplied -increases supply shifts -> supply curve right —> re ecting increase quantity supplied —> decrease in supply leftward shift at any given price sellers sell smaller quantity (riders during covid) —> increase in supply rightward shift at any given price sellers sell larger quantity ( cost of leasing a car falls more would work for uber) 13 fl fl fl fl Shifts on the supply curve ve factors Changes in input prices - produce output need input - Increase price input makes the nal good more costly ( who produce and sell it) —> sellers not willing supply nal good at any given price ( supply curve shifts left) —> supply decreases Input Any good or service used to produce another good or service Changes in the Prices of Related Goods and Services - one seller produces a mix of goods - Seller provide several products —>quantity of any good it is willing to supply at any price depends on prices of co-produced goods Substitute in production - two or more di erent goods produced using same resources - Don’t go up together its either one or the other - Producing more of one requires producing less of the other Complements in production - two or more goods that are together produced using given resource - Pair consumed together Example: beef & leather - if price leather increases farmers more leather so also more beef Changes in Technology - improvements —> reduce sellers cost of producing good or service - Supply increases —> supply curve right Changes in Expectations choice a seller makes between selling the good now or saving it and selling it later depends on a comparison of the current price and the expected future price. - an increase in expected price of a good or service reduces supply today, a leftward shift of the supply curve - fall in expected price increases supply today, a rightward shift of the supply curve. Changes in Number of Producers Individual supply curve Shows relation between how much is supplied and what the seller is selling it for Market supply curve Sum of the individual supply curves of all sellers The Demand Curve —> law of demand price inluences 14 fi ff fi fi  shift of the demand curve a change in the quantity demanded at any given price, represented graphically by the shift of the original demand curve to a new position, denoted by a new demand curve A Decrease in Demand -strong economy-> increase demand -> rise in quantity demanded at any given price -decrease in demand -> shifts demand curve left Movements along the demand curve If less/more people want something the price also changes Shift in demand curve People demand/buy less at any given price Five principles for shift Changes in the prices of related goods or services Changes in income Changes in tastes Changes in expectations Changes in the number of buyers Other things equal: quantity of good demanded falls as price rises we are assuming that no other factors change Substitutes - pair not consumed together - Public transport & Uber - Rise of the price of one —> makes buyer buy more of the other Complements - pair that is consumed together - Co ee & breakfast - Price of one rises demand complement decreases Normal goods a good for which a rise in income increases the demand for that good — the “normal” case. Inferior goods a good for which a rise in income decreases the demand for the good. Individual demand curve Shows relationship between quantity demanded & price for a given buyer 15 ff  Supply, Demand & Equilibrium A competitive market is in equilibrium when - price moved to level where quantity of demanded goods match quantity of supplied goods - No seller could make themselves better of (selling more or less of good) & no buyer (buying more or less) —> Equilibrium: price moved to level that exactly matches quantity demanded by consumers to quantity supplied by sellers Equilibrium price Price matches quantity supplied & quantity demanded Equilibrium quantity Quantity bought & sold at that price Market-clearing price ( other word for equilibrium price) Clears market every buyer willing pay nds seller willing to sell at that price Finding Equilibrium Price & Quantity - putting supply & demand curve on same diagram - Supply curve: quantity supplied at any given price & demand curve: quantity demanded any given price —> where they cross is equilibrium price How can we be sure that market arrives at equilibrium price 1. Why do all sales and purchases in a market take place at the same price? - wenn der preis zu teuer ist kauft es niemand - Und etwas wird nicht billiger verkauft wenn es woanders teuerer verkauft werden könnte 2. Why does the market price fall if it is above the equilibrium price? - because there is more supply o ered than demand at this price —> creates a surplus - Price of a good will fall whenever theirs a surplus 3. Why does the market price rise if it is below the equilibrium price? - behause there is more