Econ 2305 Notes - Liggett PDF

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Econ 2305 Notes - Liggett The Nature of Economics Economics - The social science of allocating limited resources to unlimited wants Macro: Economy behavior as a whole Macro Deals with aggregates (totals) Micro: Economy behavior by sectors 3 ECONOMIC QUESTIONS 1. WHAT & HOW MUCH will be produced? 2. HOW will they be produced? 3. FOR WHOM will items be produced? 2 ANSWERS 1. Centralized Command and Control Central planning 2. The Price System Market system The Rationality Assumption - “We assume that individuals do not intentionally make decisions that would leave them worse off” Incentives - Things that causes motivation to something Quintessential Model is always simplified

Ceteris Paribus Assumption - All other things being equal BOUNDED RATIONALITY 1. Unbounded Selfishness people only interested in self-satisfaction 2. Unbounded Willpower choices always about long term goals 3. Unbounded Rationality able to consider every rational choice ______________________________________________________________________ ______

Scarcity and Trade-Offs

SCARCITY is NOT SHORTAGE we simply do not have enough for all desire 5 FACTORS OF PRODUCTION 1. Land 2. Labor 3. Physical Capital 4. Human Capital 5. Entrepreneurship Goods vs. Economic Goods Goods: All things where satisfaction is derived from Economic Goods: goods where best decision on best utility is made

Opportunity Cost - Value of the next best alternative Economic Prosperity: - Rule of Law - Private Property - Political Stability “Broken Window Fallacy” Idea that states economy stimulates after an event 2001: Loss of Physical and Human Capital (9/11)

Recession - Decline of GDP Persona who runs Fed. Reserve = Chairman - Serves 14 year term on Board of Governors - Current Chairman is Janet Yelen

Driving Forces in Economics - Computing Power - Available Data

The ECONOMIC PROBLEM is SCARCITY

Types of Economic Systems 1. Demand Driven Economy - Market Mechanism - PRICES ARE A SIGNAL Free Enterprise Prices

= MORE prod. Of Product

Prices = LESS prods. Of Product 2. Command System Central planning involved Centralized control “Authority Knows Best” 3. Mixed Systems Combination of both U.S. = Capitalism (both)

Capitalism 1. Limited Government 2. Private Property (Incentives) 3. System of Markets & Prices 4. Self-Interest

A MARKET is where a BUYER AND SELLER come TOGETHER Self-Interest (Driving Force) - INVISIBLE HAND by ADAM SMITH - Beyond Self-Interest Price Gauging = Raising prices excessively - Laws protect against Price Gauging ______________________________________________________________________ ______

Resources (factors of production) 1. Human - Labor - Entrepreneural Ability - Human Capital (“Tools in the mind”) - Education and Training 2. Property

- Land, etc... (natural resources) -Economic Capital (also Physical Capital) - “Manufactured aid to production” Capital can be SIMPLE or COMPLEX At any point, resources can be scarce Money... - Is not a resource - Not productive, per say

How do we determine value? (Shovel example) - Who would use one? - How much does it cost? - What is the wage rate? ______________________________________________________________________ ______

3 LAWS Law of... 1. DEMAND 2. SUPPLY 3. PRICE EQUILIBRIUM LAW OF DEMAND (inverse) as PRICE

Qsupplied

as PRICE Qsupplied Qdemanded DOES NOT EQUAL Demand LAW OF SUPPLY (direct) as PRICE

Qsupplied

as PRICE

Qsupplied

Qsupplied DOES NOT EQUAL Supply LAW OF PRODUCT EQUILIBRIUM market forces work to where Qdemanded = Qsupplied DEMAND CURVE shows the WILLINGNESS TO BUY

______________________________________________________________________ ______

SCARCITY TIME is the true OPPORTUNITY COST Utility Satisfaction received from consumption of good or service Marginal extra, additional, change, ... National Debt = accumulation of debt Budget Deficit = 12 month period

