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AP MACROECONOMICS Mr. Messick THE STUDY OF ECONOMICS Economics: The study of scarcity and choice. Market Economy: Market decisions are decentralized and made by firms and individuals. i.e., United States, United Kingdom, Germany Command Economy: Market decisions are centralized and made by bureauocratic institutions. i.e., Cuba, North Korea, Saudi Arabia, Iran, & Libya Political boundaries do NOT define markets…markets are truly global and w/o borders. Resources Are Scarce! Can’t Always Get What You Want… Resource: Anything that can be used to produce something else. ECONOMIC WAY OF THINKING Economic Thinking is Marginal Thinking Rational Thinking…studying the “gray” areas Margin meands “edge” so just changing a small incremental part. What happens if I study just one more hour? Should I go to sleep 1 hour earlier? What are the benefits of making small changes? What are the costs of making small changes Why are diamonds so expensive? Why is water so cheap? RESOURCES ARE SCARCE Land Labor Capital Entrepreneurship …because resources are scarce it leads to Opportunity Costs (“Opportunity Lost”) & tradeoffs What you have to give up to choose something else. It is always the NEXT BEST ALTERNATIVE! Doesn’t have to be monetary, but it has to have meaning or utility such as TIME, HAPPINESS USE OF MODELS IN ECONOMICS Why Use Models To Answer Questions! To Evaluate Policy Characteristics of Models A Question Simplification and Abstraction Assumptions about Economic Behavior Think “wind tunnel” for aerospace engineers Ceteris Paribus (all relevant factors stay the same) Ways to Express Models 1. 2. 3. Graphs Words Equations ANALYZING IS NOT JUDGING Positive Economics Not “good” or “bad” economics…just analysis Does a cut in taxes lead to an increase in employment? What would be the effect of a carbon emissions tax? Does not judge whether or not a policy is effective. Normative Economics Assessments or Judgment of what we should do Not just one answer for normative economics Depends on your point of view, i.e. business vs environmentalists Goals must be clearly stated ahead of time Productive Efficiency (produce at a minimal cost) Allocative Efficiency (are we producing what people want) Equity (is it fair?) Economic Growth (enhance standard of living across generations Stabilizing or De-Stabilizing (employment increase or decrease) Goals are in conflict…growth vs stability, efficiency vs equity. PRODUCTION POSSIBILITIES CURVE (FRONTIER) PPC is a simple economic model showing the trade-offs an individual, firm, government faces in how to allocate scarce resources between to competing goods or services. PPC models scarcity PPC models opportunity cost What must be given up to order to have additional units of other goods. PPC models efficiency A point on the line represents efficient use of resources. All resources are efficiently and fully used. All technologies are efficiently used. PRODUCTION POSSIBILITIES CURVE (FRONTIER) Quantity Of Fish 18 16 14 12 10 8 6 4 2 D A C B 4 8 12 16 20 24 28 32 36 Quantity of Coconuts PRODUCTION POSSIBILITIES CURVE (FRONTIER) Quantity Of Capital Goods Captial Goods: Machinery, Tools, & Equipment Used To Make Consumer Goods Why is this curve bowed outward? (1) Because of the Law of Increasing Costs. The more of a good that is produced, the greater its opportunity cost. (2) Because resources are not perfectly adaptable to alternative uses, our PPC is unlikely to be linear. (3) Mathematically, this can be seen by the slopes of the lines closer to the endpoints are more horizontal and vertical showing an greater increase of opportunity costs. Quantity Of Consumer Goods Consumer Goods: Goods consumers buy directly from the firms that make them. 22 20 PRODUCTION POSSIBILITIES CURVE (FRONTIER) 18 16 Quantity of Timber 14 12 10 y 8 6 4 2 5 10 15 Quantity of Salmon 20 25 PRODUCTION POSSIBILITIES CURVE (FRONTIER) Linear PPC Graph: Constant opportunity cost Why? Because slope is constant for any two points on the PPC. Since opportunity cost = slope, therefore