demand o ered than supply at this price —> creates a shortage - Bidding up of prices happens whenever there is a shortage Surplus the excess of a good or service that occurs when the quantity supplied exceeds the quantity demanded; surpluses occur when the price is above the equilibrium price. Shortage the insu ciency of a good or service that occurs when the quantity demanded exceeds the quantity supplied; shortages occur when the price is below the equilibrium price. Using Equilibrium to Describe Markets - market price always moves towards equilibrium price —> no shortage or surplus 16 ffi ff ff fi What Happens When the Demand Curve Shifts - Original equilibrium at E1, where supply curve intersects original demand curve D1 - Fall in demand in 2020 due to pandemic shifted demand curve leftward to D2 - Surplus of rides at original price P1 caused price and quantity supplied to fall - New equilibrium reached at E2, with lower equilibrium price P2 and lower equilibrium quantity Q2 -When demand falls, equilibrium price and quantity of the good or service both fall - price of rides falls and generates a decrease in the quantity supplied, a downward movement along the supply curve Two principles When demand for a good or service falls, the equilibrium price and the equilibrium quantity of the good or service both fall. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both increase as well. What Happens when the supply curve shifts - Original equilibrium at E1 - Increase in sellers' unwillingness to provide the good - Fall in the supply of Uber rides - Shift of the supply curve leftward from S1 to S2 - New equilibrium at E2 with higher equilibrium price, P2, and lower equilibrium quantity, Q2. - rise in price and a fall in the quantity demanded, a downward movement along the demand curve Two Principles When supply of a good or service falls, the equilibrium price of the good or service increases and the equilibrium quantity of the good or service falls. 17 When supply of a good or service decreases, the equilibrium price of the good or service rises and the equilibrium quantity of the good or service falls. Simultaneous Shifts of Supply and Demand Curves -both show decrees in demand leftward shift D1 to D2 - (A) more extreme fall in number people commuting than —> (B) - Equilibrium quantity Q1 to Q2 -Equilibrium moves from E1 to E2 Two possible outcomes - When both demand and supply increase, the equilibrium quantity rises but the change in equilibrium price is ambiguous. - When both demand and supply decrease, the equilibrium quantity falls but the change in equilibrium price is ambiguous. Supply & Demand shift in opposite directions - When demand decreases and supply increases, the equilibrium price falls but the change in the equilibrium quantity is ambiguous. - When demand increases and supply decreases, the equilibrium price rises but the change in the equilibrium quantity is ambiguous. Competitive Market Example: Wheat famer —> producing more wheat will not affect the price of the wheat they were already planning to grow —> ones farmers decision not impact market (many farmers) Not competitive market Example: aluminium Alcoa —> only few big producers —> actions impact on market price —> question if producing more will drive down market price & reduces pro t 18 fi  Chapter 4 — Price Controls and Quotas: Meddling with Markets - Rent control —> marker intervention —> policy prevail over supply and demand - Government dictate market price or market quantity different from equilibrium price or quantity —> market strike back Why Governments Control Prices Price controls legal restrictions on how high or low a market price may go. Price oor the minimum price buyers are required to pay for a good or service; a form of price control. Price ceiling the maximum price sellers are allowed to charge for a good or service; a form of price control. - market inef cient —> monopolist —> price controls —> in that case can make markets ef cient - government intervention can be justi ed on the basis of equity and social welfare Price Ceilings - imposed during crises —> wars, natural disasters - Price Ceiling above equilibrium price have no effect —> won’t be binding Modeling a Price Ceiling - what can go wrong when government imposes price ceiling on ef cient market —> no price control —> Equilibrium point E Government sets price ceiling below equilibrium price -black line governments price ceiling on rent of 800$ -Reduces number of apartments Point A -Increases quantity demanded Point B -Creates shortage 19 fl fi fi fi fi  How a Price Ceiling Causes Inef ciency - gains from trade go unrealised Creates inef ciency in 4 ways —> example renting - reduces quantity of apartments below the ef cient level - Leads to inef cient allocation of apartments among would-be renters - Wasted time & effort - Landlords remain apartments in