3 ASSUMPTIONS OF PPC 1. Technology 2. Resources 3. Efficiency - Efficient if ON THE LINE

Macro Goals 1. Full Employment - Employment at natural rate - NAIRU “Non-Accelerating Inflation Rate of Unemployment” 2. Price Stability Inflation vs. Deflation 3. Increased Standard of Living 4. Freedom of Choice 5. Safety Net (sick and elderly) 6. International Trade Balance ______________________________________________________________________ ______

Non-Price Determinants of Demand 1. Expectations - Expected . Price

. Price

2. Number of Buyers - Individual Demand - Market Demand

3. Tastes and Preferences - Changes based on age, interests, health, etc.

4. Income - College Student . Bologna Bread Sandwich - Graduate + Job + Income . Filet Magnon

INCOME

and DEMAND

= Normal Good

INCOME

and DEMAND

= Inferior Good

5. Price of Related Goods - Complementary Goods (Bred and Eggs) if Price of Eggs demand for Bread goes - Substitute / Competing Goods (Coke and Pepsi) If Price of Coke

demand for Pepsi

______________________________________________________________________ ______

Non-Price Determinants of Supply 1. Price of Inputs - Materials - Labor - Inverse Price of Inputs

Supply

2. Technology - Positive

3. Regulations - Inverse Regulations

Supply

4. Subsidies 5. Price of Other Goods - Corn vs. Soybeans As a farmer... Price of Corn

, grow more Corn and less Soybeans, Supply of

Soybeans

6. Expectations 7. Number of Sellers, Suppliers, Producers 8. Taxes - Sales Tax - Excise Tax Inverse Taxes

Supply

If you want LESS of something, TAX IT!!!

Two questions thinking about non-price determinants 1. What’s the market 2. Will it effect demand or supply ______________________________________________________________________ ______

Price Controls (wage controls) Price Ceiling - Limiting Price Increases - Rent Control - New York - California - Approx. 200 cities & towns - What’s the purpose of Rent Control? - Affordable housing - Gas Prices 1970’s - Nixon Wage & Price Controls 1970’s (no salary increase, no price increase) - Results… - Shortage - Transfer of Income (From Landlord to Tenant) - No incentive to construct new housing - Non-Price discrimination - Black Market (Underground economy) - Grease the Palm (slide money or an oz. through handshake) - Reduce Maintenance - 30 hours per week, down to 15 hours - Property value falls - Inefficiency Price Floor - Minimum Price is established - Minimum Wage Law - Federal

- State can legislate higher minimum wage rates - Wages differ by skillset required and demand - Farming / Agriculture Price Supports

____________________________________________________________ _____ Wage Market Labor Demand Curve only supply curve

Wage rate /s | | / | / | / _________________ Quantity ____________________________________________________________ _____ Price Elasticity Of Demand Elasticity - Sensitivity to a change in a variable Law of Demand - Inverse relationship between P&Q but by how much? - P up Qd down a little bit = Inelastic (E1)

E= %changedQd / %changedP - ( Use Absolute Values — Ignore Negative) Determinants of Elasticity - Substitutes - Price - Income - Luxuries vs. Necessities (Wants vs. Needs) - Coffee - Alcohol - Tobacco - Time - Longer = more elastic - Gasoline in the long run vs. short run

- .08 cents gas tax example - Why elastic? - Layoffs, closing off stations - Law of unintended consequences - Static analysis vs. Dynamic analysis

______________________________________________________________________ ______

EXAM 1 = 89 % Work on Elastic, Inelastic, analyzing graphs ______________________________________________________________________ ______

Economic (and Political) Functions of Government What roles do government play in economic activity? Important Institutions Rule of Law Private Property Political Stability What happens if markets “fail”?

