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ECON 1250 Introduction to Economics 1.

What are the 5 basic questions in determining the allocation of resources? 1- What good and services are to be produced? 2- Where are these goods and services to be produced? 3- Who will receive these goods and services produced? 4- How will these goods and services be produced? 5- How many goods and services are to be produced?

The four basic economic questions are (1) what goods and services and how much of each to produce, (2) how to produce, (3) for whom to produce, and (4) who owns and controls the factors of production. 2.

Define ‘economics’.

“The study of mankind in the ordinary business of life.” - Alfred Marshall (1842 - 1924) Economics is the study of the efficient allocation of scarce resources to satisfy unlimited human wants. 3. Explain what a resource is and what the three categories of resource are. Provide two examples of each. Anything that can be used in the production process. Resources or Factor of Productions goes through Production Process and produce Final Goods and Services. Land, Labour and Capital are the three resources. Examples: Land - Trees, natural gas Labour - mental ability, physical ability Capital - Computers, buildings, etc. 4.

Describe the three basic allocation mechanisms.

3 basic allocation mechanisms Traditional (Customary) - All allocations questions are determined by custom or tradition. Example: Somalia, Ethiopia, etc. where allocations of resources are done customarily. Command - A small group or an individual decides all allocation questions. Example: N. Korea, Albania, Cuba, etc. Free Market - every individual endeavours as much as he can to employ his capital in support of the domestic industry. Characteristics of Market economy: Self interest - utility/profit maximization Incentives Decisions made “at the margin”

Specialization and division of labor Money and trade Institutions - including property rights 5.

What is meant by the ‘scientific method’?

a method of research in which a problem is identified, relevant data are gathered, a hypothesis is formulated from these data, and the hypothesis is empirically tested (Pls. see diagram from class presentation below).

6.

Explain why economists use models to explain the world.

An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be tested. ... For example, a theoretical model of an agent's consumption behavior would generally suggest a positive relationship between expenditure and income. 7.

Illustrate the difference between a positive and a normative statement.

Normative: statements those are based on opinions, often insupportable with rational argument. Example: 1. Government should not spend taxpayers’ money in supporting commercial banks. 2. The majority of the population would prefer a policy that reduced unemployment to one that reduced inflation. Positive: statements based on fact or theory, can be supported by logical argument. Example: 1. Raising interest rates encourage people to save 2. Unemployment is a more important social problem than inflation.

8. With the use of examples, distinguish between microeconomic and macroeconomic problems. Microeconomics - deals with questions pertaining to individual decision makers, individual markets, and individual prices. For example: how an individual person or market demand or supply react with increase or decrease of price of some certain commodity. Macroeconomics - deals with questions pertaining to the economy as a whole - the decision of consumers and firms in general, total consumption and price level. Inflation, unemployment, interest rate, exchange rate, etc. are major concern of macroeconomics.

9. Briefly explain why people continue to use cell phones when they drive, even though they know that it is illegal.

Introduction and PPC 1.

Explain why a Production Possibilities Frontier can never be upward sloping.

The outward-bowed shape of the PPF reflects increasing opportunity cost. The PPF is bowed outward because resources are not all equally productive in all activities. If some of the people, who are expert in producing product A, is moved to produce product B, they might not be equally productive. So, we’ll get small increase in product B, but a large decrease in the quantity of product A; and vice-versa. 2. Use a Production Possibilities Frontier to explain the effects of a change in technology on the output of the economy.

3. Use an example to illustrate that you understand the difference between absolute and comparative advantage. Absolute advantage means being more productive or cost-efficient than another country whereas comparative advantage relates to how much productive or cost efficient one country is than another. In order to understand how the concept of comparative advantage might be applied to the real world, we can consider the simple example of two countries producing only two goods - motor cars and commercial trucks.

Here, Country B has absolute advantage in producing both Cars and Trucks. But, country A has comparative advantage of producing Cars, since it can produce one car sacrificing less number of trucks than the other country.