low quality or condition Inef ciently Low Quantity - reduces quantity of good bought & sold below market equilibrium quantity - p.c -> reduces quantity of good bought & sold Inef cient Allocation to Consumers - misallocation of apartments available: people who badly need apartments won’t get any because people who don’t need them as bad are occupying them - Ef cient allocation of apartments would re ect these differences: people who really want an apartment get one & people who aren’t that eager or can’t afford it won’t. - inef cient distribution opposite: people who not especially interested in nding an apartment will get one who are very eager won’t. - Example: retiree George and Family Lee —> who would gladly rent the place from him & and he could sublease the place for more —> missed opportunity - Subletting leads to emergence of a shadow market Wasted Resources - price ceiling causes inef ciency —> leads to wasted resources Wasted resources a form of inef ciency in which people expend money, effort, and time to cope with the shortages caused by a price ceiling. Example: Family Lee - Because of rent control -> Lees will spend spare time for several months searching for an apartment - time they would rather have spent working or in family activities - That is, there is an opportunity cost to the Lees’ prolonged search for an apartment — the leisure or income they had to forgo. - If market worked freely lees would have nd apartment quicker and can spend time else —> outcome: make them better of without making anyone else worse off 20 fi fi fi fi fi fi fi fi fi fi fl fi fi  Inef ciently Low Quality sellers offer low-quality goods at a low price even though buyers would rather have higher quality and would be willing to pay a higher price for it. Example: Rent Control in New York Landlords would be willing to put the apartments in a better conditions for higher rent price and tenants would be willing to pay that in order to have a better quality —> exchange only for markets that operate freely —> missed opportunities Shadow Markets ( Black Markets) - in the end, society as a whole is made worse off by the presence of a shadow - Even if the Family Lee & George example would make everyone better off Why are there price ceilings Three common results of price ceilings - A persistent shortage of the good - Inef ciency arising from this persistent shortage in the form of inef ciently low quantities transacted, inef cient allocation of the good to consumers, resources wasted in searching for the good, and the inef ciently low quality of the good offered for sale - The emergence of illegal, shadow market activity - bene t some people -> give small minority of renters much cheaper housing —> better organized and more vocal than those who are harmed by them. Review: - Price controls take the form of either legal maximum prices — price ceilings — or legal minimum prices — price oors. - A price ceiling below the equilibrium price bene ts successful buyers but causes predictable adverse effects such as persistent shortages, which lead to four types of inef ciencies: deadweight loss, inef cient allocation to consumers, wasted resources, and inef ciently low quality. - A deadweight loss is a loss of total surplus that occurs whenever a policy or action reduces the quantity transacted below the ef cient market equilibrium level. - Price ceilings also lead to shadow markets, as buyers and sellers attempt to evade the price controls. - Price ceilings can be justi ed when the market is inef cient or when a natural disaster leads to shortages that, if left to a free market, would greatly diminish equity and social welfare. Price Floors - governments intervene to push market prices up instead of down —> agricultural products improve income of farmers Example price oor: Minimum wage - have side effects -Without intervention market —> equilibrium at price of $1 per pound with 10 million pounds bought & sold 21 fi fi fi fl fl fi fi fi fi fi fi fi fi fi fi  Government imposes price oor support dairy farmers -black horizontal line price oor - $1,20 per pound butter -> demand falls to 9 million pounds -Quantity supplied rises to 12 million pounds -Surplus of 3 million pounds butter - not binding: when the price oor is set below the equilibrium price - Binding: governments buy the surplus, or pay exporters to sell products at a loss overseas, give away to less fortunate, destroy When government not purchasing surplus —> would-be sellers cannot nd buyer How a Price Floor Causes Inef ciency It causes inef ciently low quantity. - raises price of good to consumers -> reduces quantity of good demanded - Quantity of good bought & sold below market equilibrium quantity - PC & PC effect—> reducing quantity of good bought & sold -reduces quantity goods demanded below market equilibrium quantity -Sellers can’t sale more than buyers willing to buy