Market Failure = too few or too many resources in specific economic activity Presents economic efficiency and individual freedom Is addressed by public policy (government)

Micro Failure Legal Framework (Institutions) - “Rules of the Game” - Sports analogy ~ think about the rules - Administration of Justice ~ legal system - Agencies ~ FCC, FAA, EPA, SEC, FDA, etc. - Perhaps the biggest impact on Government Maintain Competition - Avoid Monopoly situation - AT&T acquire T-Mobile

- American Airlines acquire US Air

Re-distribution of Income (3 Types) - Income Tax (progressive) - aren’t all taxes a re-distribution? - Re-dist for FUND vs. Re-dist for EQUITY - Transfer Payments (safety net) - Dollars received and you’ve done nothing in terms of work - Food Stamps, Medicaid, Welfare - Price Controls - Ceilings, Floors… Reallocation of Resources Private Goods = Consumption by one person does exclude consumption by another i.e: food, clothes Public Goods = Consumption by one person does not exclude consumption by another i.e: police, fire truck, national defense, park

- Solves Free Rider problem Free Rider Problem = person who benefits but does not contribute payment for benefit

Externalities third

= When the consequences of an economic activity spill over to affect parties Two Types - Negative (Spillover Costs) Gov’t can correct negative externalities Supply shifts left - Special taxes (i.e: pollution tax) - Positive (Spillover Benefits) - Demand shifts right Third Parties Parties who are not directly involved in a given activity or

transaction Property Rights

Rights of an owner to use and exchange property

Resource Misallocations Market Overallocations = External Costs Negative Externality SUPPLY CURVE SHIFTS LEFT Market Underallocations = External Benefits Positive Externality DEMAND CURVE SHIFTS RIGHT (Dp = Perceived Demand)

Macro Failures Stabilize the Economy (reluctantly)

- Unemployment - Employment Act of 1946 - Full Production, Employment - Embraced Keynesian Economics (Some Gov’t intervention) - Humphrey Hawkins - 1978 - Provided for specifics. Attempt to quantify goals - 4% or less unemployment % inflation - adjustable by congress - Inflation - National Debt (?) - Global Trade Deficit (??)

______________________________________________________________________ ______

Business Cycle Peak Contraction Trough Expansion ______________________________________________________________________ ______

Labor Force = 16 and older (adult…), working or looking for work, and non-institutionalized.

Labor Force Participation Rate = Proportion of labor force

- Find the total 16+ Population (non-institutionalized) / Labor force

Major Types of Unemployment - Frictional = Short-Term - Frictional is always happening (voluntarily leaving job) - “Creative Destruction”

- Structural = Long-Term - Persistent - Re-train, Re-educate, or Re-locate

Structural + Frictional = Natural Rate of Unemployment

- Cyclical = Recession Type Unemployment - More Serious - The Business Cycle

- Seasonal - Agriculture - Sports Seasons - Holiday Seasons

Costs of Unemployment - Think PPC - Erosion of skills over time - Crime - Yes, for property crime, robbery, burglary, etc. - For every 1% increase in Unemployment, about 2% increase in crime - Psychological - Mental Impact - Stress Induced Illness

Discouraged Workers - Individual stopped looking for a job - Subset of larger group - Marginally Attached Workers - How does the existence of discourage workers bias the unemployment rate? - They are not counted in the unemployment rate ______________________________________________________________________ ______

Who is Unemployed? - Mary leaves her job to become a stay-at-home mom ~ no - Marty leaves his job as a cashier to work as a waiter ~ yes, frictional - Larry drops out of high school and has difficulty finding work ~ yes, structural ______________________________________________________________________ ______

Inflation and Price Levels

Inflation an increase in the AVERAGE level of prices Some prices go UP Some prices go DOWN

Index Prices in current yr / Prices In base yr

CPI CPI flaws - Slow to adjust - Problems with technology increases Consumer Price Index Measures Inflation Price Index = Cost of Market Basket today / cost of MB in base year Percentage Inc. = (New Price - Old Price) / Old Price Inflating it Up = Base price x (Today price / Old Price)

GDP Deflator - Broader than CPI - More Adjustment - Goal is to compare year-to-year Problems from Inflation - Price Confusion - Pricing SIGNAL is “difficult to interpret” - Long term planning / forecasting - Uncertainty Inflation redistributes wealth - As a TAX (chips away at purchasing power) - Transfers wealth away from Lenders

Who’s impacted by Inflation? - Fixed Income folks (retirees) - Creditors / Lenders (Money payed back with has less purchasing power) - Business - Re-pricing / Menu costs, etc. Protecting against inflation - Cost-Of-Living Adjustments (COLAs) Clauses in contracts that allow for increases in specified nominal values to take account of changes in the cost of living ______________________________________________________________________ ______