4. Use a Production Possibilities Frontier to explain why a traditional economy was efficient during the Middle Ages.

In the middle ages, an economy that chose point B in the PPF shown above, would not have enough food to feed its entire population. Starvation, death and civil unrest are likely to follow. This outcome is true for every point on the PPC below the subsistence level, so the optimal choice for the economy in this situation is point A. they must devote all of their resources to the production of food. So, there were no resources available to devote to research and development and no new technologies are discovered, and they were affected some natural diseases like plague. A good number of population died from these diseases and ‘subsistence level’ dropped, since there were less food requirement during the upcoming years. Then they could deploy the additional resources to development of tools, researches etc.

5. How will the current choice of position on the Production Possibilities Frontier influence the future growth rate of the economy?

On a PPF, if a country choose a point that produces more tools than consumables, future growth rate of the economy will expedite. But if the country choose a point that produces more consumables than tools, future growth rate will be slower.

6. Explain why governments may be loathe to increase spending on education. Use a PPF in your answer.

7.

Use a PPF to explain why Canada is experiencing a higher growth rate than Ethiopia.

8. In the mythical country of Margaritaville, they produce only two products: cheeseburgers and boat drinks. The following table indicates how much of each product each resident can produce in a week. Draw and correctly label the PPF for Margaritaville. Cheeseburgers Boat Drinks Jimmy Buffett

30

5

Mac MacAnally

12

3

Roger Guth

4

2

John Mayer

40

8

Michael Utley

12

4

Robert Greenidge

1

1

Cheeseburger s

Boat Drinks

Opportunity cost (1 Boat drinks/cheeseburger)

Jimmy Buffett

30

5

1/6

Mac MacAnally

12

3

1/4

Roger Guth

4

2

1/2

John Mayer

40

8

1/5

Michael Utley

12

4

1/3

1

1

1

99

23

Robert Greenidge Total

Sort the table above by opportunity cost column Cheeseburgers

Boat Drinks

99 (total)

0

98 (99 - Robert’s capacity 30)

1 (0 +Robert Greenidge’s capacity)

94 (98 -Guth’s capacity 4)

3 (1 + Guth’s capacity 2)

Michael Utley

82 (ditto)

7 (ditto)

Mac MacAnally

70 (ditto)

10 (ditto)

John Mayer

30 (ditto)

18 (ditto)

Jimmy Buffett

0 (ditto)

23 (total)

All works in Cheese burgers Remove Robert Greenidge (from Cheeseburger to boat drinks) Roger Guth

Plot the above points into a graph:

Supply Demand 1. If the supply and demand for a particular good can be expressed as follows, what will the amount of consumer and producer surpluses be at the equilibrium price? Q = 1600 - 400P Q = -200 + 500P d

s

At equilibrium Qd = Qs or -200 + 500P = 1600 - 400P or 900P = 1800 or P* = 2; and Q* = 800 At price axis, demand curve cuts at Q = 0, or 0 = 1600 - 400P, or P = 4 At price axis, supply curve cuts at Q = 0, or 0 = -200 + 500P, or P = 0.4 From the diagram below: area of a triangle = 0.5 * Base * height

2 If there is a devastating typhoon in Sri Lanka, what will likely happen to the street price of cocaine in Vancouver? Explain your answer. After a devastating typhoon in Sri Lanka, tea price will increase worldwide and that will increase the demand for coffee. Some South American countries will allocate their resources towards producing of coffee instead of cocaine. That will cause increase in cocaine price in Vancouver street.

3

Explain why demand curves are downward sloping.

For the following reasons demand curves are downward sloping: 1. Income effect 2. Substitution effect, and 3. Diminishing marginal utility 4. If there is a technological breakthrough in the production of an absolute necessity, will this lead to a lower price and larger quantity produced? Explain.