It causes Inef cient Allocation of Sales Among sellers inef cient allocation of sales among sellers a form of inef ciency in which sellers who would be willing to sell a good at the lowest price are unable to make sales while sales go to sellers who are only willing to sell at a higher price; often the result of a price oor. 22 fi fi fi fi fl fl fl fl fi fi  —> Example: two-tier high minimum wage: some people are willing to sell labour force below that in order to have a job but employers not allowed Wasted Ressources - government purchasing unwanted surplus - Wasted time and effort —> job search Inef ciently High Quality a form of inef ciency in which sellers offer high-quality goods at a high price even though buyers would prefer a lower quality at a lower price; often the result of a price oor. Example: supplies spend a lot of time making a good but its not worth much to consumer missed opportunity: suppliers and buyers could make a mutually bene cial deal in which buyers got goods of lower quality for a much lower price. Why are there Price oors? Negative side effects - A persistent surplus of the good - Inef ciency arising from the persistent surplus in the form of inef ciently low quantity transacted, inef cient allocation of sales among sellers, wasted resources, and an inef ciently high level of quality offered by suppliers - The temptation to engage in illegal activity, particularly bribery and corruption of government of cials - disregard warnings about consequences - PF&PC bene t some in uential buyers & sellers Review - The most familiar price oor is the minimum wage. Price oors are also commonly imposed on agricultural goods. - A price oor above the equilibrium price bene ts successful sellers but causes predictable adverse effects such as a persistent surplus, which leads to four kinds of inef ciencies: deadweight loss from inef ciently low quantity, inef cient allocation of sales among sellers, wasted resources, and inef ciently high quality. - Price oors encourage illegal activity, such as workers who work off the books, often leading to of cial corruption. Controlling Quantities Example: New york only cabs with a medallion allowed to transport passengers Form of Quantity control an upper limit, set by the government, on the quantity of some good that can be bought or sold; also referred to as a quota. Quota an upper limit, set by the government, on the quantity of some good that can be bought or sold; also referred to as a quantity control. —> government intervenes in the market Quota limit Total amount transacted under quantity control - Quotas set an upper limit on the quantity of a good that can be transacted Example: limit on endangered sh stock —> Quotas implemented good economic reasons: protect sh stock 23 fi fi fi fi fi fl fl fi fi fl fl fl fi fi fi fi fi fl fi fi fl fi fi fi  —> Quotas implemented bad economic reasons: For example, quantity controls introduced to address a temporary problem such as assuring that only safe and clean taxis are allowed to operate, become dif cult to remove later, once the problem has disappeared, because quota holders bene t from them and exert political pressure Anatomy of Quantity Controls - taxi medallion worth a lot of money -without intervention market reaches equilibrium at 10 million rides taken per year $5 fare per ride New York medallion system limits number of taxis each driver can offer as many rides as they can Demand price the price of a given quantity at which consumers will demand that quantity. Supply price The price at which suppliers will supply a given quantity Analyse Quota - City government limits taxi rides to 8 million per year - Medallions give right to provide speci c number of rides - Medallions can be used to drive own taxis or rented out -quota 8 million rides -Price paid by consumer $6 per ride —> demand price 8 million rides shown point A - Supply price is only $4 per ride shown by B - Di erence is quota rent per ride -Quota rent drives a wedge between demand & supply price & discourages mutually bene cial transactions - how price received by taxi drivers be $4 when the price paid by riders is $6 Consider two sets of transactions here so two prices: (1) the transactions in taxi rides and the price at which these will occur (2) the transactions in medallions and the price at which these will occur. It turns out that since we are looking at two markets, the $4 and $6 prices will both be right. Example: - Jean can make $6 per day with the medallion and is willing to rent it only if she makes at least $4 per day. - Ali cannot demand a rent of more than $2, which is the di erence between the demand and supply prices. - Jean must o er Ali at least $2 to get the medallion. 