Download chapter 1: 10 lessons from economics

CHAPTER 1: 10 LESSONS FROM ECONOMICS Economy: one who manages a household Economics: the study of how society manages its scarce resources Economists study how people make decisions with their work & interact with one another & they analyse forces & trends, eg. Average income, rate of price rise Scarcity – the limited nature of society’s resources Microeconomics: the study of how households & firms make decisions & how they interact in specific markets Macroeconomics: the study of economy-­‐wide phenomena, eg. inflation, unemployment & economic growth, impact of competition, borrowing from government, policies to change living standards, effects of compulsory school HOW PEOPLE MAKE DECISIONS 1. PEOPLE FACE TRADE-­‐OFFS, eg. One hour spent studying is one hour less partying, or income vs. environment, or defence vs. living standard, efficiency vs. equity Efficiency – society is getting the most it can from its scarce resources, eg. Size of pie Equity – the benefits of those resources are distributed fairly among society’s members, eg. How pie is divided Eg. Pensioners receive money which is equitable but not efficient as the rich may not work as hard if they have to give their income to the poor anyway (pie gets smaller if its too equal) 2. THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT – cost vs. benefits, eg. Going to uni will result in better opportunities but fees & time are expensive Opportunity cost – what you give up to get an item, eg. Opportunity cost for athletes to go to uni is high & often not worth it 3. RATIONAL PEOPLE THINK AT THE MARGIN Marginal change – a small incremental adjustment to a plan of action Rational people make decisions by comparing if marginal benefits exceeds marginal costs, eg. Diamonds have a large marginal benefit & selling a ticket below price still receives benefit 4. PEOPLE RESPOND TO INCENTIVES Incentive – something that induces a person to act, eg. Baby bonus OR seatbelt law increases pedestrian deaths HOW A GROUP OF PEOPLE INTERACT TO MAKE DECISIONS 5. TRADE CAN MAKE EVERYONE BETTER OFF – eg. A family gains from its ability to trade with others, despite competition for jobs & cheap items. Trade allows people to specialise so goods & services are cheaper & everyone can have a comparative advantage, eg. Australian wool in exchange for Chinese clothes 6. MARKETS ARE USUALLY A GOOD WAY TO ORGANISE ECONOMIC ACTIVITY Market economy – an economy that allocates resources through the decentralised decisions of many firms & households as they interact in markets for goods & services (instead of communism with centrally planned economies) It awards people according to their ability to produce things other people are willing to pay for. Invisible hand – the idea that buyers & sellers freely interacting in a market economy will create an outcome that allocates G&S to those who value them most highly, thus making the best use of our scarce resources – however can only work if government enforces rules & maintains them 7. GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES They government may intervene & change resource allocation to promote equity & efficiency. Market failure – when a market left on its own fails to allocate resources efficiently; may be due to externality (the impact of one person’s actions on the wellbeing of a bystander, eg. pollution) OR due to market power (the ability of few people to improperly influence market prices, eg. Well owner when no water is left) HOW THE ECONOMY AS A WHOLE MAKES DECISIONS 8. A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS & SERVICES Productivity – the quantity of G&S produced from each hour of a worker’s time – determines living standards in countries, eg. Large quantity of goods in short time = higher standard of living. The concern of budget deficit in Australia is based on the impact it has on productivity; as it borrows funds & reduces investment on human capital (education) & physical capital (factories). 9. PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY Inflation – an increase in the overall level of prices in the economy When the government makes small quantities of money, inflation increases because the value of the money falls. 10. SOCIETY FACES A SHORT-­‐TERM TRADE-­‐OFF BETWEEN INFLATION & UNEMPLOYMENT Phillips curve – the short-­‐term trade off between inflation & unemployment When the government wants to hire more people, they are required to make more money therefore prices go up. If the government reduces quantity of money in the economy, prices will eventually fall and people will spend less, but in the meantime (while firms are issuing new catalogues & restaurants changing their menus) prices are sticky, which reduces the quantity of G&S that firms sell & thus workers have to be laid off. By changing the amount of money that the government spends, taxes and prints, policymakers can temporarily influence inflation & unemployment to control the economy. CHAPTER 2: THINKING LIKE AN ECONOMIST Economist language – supply, demand, elasticity, comparative advantage, consumer surplus, deadweight loss Economists use different assumptions when studying the short & long term effects of change. MODELS TO REPRESENT THE ECONOMY 1. CIRCULAR-­‐FLOW DIAGRAM – a visual model of the economy that shows how dollars flow through markets among households & firms (decision makers) In the markets for S&G  householders are buyers and firms are sellers In the markets for the factors of production  householders are sellers and firms are buyers 2. THE PRODUCTION POSSIBILITIES FRONTIER – a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and available production technology (points outside the frontier are not feasible given the resources); representing economic growth. An outcome is efficient if a point lies on the frontier (only produce more of a good by producing less of another, eg. Opportunity cost of 200 computers to get 100 cars) & inefficient if it lies inside the frontier. The graph highlights; scarcity, efficiency, trade-­‐offs, opportunity cost & economic growth Positive statements – claims that attempt to describe the world as it is (scientist), eg. Minimum wage law causes unemployment Normative statements – claims that attempt to prescribe how the world should be (policy advisor), eg. The government should raise minimum wage  Normative conclusions require positive analysis (science) as well as value judgements from ethics, religion & political philosophy. Economists often give conflicting advice to policy makers because; 1) They may disagree about the validity of alternative positive theories about how they world works 2) They may have different values & therefore different normative views about what policies should try to accomplish, eg. Taxing income CHAPTER 3: INTERDEPENDENCE & THE GAINS FROM TRADE GRAPHS – pie chart, bar graph, time-­‐series graph Positive correlation – both x and y axis increase, Negative correlation – decrease The demand curve – traces the effect of a good’s price on the quantity of the good consumers want to buy; often has 3 variables, eg. Emma’s income determines the price she will pay & the amount of books she will buy – to graph this, we hold her income constant & show the relationship between the other two Downward slope = x is negatively related to y ANALYSING GRAPHS Economists often measure the sensitivity of one variable to changes in another variable, not with the slope, but with elasticity, which uses the percentage change in a variable rather than the numerical magnitude of the change. If graphs aren’t constant we may believe (1) a variable has caused another when in fact another variable is involved (omitted variable – eg. cigarette lighters & cancer) OR (2) A causes B when in fact B causes A (reverse casuality – may be based on expecations, eg. High police = high crime OR station wagon sale causes population growth). THE PRINCIPLE OF COMPARATIVE ADVANTAGE Absolute advantage – the comparison among producers (person, firm, nation) of a good according to their productivity – smaller quantity of inputs = advantage Comparative advantage – the comparison among produces of a good according to their opportunity cost – smaller cost = advantage Eg 1. Cameron takes 4 hours for laundry & 2 hours cooking  2 is to 1/2 Mitch takes 3 hours for laundry & ½ hour cooking 6 is to 1/6 Therefore C has lower opportunity cost (comparative advantage) than M for laundry, but higher for cooking (impossible to have both higher as one cost is inverse of other). M has absolute advantage in both areas. Eg. 2. Aus produces 2 tonne of food & 1 car, Japan produces 1 tonne of food & 1 car, then opportunity cost of 1 tonne of food is 1 car in Japan & ½ car in Aus, therefore they are better producing goods & exporting to one another in trade Consumers from different countries that trade goods based on comparative advantage, will both be better off because each country specialises & they are able to consume outside their country’s production possibilities frontier. Imports – goods produced abroad & sold domestically Exports – goods produced domestically & sold abroad International terms of trade/exchange – the domestic terms of trade moving towards the same level in both markets