Demand curve is vertical and the demand is inelastic. After technological breakthrough supply will be increased. It will decrease the equilibrium price but quantity will not be increased at all.

5.

List the variables that will cause the supply and demand curves to shift. (5 for each).

Non-price determinants of supply those will cause the supply curves to shift: Technology, input prices (W), number of sellers, price of other goods, expectations (future price and future input prices). (in short TINPE) Non-price determinants of demand those will cause the demand curves to shift: Tastes, preference & demographics, Income, Number of consumers, price of other goods, and Expectations (future price and future income). (in short TINPE)

6. Wheat and oats are grown under similar conditions and are both used in breads and cereals. What will happen to the quantity of oats grown if the price of wheat were to rise?

7.

Explain the relationship between the shapes of the PPF and the supply curve.

8. Both sellers and buyers of gasoline expect that the price will increase tomorrow. What are the likely effects on the equilibrium quantity and price today. Use a diagram in your answer.

Equilibrium quantity is uncertain, though the increase of price is certain.

9. A recent news report suggested that university enrollment was rising as a result of the recession. Does this imply that education is an inferior good? Explain your answer. The opportunity cost of going to college – the job opportunities a person forgoes while in college – drops very dramatically during recessions. It is harder to find a job, to keep a job or to get a promotion. Thus, some people who would not enroll do enroll. People who would drop out stay enrolled. It does not imply that education is an inferior good.

10. Suppose that the market for ice cream cones can be expressed using the following equations. Q = 2100-300(P) Q = -100+250(P) What is the total expenditure by consumers on ice cream? d

s

At equilibrium, Qs = Qd, or, -100+250P = 2100-300P, or, 550P = 2200, or P* = 4 and Q* = 900 Total expenditure by consumers on ice cream is P* x Q* = 4 x 900 = 3600 11.

If the supply and demand for a particular good can be expressed as follows. Q = 600 + 100Y - 400P Q = -200 + 500P Where Y stands for income. Determine the increased expenditure when income rises from 10 to 12. d

s

When Y = 10, Qs = Qd, or, -200+500P = 600+100x10-400P, or, P* = 2 and Q* =800 Expenditure = PQ = 1600 When Y = 12, Qs = Qd, or, -200+500P = 600+100x12-400P, or, P* = 2.22, Q* = 911 Expenditure = PQ = 2.22 x 911 = 2022 Therefore, increase in expenditure (2022 - 1600) = 422 12.

When studying comparative statics, there are eight possible outcomes. What are they?

From, class presentation of week 3:

Circular Flow

1. Draw and correctly label a circular flow model for an economy with a budget deficit, a trade deficit, a capital account surplus and GDP > GNI. A surplus in the capital account means money is flowing into the country, but unlike a surplus in the current account, the inbound flows effectively represent borrowings or sales of assets rather than payment for work. Here, government takes money from financial market which indicates budget deficit Foreign sector takes money from financial market which indicates trade deficit Resource market takes money from foreign sector, which indicates capital account surplus (not sure of it) again since, GDP > GNI, net factor payments to foreigners.

2. The circular flow model works on the premise that “arrows in equal arrows out”. Explain why this is true for both the firms and the households. (from class presentation)

3. Use a circular flow model to explain what Friedman and Schwartz believed led to the depression of the 1930’s. (from class presentation)

4. Show how the Production Possibilities curve is related to the circular flow. (from class presentation)

5. What happens to the rate of economic growth when the government runs a budget deficit in a closed economy? When the government runs a budget deficit in a closed economy, the government borrows funds from financial institutions. Therefore, the firms do not get sufficient funds from the financial institutes for investment.

6. What happens to the rate of economic growth when the government runs a budget deficit in an open economy with free capital flows?

7. If there are free capital flows between nations, then all small countries should have the same interest rate. Why don’t they?

8. Use a circular flow model for an open economy to show how the exchange rate between two countries is determined.

9. Why would the Canadian dollar likely rise against the US dollar if Stephen Poloz decided to raise the target rate for overnight money?