24 ff fi ff fi fi fi ff  - The rent can be no more than $2 and no less than $2, so it must be exactly $2. Wedge the di erence between the demand price of the quantity transacted and the supply price of the quantity transacted for a good when the supply of the good is legally restricted. Often created by a quantity control, or quota. The price paid by buyers ends up being higher than that received by sellers. Wedge in Figure 8: Quota rent the di erence between the demand price and the supply price at the quota limit; this di erence, the earnings that accrue to the license holder from ownership of the right to sell the good, is equal to the market price of the license when the licenses are traded. What happens if Ali doesn’t rent out the medallion? - could have rented it out opportunity cost $2 Ali's businesses: - Taxi-driving business: earns $4 per ride - Medallion-renting business: earns $2 per ride - Medallion is a valuable asset, even when rented to oneself - Before Uber and Lyft, New York taxi medallions traded for around $500,000 - Quotas, like price ceilings and oors, don't always have a real e ect The Costs of Quantity Controls - Quantity control prevent mutually bene cial transactions —> buyers & sellers - New Yorkers are willing to pay at least $5.50 per ride when 9 million rides are o ered, and taxi drivers would provide rides for at least $4.50 per ride, causing 2 million "missed-opportunity rides" due to the quota limit. - Quantity controls create an incentive to circumvent them, which led to the emergence of unlicensed taxis and, later, the entry of Uber and Lyft. - The quantity restriction on New York City taxicabs has been undermined, causing the prices of taxi medallions to fall signi cantly. - Quantity controls typically lead to ine ciencies and incentives for illegal activities. Review: - Quantity controls, or quotas, are government-imposed limits on how much of a good may be bought or sold. The quantity allowed for sale is the quota limit. The government then issues a license — the right to sell a given quantity of a good under the quota. - When the quota limit is smaller than the equilibrium quantity in an unregulated market, the demand price is higher than the supply price — there is a wedge between them at the quota limit. - This wedge is the quota rent, the earnings that accrue to the license-holder from ownership of the right to sell the good — whether by actually supplying the good or by renting the license to someone else. The market price of a license equals the quota rent. - Like price controls, quantity controls create deadweight loss and encourage illegal activity. 25 ff ff fi fl ffi fi ff ff ff Chapter 5 — International Trade -panel (a) shows course of ratio of goods crossing national borders to world GDP —> total value of goods & services produced in the world since 1870 - Panel (b) international trade more important to others than US Globalisation the phenomenon of growing economic linkages among countries. - growth of trade accompanied —> large-scale international investment & migration Hyperglobalisation Dramatic increase international linkages, goods which involve supply chains of production span the globe Reshoring Bringing production closer to markets —> long shipping times Production Possibilities and Comparative Advantage, Revisited - produce phones —> use resources ( land, labor, capital) - Opportunity cost of phone -> potential production of other goods country must forgo to produce it - Comparative advantage: A country has a comparative advantage in producing a good or service if the opportunity cost of producing the good or service is lower for that country than for other countries. - China's comparative advantage: China has a comparative advantage in producing smartphones because the opportunity cost of smartphone assembly in China is less than it is in the United States. - Productivity: Chinese workers are less productive than U.S. workers in automobile and chemical production, but more productive in assembling smartphones. Comparitive Advantage and the Production Possibility Frontier - China has a comparative advantage in producing phones because they have to give up less trucks -US has a comparative advantage in producing trucks bacause they have to give up less phones 26  Ricardian model of international trade analysis of international trade under the assumption that opportunity costs are constant, which makes production possibility frontiers straight lines US: Produce 100.000 trucks & 0 phones 100 million phones & 0 trucks slope of the U.S. PPF, is −100,000/100= −1,000. —> produce additional million phones US forgo production of 1000 trucks —> produce one more truck US forgo 1000 phones ( 1 mio. Phones divided by 1000 trucks) China: Produce 50.000 trucks & 0 phones 200 million phones & 0 trucks Slope of China PPF, is -50.000/200= -250 —>produce additional million phones China forgo production of 250 trucks —>produce one more truck China forgo 4000 phones ( 1 mio. Phones divided by 250 trucks) Autarky Situation