opportunity costs are constant! Curved PPC Graph: Increasing Opportunity Costs Why? Because the slope is not constant! If you keep increasing the quantity of salmon at a constant rate, the quantity of lumber (opportunity cost) decreases at an ever faster rate! PRODUCTION POSSIBILITIES CURVE (FRONTIER) Resource Increase Resource Decrease Land Land Labor Labor Capital Capital Entrepreneurship Entrepreneurship PRODUCTION POSSIBILITIES CURVE (FRONTIER) Resource Increase Resource Decrease Causes • Recession • Depression Land • Increase in quantity of land • Increase in quality of land • Discovery of new resources Land • Decrease in quantity of land • Decrease in quality of land • Exhaustion of current resources Labor • Increase in Labor Force • Increase in Education (Skills) Labor • Decrease in Labor Force • Decrease in Education (Skills) Capital • Increase in quality of machinery • Increase in quantity of machinery • Increase in Capital technology Capital • Decrease in quality of machinery • Decrease in quantity of machinery Entrepreneurship • Increase in technology helps physical capital to improve. • Development of new markets & products Entrepreneurship • Decrease in use of new technology. • No development of new markets & products PRODUCTION POSSIBILITIES CURVE (FRONTIER) Determinants of Long Term Economic Growth @ 25% is attributable to growth in human capital (Labor) 1. 2. @ 25% is attributable to physical capital 3. More education as well as more experience More machinery as well as more places producing goods @ 50% is attributable to New Technology (Entrepreneurship) Source: The Instant Economist, Timothy Taylor, p.128 PRODUCTION POSSIBILITIES CURVE (FRONTIER) Some example PPC graphs with explanations… PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE Trade: Using specialization, individuals provide goods and services to others and receive goods and services in return. By trading, economies gain more goods and services than trying to be self-sufficient. Comparative Advantage shows us how this economic gain is made. Comparative Advantage: Determines specialization for trade between nations; based on the nation with the lower relative or comparative cost of production. Absolute Advantage: An economy that produces absolutely more of a certain good than another economy. PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE Military Equipment (000’s) United States Ukraine Military Equipment (000’s) Butter (000’s) Equipment Butter Butter (000’s) Equipment Butter 1,000,000 0 80,000 0 700,000 30,000 40,000 40,000 0 100,000 0 80,000 PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE • Even though the United States enjoys ABSOLUTE ADVANTAGE-that does not alone tells us what to produce…. • …rather it is COMPARATIVE ADVANTAGE that should dictate what the Ukraine or United States produces. • How do you calculate comparative advantage? • Know the definition of comparative advantage! Comparative Advantage means one entity can produce something at a lower marginal opportunity production cost than another entity. 1. What is the opportunity cost of military equipment? To produce guns what do you have to give up? (answer: butter production) 2. What is the opportunity cost of butter? To produce butter what do you have to give up? (answer: military equipment) 3. Find the marginal opportunity costs for guns and butter for each country… PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE Since marginal means additional, we must find out the marginal opportunity cost for one gun and one butter of both countries. Just set up a table… Ukraine United States 1 butter = ____ guns 1 butter = ____ guns 1 gun 1 gun = ____ butter = ____ butter Remember marginal opportunity cost is just slope …so start with butter on the x-axis for both countries. But use the two most extreme points which are the x and y intercepts to find slope. Then determine which country can produce that good at a LOWER marginal opportunity cost-that country has the comparative advantage in producing that good! PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE How much should each country produce & trade in order to maximize their benefit? What about point B? Produces 1,000,000 Trades -140,000 Consumes after Specialization & Trade 860,000 Butter 0 35,000 35,000 30,000 5,000 Guns 0 140,000 140,000 40,000 100,000 Butter 80,000 -35,000 45,000 40,000 5,000 United States Guns Ukraine Consumes Before Trade (Point B) 700,000 Gain From Trade 160,000 On your graph, plot the new points for each country under “Consumes after Specialization & Trade”. What do you notice? PRODUCTION POSSIBILITIES CURVE & COMPARATIVE ADVANTAGE Military Equipment (000’s) United States Military Equipment (000’s) Butter (000’s) Ukraine Butter (000’s) SECTION 2 MODULE 5: INTRO TO DEMAND Competitive Market: A market with many buyers and sellers of the same service. Supply & Demand Model: A pictorial model to describe behaviors in a competitive market. The Demand Curve The Supply Curve Set of factors that cause demand curve to shift Set of factors that cause supply curve to shift The Market Equilibrium Equilibrium price Equilibrium quantity The way the market equilibrium changes when supply or demand curve shifts. SECTION 2 MODULE 5: INTRO TO DEMAND Ex. 1: Selling my ebook Demand Schedule Price ($) Quantity Demanded (units) A 2.00 60,000 B 4.00 40,000 C 6.00 30,000 D 8.00 25,000 E 10.00 21,000 F 12.00 20,000 Scenarios What do you notice about the relationship between price and quantity demanded? Law of Demand price …. Quantity demanded -Or- Quantity demanded …. price ceteris paribus: all else being equal SECTION 2 MODULE 5: INTRO TO DEMAND Price ($) 12 10 8 6 4 F Demand Curve E Plot the points from the demand schedule to create the: DEMAND CURVE We have to be very careful…. D Movement ALONG the demand curve just tells us at a given price this is the “quantity demanded” for ebooks…. C B A 2 20 23 25 30 40 50 60 We never, ever say demand at $2.00-we say “quantity” demanded at $2.00. Quantity Demanded of My Ebook (000’s) DO NOT confuse DEMAND with QTY. DEMANDED Your Graphs Should Always Have “Qty Demanded” on the x-axis PRICE always determines Quantity Demanded SECTION 2 MODULE 5: INTRO TO DEMAND Increases or Decreases in Demand of a Good Causes Shifts in Demand Curve 12 10 8 6 4 Price ($) F F E E F 12 10 D D C 8 C B 6 B 4 A 2 20 23 25 30 40 50 60 Increase in Demand for My Ebook A 2 E F D E C D B C A B A 20 23 25 30 40 50 60 Decrease in Demand for My Ebook SECTION 2 MODULE 5: INTRO TO DEMAND Five Principal Factors That Shift The Demand Curve for a Good or Service 1. Changes in the prices of related goods or services 2. Changes in income 3. Changes in tastes 4. Changes in expectations 5. Changes in the number of consumers SECTION 2 MODULE 5: INTRO TO DEMAND 1. Changes in Related Prices Goods or Services “The Case of Substitute Goods” Price ($) Price ($) D D McDonald’s McMuffin Sausage Sandwich Qty. Demanded (000s) Dunkin Donuts Sausage Croissant Sandwich Qty. Demanded (000s) ….but suppose the price of McDonald’s sandwich increases …. Price ($) Price ($) Effect of the price P2 P1 D’ D McDonald’s McMuffin Q2 Q1 Sausage Sandwich Qty. Demanded (000s) Dunkin Donuts D Sausage Croissant Sandwich Qty. Demanded (000s) SECTION 2 MODULE 5: INTRO TO DEMAND ….but suppose the price of McDonald’s sandwich decreases …. Price ($) Price ($) Effect of the price P1 P2 D McDonald’s McMuffin Q1 Q2 Sausage Sandwich Qty. Demanded (000s) D’ Dunkin Donuts D Sausage Croissant Sandwich Qty. Demanded (000s) SUBSTITUTE GOODS • • If the rise in the price of one good causes consumers to switch to another good. If the decrease in the price of one good causes consumers to switch to another good. SECTION 2 MODULE 5: INTRO TO DEMAND 1. Changes in Prices of Related Goods or Services “The Case of Complementary Goods” Price ($) Price ($) D D Panara Bread’s Cinnamon Crunch Bagels Qty. Demanded (000s) Panara Bread’s Soft Spread Cream Cheese Qty. Demanded (000s) ….but suppose the price of the Cinnamon Crunch bagels increases …. Price ($) Price ($) Effect of the price P2 P1 D Panara Bread’s Q2 Q1 Cinnamon Crunch Bagels Qty. Demanded (000s) D’ D Panara Bread’s Soft