Measuring the Economy 1. List the components of GDP for both the expenditure approach and the income approach. Expenditure Approach  Consumption o Durable Goods (automobile) o Semi Durable Goods (clothing) o Nondurable Goods o Services  Investment o Fixed capital formation o All new construction o Change in inventories o Non-military durable purchases by government  Government Expenditure o Current Expenditure by all four levels of government o Excludes transfer payments, non-military durables, interest on the public debt  Exports

o Goods and services produced in Canada and sold to residents of another country/Causes money to flow into Canada  Imports o Goods and services produced in another country and sold to residents of Canada o Causes money to flow out Canada Income Approach  Wages, salaries and supplementary labour income  Interest and miscellaneous investment income o Excluding interest on personal and government debt  Corporate profits before taxes  Accrued net income of farm operators  Net income on non-farm unincorporated business, including rent  Inventory valuation adjustment 2. The Consumer Price Index for September 2013 was 115.7 (2002=100). The same index was 111.9 in September 2014. What was Canada’s inflation rate for that period? CPIseptember2014 - CPIseptember2013/CPIseptember2013 x100%=-3.28% 3. List 4 of the 5 different types of unemployment. What are their causes and their cures. Seasonal unemployment: Unemployment that occurs at the same time every year (teachers) Frictional Unemployment: Causes → New entrants to labour force, awaiting a definite start date, temporarily between jobs Solution → Reduce search time and search costs Structural Unemployment: Indicated by simultaneously high unemployment and a high help wanted index. Caused by structural changes in the economy. Policy Induced Unemployment: Price Controls, Disincentives Natural Rate of Unemployment: Full employment rate of unemployment, non accelerating inflation rate of unemployment (NAIRU) The level of unemployment that is consistent with an economy operating at capacity = Frictional + Structural + Policy Induced Cyclical/Demand Deficient Unemployment: Economic activity is insufficient to employ everyone that is willing to work, caused by short run economic fluctuations.

4. What is the relationship between the GINI index and the Lorenz curve? What are they used for? The Line of Perfect Inequality. The GINI coefficient is the ratio of the area between the line of perfect equality and the observed Lorenz curve to the area between the line of perfect equality and the line of perfect inequality. The higher the coefficient, the more unequal the distribution is.

Gini index = a/(a+b) Lorenz Curves The Lorenz curve is a graphical representation of income inequality or wealth inequality developed by American economist Max Lorenz in 1905. The graph plots percentiles of the population according to income or wealth on the horizontal axis. It plots cumulative income or wealth on the vertical axis,

5.

State and define the four elements of Consumption in national income accounting.

Personal consumption expenditure is what households buy (except houses). It is made of durables (cars, appliances), semi-durables, nondurables (clothing, food) and services (haircuts, doctor visits, airline tickets). A convention is made on nondurables to be all items which last less than a year, including clothing. 6. Ford Canada builds a new F150 pickup truck in its Ontario plant. Explain how this may be counted in national income accounting. Increase of inventory of a durable goods. This is an investment activity (changes in inventory). Households or firms might buy this for consumption or investment purpose.

7. Do the income approach and the expenditure approach to national income accounting always equal each other? Explain your answer. These two primary methods for measuring GDP should yield the same result even though they measure completely different factors.  The income approach: measures the total incomes earned by households in a nation in a year.  The expenditure approach: measures the total amount spent on the goods produced by a country in a year. By examining the circular flow model of a nation’s economy, we see every dollar earned by a household in a nation’s resource market will ultimately be spent in the product market, or leaked through taxes, savings, and import spending, leading to injections in the form of government spending, investment and export sales. econclassroom.com

8.

Explain 4 reasons why GDP is not a good measure of national welfare

GDP does not give us any idea about the quantity of the goods produced GDP does not measure per capita GDP does not measure welfare - Lorenz curve, GINI ratio Others - illegal activities, und...