countries do not trade with other countries Example: United States: produce and consume 50 million phones and 50,000 trucks China produces 100 million phones and 25,000 trucks. US & Chinese Opportunity Costs of Phones & Trucks -> US -> comparative advantage trucks & lower opportunity cost in phones than China: 1 truck 1000 phones -> China -> comparitive advantage phones & higher opportunity cost I phones: 1 truck 4000 phones The Gains from International Trade -trade increases world production on both goods -> both countries consume more -Each country specialises -> result of trade - with trade every country can focus on producing what they have a comparative advantage in - World production of both goods is higher than in autarky —> trade possible consume more both goods -> mutual gain —> liberates both countries from self-su ciency —> from need to produce same mixes of goods the consume -> both can focus on good they have 27 ffi  comparative advantage in —> higher standard living - requirement: relative price must satisfy —> no country pays relative price greater than opportunity cost of obtaining good in autarky - Requirement satis ed—> actual relative price in international trade determined by supply & demand Comparative Advantage versus Absolute Advantage - gains from trade depend on comparative advantage - Comparative advantage is determined by opportunity cost of that good —> quantity of other goods forgone to produce a phone - Opportunity cost of phones lower in China than in US How it works: - Chinese workers low productivity compared US in electronics —> but they have even lower productivity compared to US in other industries - Because china is bad in other industries —> producing a phone in China even takes a lot of labor doesn’t requires forgoing the production of large quantities of other goods —> in US the opposite - countries wage rates re ect its labor productivity - China case: low wages gives them a cost advantage Misconceptions from Misunderstanding Comparative advantage Pauper labor fallacy Belief when country with high wages imports goods produced by workers who are paid low wages, it must hurt the standard of living of workers in the importing country. Sweatshop labor fallacy Belief that trade must be bad for workers in poor exporting countries because those workers are paid very low wages by our standards. —> both miss nature of gains from trade: —> both countries able to achieve higher standard of living through trade Sources of Comparative Advantage Di erences in Climate - tropical countries export tropical products —> co ee & bananas - Countries temperate zone export crops like wheat & corn —> also season northern & southern hemispheres Di erences in Endowments - Canada has a greater endowment of forestland than US gives Canada a comparative advantage in forest products - International trade result of di erences in factor endowments Factors of production An input used to produce goods and services: Forestland, like labor & capital - due history & geography mix of available factors of production di ers among countries —> source of comparative advantage 28 ff ff fi fl ff ff ff  Heckscher—Ohlin model a country that has a relative abundance of capital will have a comparative advantage in capital- intensive industries such as oil re ning, but a country that has a relative abundance of labor will have a comparative advantage in labor-intensive industries such as phone production. —> based on OC —> Example: World trade in clothing —> labor-intensive activity: not much physical capital or human capital —> expect countries like china & Bangladesh to comparative advantage in this industry and they do - two key concepts: factor abundance & factor intensity Factor abundance How large countries supply of factor is relative to supply of other factors Factor intensity Refers to ranking of goods according to which factor is used in relatively greater quantities in production compared to other factors —> oil re ning: capital-intensive good uses high ratio of capital to labor —> phone production: labor-intensive good tends use high ratio of labor to capital Di erences in Technology Example: In 1970s & 1980s Japan became largest exporter of automobiles —> superior production techniques Japans comparative advantage —> techniques used in production - Technology advantage is often temporary - Lean production helped U.S. auto manufacturers catch up with Japanese competitors - Europe's aircraft industry also closed the gap with the U.S. - Technology di erences are a signi cant source of comparative advantage Review: - Imports and exports account for a growing share of the U.S. economy and the economies of many other countries. - The growth of international trade and other international linkages is known as globalization. Extremely high levels of international trade are known as hyperglobalization. - International trade is driven by comparative advantage. The Ricardian model of international trade shows that trade between two countries makes both countries better o than they would be in autarky — that is, there are gains from international trade. - The main sources of comparative advantage are international di erences in climate, factor endowments, and technology. - The Heckscher–Ohlin model shows how comparative advantage can arise from di erences in factor endowments: goods di er in their factor intensity, and countries tend to export goods that are intensive in the factors they have in abundance. 