Spread Cream Cheese Qty. Demanded (000s) SECTION 2 MODULE 5: INTRO TO DEMAND 1. Changes in Prices of Related Goods or Services “The Case of Complementary Goods” ….but suppose the price of the Cinnamon Crunch bagels decreases …. Price ($) Price ($) Effect of the price P1 P2 D Q1 Q2 Panara Bread’s Cinnamon Crunch Bagels Qty. Demanded (000s) D’ D Panara Bread’s Soft Spread Cream Cheese Qty. Demanded (000s) COMPLEMENTARY GOODS • • The rise in the price of one good causes lower demand for the complimentary good. The decrease in the price of one good causes higher demand for the complimentary good. SECTION 2 MODULE 5: INTRO TO DEMAND 2. Changes in Income Inferior Good Luxury Good Normal Good …but as income Price ($) Price ($) Price ($) D D’ Yugo Qty Demanded (000s) (Inferior Good) D D’ Accord Qty Demanded (000s) (Normal Good) D’ D BMW Qty Demanded (000s) (Luxury Good) SECTION 2 MODULE 5: INTRO TO DEMAND 2. Changes in Income Inferior Good Luxury Good Normal Good …but as income Price ($) Price ($) Price ($) D’ D Yugo Qty Demanded (000s) (Inferior Good) D D’ Accord Qty Demanded (000s) (Normal Good) D D’ BMW Qty Demanded (000s) (Luxury Good) SECTION 2 MODULE 5: INTRO TO DEMAND 3. Changes in Consumer Tastes Teens are no longer shopping at Abercrombie & Fitch or American Eagle because teens do not want these names plastered on the front of their shirts; or, simply put, these retailers are no longer “in”. Apple’s Iphone 6 is here. Teens want it!! C’mon Dad & Mom …splurge for me! Price ($) D D’ American Eagle Qty Demanded (000s) Price ($) D D’ Apple Iphone Qty Demanded (000s) (Inferior Good) SECTION 2 MODULE 5: INTRO TO DEMAND 4. Changes in Expectations Market coffee prices are expected to substantially increase in the next three months. Price ($) D D’ Dunkin Donuts 2 lb Coffee Beans Qty Demanded (000s) The Platinum X-Box debuts in November 2014 Price ($) D D’ Standard X Box Qty Demanded (000s) SECTION 2 MODULE 5: INTRO TO DEMAND 2. Changes in Expectations Inferior Good Luxury Good Normal Good …income is expected to increase in the near future Price ($) Price ($) Price ($) D’ D Yugo Qty Demanded (000s) (Inferior Good) D D’ Accord Qty Demanded (000s) (Normal Good) D D’ BMW Qty Demanded (000s) (Luxury Good) SECTION 2 MODULE 5: INTRO TO DEMAND 2. Changes in Expectations Inferior Good Luxury Good Normal Good …income is expected to decrease in the near future Price ($) Price ($) Price ($) D D’ Yugo Qty Demanded (000s) (Inferior Good) D D’ Accord Qty Demanded (000s) (Normal Good) D’ D BMW Qty Demanded (000s) (Luxury Good) SECTION 2 MODULE 5: INTRO TO DEMAND 5. Changes in Number of Consumers Communist Cuba now opens up trade with the United States. Price ($) D D’ US Automotive Market Qty Demanded (000s) China announces huge import tax on Orange Juice. Price ($) D D’ Orange Juice Market Qty Demanded (000s) SECTION 2 MODULE 5: INTRO TO DEMAND ~Demand Summary~ Variable Price of the good itself A Change in that Variable Represents a movement along the Demand curve Income Shifts the Demand Curve Prices of Related goods Shifts the Demand Curve Consumer Tastes Shifts the Demand Curve Expectations Shifts the Demand Curve Number of Buyers Shifts the Demand Curve SECTION 2 MODULE 6: INTRO TO SUPPLY Ex. 1: Producing Calaphon® Spatulas What do you notice about the relationship between price and quantity supplied? Supply Schedule Price ($) Quantity Demanded (units) A 1.00 95,000 B 2.00 100,000 C 3.00 115,000 D 4.00 125,000 E 5.00 150,000 F 6.00 200,000 Scenarios Law of Supply price …. Quantity Supplied -Or- Quantity Supplied …. price ceteris paribus: all else being equal SECTION 2 MODULE 6: INTRO TO SUPPLY Price ($) E 5 We have to be very careful…. D 4 C 3 Supply Curve B 2 1 Plot the points from the supply schedule to create the: SUPPLY CURVE F 6 A 95 100 115 125 150 200 Movement ALONG the supply curve just tells us at a given price this is the “quantity supplied” for spatulas…. We never, ever say supply at $2.00-we say “quantity” supplied at $2.00. Quantity Supplied of My Ebook (000’s) DO NOT confuse SUPPLY with QTY. SUPPLIED Your Graphs Should Always Have “Qty Supplied” on the x-axis PRICE always determines Quantity Supplied SECTION 2 MODULE 6: INTRO TO SUPPLY Five Principal Factors That SHIFT The Supply Curve for a Good or Service 1. Changes in the input prices 2. Changes in prices of related goods or services 3. Changes in technology 4. Changes in expectations 5. Changes in the number of producers SECTION 2 MODULE 6: INTRO TO SUPPLY Increases or Decreases in SUPPLY of a Good Causes Shifts in SUPPLY CURVE Price ($) 6 F’ E 5 E’ D 4 2 A 5 2 B’ 1 A’ 95 100 115 125 150 200 Qty. Supplied of Spatulas (000’s) Increase in Supply Curve F E’ E D’ D C’ 3 C’ B F’ 6 4 D’ C 3 1 Price ($) F C B’ A’ B A 95 100 115 125 150 200 Qty. Supplied of Spatulas (000’s) Decrease in Supply Curve SECTION 2 MODULE 6: INTRO TO SUPPLY 1. Changes in Input Prices To make my spatulas I need plastic pellets, black dye, and stainless steel. These ingredients are called “inputs” in the business world. As you could imagine pricing changes in my inputs change my ability to produce and will affect the overall supply of spatulas. Plastic Pellets Price Price ($) S’ S Spatulas Qty. Supplied (000s) Plastic Pellets Price Price ($) S S’ Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY 2(a) Changes in the Prices of Related Goods or Services “The Case of Substitute Goods” As a manufacturer, I supply more than just spatulas to the market. I also produce spoon strainers using the same exact inputs. Let us see how the market for spoon strainers affects my supply of spatulas. Price of Spoon Strainers Price of Spoon Strainers Price ($) S’ S Spatulas Qty. Supplied (000s) Price ($) S S’ Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY 2(b) Changes in the Prices of Related Goods or Services “The Case of Complementary Goods” As a manufacturer, I also supply the complementary good of sheets of molded resin as a byproduct of my manufacturing process. Let us see how the market for sheets of molded resin affect my supply of spatulas. Price of Sheets of Molded Resin Price ($) S Price of Sheets of Molded Resin Price ($) S’ Spatulas Qty. Supplied (000s) S’ S Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY 3. Changes in Technology Any changes in technology, help me to reduce my inputs yet still let me to produce at the same level of output. Threfore, I can increase my production capacity without additional cost. This causes my supply of spatulas to increase and results in the supply curve shifting to the right. I am more willing to supply spatulas at any given price. Technology Technology Price ($) S S’ Spatulas Qty. Supplied (000s) Price ($) S’ S Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY 4. Changes in Expectations If I anticipate a price increase of spatulas in the near future, I will idle some manufacturing capacity now in anticipation of the future downturn. Likewise, if I anticipate a price decrease of spatulas in the near future, I will re-start idle manufacturing capacity now in anticipation of the future upturn. Anticipated Increase in Price of spatulas in the near future Price ($) S’ S Spatulas Qty. Supplied (000s) Anticipated Reduction in Price of spatulas in the near future Price ($) S S’ Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY 5. Changes in Number of Producers If I anticipate a price increase of spatulas in the near future, I will idle some manufacturing capacity now in anticipation of the future downturn. Likewise, if I anticipate a price decrease of spatulas in the near future, I will re-start idle manufacturing capacity now in anticipation of the future upturn. Anticipated Increase in Price of spatulas in the near future Price ($) S’ S Spatulas Qty. Supplied (000s) Anticipated Reduction in Price of spatulas in the near future Price ($) S S’ Spatulas Qty. Supplied (000s) SECTION 2 MODULE 6: INTRO TO SUPPLY ~Supply Summary~ Variable Price of the good itself A Change in that Variable Represents a movement along the supply curve Input Prices …. Shifts the Supply Curve Technology …. Shifts the Supply Curve Expectations ….. Shifts the Supply Curve Number of Sellers …. Shifts the Supply Curve