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					               Economics 101:
           Principles of Economics
1. Any questions?
2. Quiz next Friday (MC, SA)
             10 Principles of Economics
• Principle #1: People Face Trade-offs
   – “There is no free lunch”
   – Allocation of time
   – Family budgets
   – US government and tax dollars
   – Environmental concerns vs. Business concerns
   – Efficiency = society is getting the most it can from scarce
     resources (positive)
       • “How big is the pizza?”
   – Equity = “fair” distribution of the benefits derived from
     society’s resources (normative)
       • “How many slices do I get?”
               10 Principles of Economics
• Principle #2: Cost of something is what you Give Up to Get It
   – Opportunity cost = Explicit costs (tuition, books, parking)
     + Implicit costs (foregone wages, psychic costs)
   – The value of the next best alternative
   – Arise because of scarce resources
   – Eli Herring & Kobe Bryant vs. Tim Duncan

   – “There is no free lunch”
• Principle #3: Rational People Think “At the Margin”
   –   Marginal = “edge” = “next” = “a small addition to an existing amount”
   –   Should I hire another worker?
   –   Comparison of Marginal Benefits vs. Marginal Costs
   –   Should I exceed the class ceiling for number of students?
               10 Principles of Economics
• Principle #4: People Respond To Incentives
   – MB > MC, but what if the MB or MC changes?
   – Prices, Income, Tastes, etc.
   – Effects in related markets – direct and indirect
• Principle #5: Trade Can Make Everyone Better Off
   – Comparative advantage
• Principle #6: Markets are usually a good way to organize
  economic activity
   –   Central planning vs. Markets
   –   “The Invisible Hand” utilizes prices to convey information
   –   Prices are signal for both the consumer AND the producer!
   –   Gov’t intervention can distort prices and thus behavior
                 10 Principles of Economics
• Principle #7: Governments can sometimes improve market outcomes
   – Market Failure = when an uninterrupted market doesn’t allocate resources
     efficiently (we say there’s a “role for the government”)
   – Causes of market failures:
     Externality = impact of one agent’s action on welfare of another (+ or - )
     Market Power = ability of one economic agent to have great control over price
   – Governments also intervene with efforts to promote equity
• Principle #8: A Country’s Standard of Living depends on its Ability
  to Produce Goods & Services
   –   Variation in living standards is primarily due to differences in productivity
   –   Productivity = amount of goods & services made PER HOUR WORKED
   –   Not min wage laws, stronger unions, etc.
   –   Public policy must ask itself, “How can we  productivity?”
                10 Principles of Economics
• Principle #9: Prices Rise when the Gov’t Prints too much Money
   – Inflation = increase in overall price level in an economy
   – Hyper-inflation = really, really high inflation 
       • Germany 1920’s
       • Russia 1990’s
• Principle #10: Society Faces a Short-Run Tradeoff between Inflation and
   – Phillips curve shows short-run tradeoff between inflation and unemployment
   – Short-run can be several years however
   – Why?
       • Prices are “sticky” (slow to adjust) in the short-run. Why?
       •  qty. money   spending  excess supply of goods   sales
                    production   workers needed   unemployment
   – Monetary (interest rate, qty. money) & Fiscal policy (G, tax rate)
          Production Possibilities Frontier
• Depicts the maximum                 Movies
  combinations of goods/services a
  rational actor with certain goals
  can attain with fixed amount of      100
                                        90           B
  resources and constant
• Illustrates 3 assumptions &                    Y
  opportunity costs or “trade-offs”
• Positive vs. normative                                             Z
                                             0 5                 49 50
• May show constant, increasing,
  or decreasing opportunity cost                                     TV shows
• Shifts in the PPF – causes
      Interdependence & Gains from Trade
• Principle #5: Trade Can Make Everyone Better Off
   – Why trade with others? What do you gain?
• Back to Production Possibilities Frontier (PPF)
• Example
   – In the US, 1 worker can produce 4 Apple pies or 3 Sweaters
   – In Ireland, 1 worker can produce 2 Apple pies or 2 Sweaters
• Productivity of Labor: US = (4A, 3S), Ireland = (2A, 2S)
• What do we notice?
   – US has an absolute productivity advantage in both goods.
• Key Insight: Both countries can still gain from trade.
• Draw the PPF’s assuming 100 workers each, that Labor is the only
  input necessary, and the opportunity cost is constant.
      Interdependence & Gains from Trade
• Further assume the following PRE-TRADE production decisions:
  US devotes 55% to Apple pies, rest to Sweater production.
  Ireland devotes 72% to Apple pies, rest to Sweater production.
• Comparative Advantage is the principle that a country should
  specialize in production of those goods it can produce with lower
  opp. costs than other countries & trade for goods that others can
  produce with lower opp. costs
• Who has comparative advantage in production of Apple Pies?
   – US, of course  Why?
   – In US, 4 more Apple pies has an Opp Cost of 3 Sweaters while
     in Ireland, 4 more Apple pies has an Opp Cost of 4 Sweaters
       Interdependence & Gains from Trade
• Both countries can increase consumption by specializing.
• What are the limits of the terms of trade?
    – 1S = (4/3A, 1A)
    – US must get at least .75S for each A, and for 1A Ireland will give up to 1S
    – Ireland must get at least 1A for each S, and for 1S US will give up to 1.33
•   Let’s assume that they bargain and settle on 1.25 A for 1 S.
•   What are their respective Consumption Possibility Frontiers?
•   Let’s assume America sends 175A to Ireland in exchange for 140S.
•   What are the final consumption points?
                Before Trade          After Trade
    US          (220 A, 135 S)        (225 A, 140 S)
    Ireland     (144 A, 56 S)         (175 A, 60 S)
      Interdependence & Gains from Trade
• Causes of Incomplete specialization or Reduced Trade?
   (1) Costs of trading (e.g., ice cream, services, etc.)
   (2) Size of countries (e.g., US still produces bananas despite higher opp. costs
                           compared to smaller Latin American nations)
   (3) Increasing opportunity costs
        Concave PPF’s means trading partners will shift production until opp. costs
        are equalized.
   (4) Government barriers to trade
        Tariffs = a tax on imported goods
        Quota = a limit on the physical volume of imports
      Result: domestic producers and workers are helped, domestic consumers hurt,
      nation as a whole loses
         Examples of National Specialties
• Country         Specialty (from natural resources or climate)
  Saudi Arabia                   Oil
  Canada                         Timber
  United States                  Grain
  Spain                          Olive Oil
  Mexico                         Tomatoes
  Italy                          Wine
  Israel                         Citrus fruit
  Jamaica                        Aluminum ore
         Examples of National Specialties
• Country         Specialty (not from natural resources or climate)
  Japan            Cars, consumer electronics (not printers!)
  United States            Software, movies, music
  Switzerland              Watches
  Korea                    Steel, ships
  Hong Kong                Textiles
  Great Britain            Financial services