29 ff fi ff ff fi fi ff ff ff  Supply, Demand and International Trade E ects of Imports —> shows US market for phones ignoring international trade —> absence of trade: domestic price PA —> autarky price where domestic supply curve & domestic demand curve intersect —> Quantity produced & consumed domestically is QA Domestic demand curve Quantity of good demanded in a country depends on the price Domestic supply curve quantity of a good supplied by producers inside our own country depends on the price of that good Domestic price Autarky price In autarky: With no international trade —> equilibrium in market determined by intersection of domestic demand & domestic supply curves point A —> equilibrium price PA —> equilibrium quantity QA Consumers & Producers both gain from existence of domestic market Consumer surplus equal to area of blue shaded triangle Producer surplus equal to area of red shaded triangle —> Total surplus: equal both triangles Opening the market to imports —> to open the market to imports —> must make an assumption about supply of imports ( unlimited quantities of phones can be purchased from abroad for a xed price) World price Price at which good can be bought and sold abroad 30 ff fi  The Domestic Market with Imports -World Price (PW) below Autarky Price (PA) -Economy opened to international trade imports enter domestic market -Domestic price falls from autarky to world price -As price falls: domestic quantity demanded rises from —> QA to QD - Domestic quantity supplied falls from —> QA to QS -Di erence between domestic quantity demanded and domestic quantity supplied at PW the quantity QD - QS is lled by imports -world price is below domestic price more pro table —> buy abroad & resell domestically -Imported phones increase supply of phones in domestic market —> lower domestic market price -Phones will continue to be imported from abroad until domestic price falls to a level equal to world price The E ects of Imports on Surplus Explanation: - when domestic price falls to PW (international trade) consumers gain additional surplus ( areas X+Z) & producers lose surplus ( area X) - Gains to consumers outweigh losses to producers —> increase in total surplus in economy as a whole ( area Z) - Sum of producer & consumer surplus —> total surplus increase by Z - Result of trade consumers gain and producers lose - Opening up market to import —> net gain in total surplus (gains from international trade) - Althought country as a whole gains some groups (domestic phone producers) lose as a result of international trade 31 ff fi ff fi  The E ects of Exports Explanation: - World price Pw is greater than autarky price Pa - Opened international trade -> some of domestic supply is exported - Domestic price rises from autarky price Pa to world Price Pw - Price rises —> domestic quantity demand falls from Qa to Qd - Price rises —> domestic quantity supplied rises from Qa to Qs - portion of domestic production that is not consumed domestically, Qs toQd exported. Results in: - the higher world price —> pro table buy trucks domestically & sell overseas - Purchases of domestic trucks lifts domestic price up until its equal to world price - Result quantity demanded by domestic consumers fall from Qa to Qd & quantity supplied by domestic producers rises from Qa to Qs - Di erence between domestic production & domestic consumption Qs - Qd is exported E ects of Exports on Surplus - Exports lead to an overall gain in total surplus for the exporting country - Trade creates losers as well as winners - Price rises from PA to PW as a result of trade - Producers gain X+Z, consumers lose X - The economy gains total surplus in the amount of Z 32 ff ff ff fi  International Trade & Wages - along with producers & consumers —> owners factors of production a ected —> owners labor, land, and capital employed in producing goods exported or compete with exported goods Example Mia: has to move jobs result of growing international trade —> Mia is not a producer of apparel who is hurt by competition from imports BUT —> worker with particular skills who is a ected by imports - wage rate of accountants is factor price —> employers have to pay for the services of factor of production Exporting industries industries that produce goods or services that are sold abroad. Import-competing industries industries that produce goods or services that are also imported. —> international trade leads to higher production in exporting industries and lower production in import-competing industries —> increases the demand for factors used by exporting industries and decreases the demand for factors used by import-competing industries. In other words, international trade tends to redistribute income toward a country’s abundant factors and away from its less abundant factors. US exports human-capital-intensive (such as high-tech design and Hollywood movies) while U.S. imports tend to be unskilled-labor-intensive (such as phone assembly and clothing production) - e ect international trade US factor markets —> raise wage rate educated US workers (have high income) & reduce it with those who aren’t and haven’t —> wage inequality The e ects of Trade Protection - david ricardo —> principle of comparative advantage Free trade occurs in an economy when the government does not attempt either to reduce or to increase the levels of exports and imports that occur naturally as a result of supply and demand. Trade protection Policies limit imports -> protect domestic producers in import-competing industries The E ects of a Tari Tari a tax levied on imports.(Importsteuern) —> raises price received by domestic producers & price paid by domestic consumers 33 ff ff ff ff ff ff ff  —> tari raises domestic price of good from Pw to Pt —> domestic quantity demanded reduces Qd to Qdt —> domestic quantity supplied increases from Qs to Qst —> result imports get less from Qd - Qs before tari to Qdt - Qst Result: Raises domestic price —> increased domestic production Reduces domestic consumption compared to free trade situation Three e ects: Higher domestic price —> increases producer surplus —> gain area A Reduces consumer surplus —> reduction areas A,B,C & D Tari —> revenue government —> di erence Pt & Pw on each of the Qdt - Qst units imported Total revenue —> (Pt-Pw) x (Qdt-Qst) —> equal area C —> domestic price rises: producers gain surplus (area A) Government gains revenue (area C) Consumers lose surplus ( areas A+B+C+D) —> losses to consumers outweigh the gains to producers & government — economy loses surplus ( areas B and D) - Verbrauchssteuer creates ine ciency or deadweight loss —> prevents mutually bene cial trades - Here deadweight loss equal to loss total surplus areas B+D Tari s generate deadweight losses — create ine ciencies 1. mutually bene cial trades go unexploited —> consumers willing pay more than Pw dont purchase good even though Pw us true cost of unit of good to economy —> cost of ine ciency area D 2. ressource wasted on ine cient production: some producers produce something even though it can be bought cheaper abroad —> area B E ects Import Quota Import quota Another from of trade protection legal limit on quantity of good that can be imported —> same e ect as excise tax 34 ff ff ff ff ff ff ff fi ffi ffi ff ffi ffi fi  Quota rents license-holders’ revenue under a quota. Import licenceses given to companies Review - Most economists advocate free trade, although many governments engage in trade protection of import-competing industries. The two most common protectionist policies are tari s and import quotas. In rare instances, governments subsidize exporting industries. - A tari is a tax on imports. It raises the domestic price above the world price, leading to a fall in trade and domestic consumption and a rise in domestic production. Domestic producers and the government gain, but domestic consumer losses more than o set this gain, leading to deadweight loss. - An import quota is a legal quantity limit on imports. Its e ect is like that of a tari , except that revenues — the quota rents — accrue to the license holder, not to the domestic government. Arguments of Trade Protection 1. national security: protect domestic suppliers in case something happens aim self-su cient — > coronavirus mask 2. Job creation: jobs created through trade protection 3. Infant Industry: new industries need some protection get established —> reality: industries politically in uencial get protection International Trade agreements treaties in which a country promises to engage in less trade protection against the exports of another country in return for a promise by the other country to do the same for its own exports Trade wars countries impose tari s and other protectionist measures against other countries’ products in an attempt to force them to make policy concessions World Trade Organisation international organization composed of member countries — 164 of them currently, accounting for the bulk of world trade Plays two roles: 1. Framework for negotiations in major international trade agreement 2. Resolves disputes between members —> violating of previous agreements 35 ff ff fl ff ff ff ffi ff