Economy’s Performance - GDP, circular flow, other concepts Circular Flow Diagram (Firms > Resource Market > Household > Product Market) - Product Markets - Resource Markets - Firms and Households - Leakages (money falling out of the circular flow) - Savings - Taxes - Imports - Injections (money coming in to the circular flow) - Investments (what does bank do with savings?) - Government Spending (opposite of taxes) - Exports

What is GDP? Market value of FINAL goods AND services within the nation’s borders in a year timeframe. Excluded Transactions - Financial T/A’s - Securities (Stocks, bonds, etc.) - Private T/F’s (welfare, etc.) Used Goods - Why not? - 2nd hand already included Non-Reported Cash payments Illegal Activities (Black Market) GDP Limitations - Non-Market T/A’s - Quantity, not Quality - Leisure?? - Environmental

______________________________________________________________________ ______

Expenditures Approach GDP = C + G + I + Xn C = Consumer G = Government I = Investments Xn = Net Exports (Exports - Imports)

Consumption (C) - Durable, Non-Durable goods - Services - LARGEST component of GDP Government (G) - Federal, State, Local Investments (I) (Inverse between Rate of investment & Interest Rates) - Capital Goods - Factories / Plants - Inventories - Taxes, Market Expectations Investment is the MOST VOLATILE COMPONENT OF SPENDING Investment Volatility - Technology - Electricity - Automobiles - Computer chip Net Exports (Xn) - Federal, State, Local

Animal Spirits - Spontaneous urge to action other than inaction NDP (Net Domestic Product) = GDP - Depreciation (or Capital Consumption Allowance) Disposable Income = Personal Income - Taxes Real vs. Nominal Real = Adjusted for Inflation Change in Real =

Nominal = not adjusted for inflation Change in Nominal = STUDY REAL AND NOMINAL GDP

Nominal GDP = 12.5 Billion (Base Year) Nominal GDP = 15.9 Billion (Current Year) DGP Deflator Index = 1.24 % Change in Nominal GDP between the two years? What is the real GDP in the base year? 12.5 Billion. What is the Real GDP in Current Year? 15.9 Billion. What is % change in Real GDP between the two year? 27.2% Test = 50 questions Calculate GDP, base current year, % change, Nominal and Real GDP Chapter 5 = 15 questions — Economic functions of government - Externalities Chapter 7 = 19 Questions — Unemployment and Inflation - Identify Structural, Frictional, Cyclical - Identify labor force - 16, Looking for work - Calculate Unemployment - Unemployed / Labor Force - Calculate Labor Force Participation Rate - Labor Force / Working age population - Military = Institutionalized - Inflation - Lenders are impacted due to change of rate - Fixed income - Index = Current year prices / Base year prices - Base year index is always d00 Chapter 8 = 16 Questions - GDP = C + Ig + G + Xn - Investment is Volatile ______________________________________________________________________ ______

EXAM 2 = 66 % ______________________________________________________________________

______

Aggregate Supply and Aggregate Demand Real GDP & Price Level in Long-Run LRAS = Vertical | |(LRAS) | | | | _______________ P = Price Level Q = Real National Output More horizontal = less unemployment Aggregate Demand (AD) = downwards sloping 4 Components of Spending AD = C+I+G+Xn 1. Real-Balance Effect Price Level ^ = Decrease in purchasing power 2. Interest Rate Effect Price Level

= Need for money

= Interest Rates

= Investments

Higher price = Less Expenditures 3. Foreign Goods Effect Global Economy - Increase in Price Level means - Domestic Goods more Expensive, therefore… - We purchase more foreign goods - Imports increase, therefore Xn falls

Classical (Pre-Depression) vs. Keynesian Economics Classical

- Laissez Faire - Say’s Law (Production > Demand) - Inherently Stable Keynes - Needs Stimulus (G) (Consumption > Demand) - Unstable Increase in AD 1. An increase in the amount of money in circulation 2. Increased security about jobs ad future income 3. Improvements in economic conditions in other countries 4. A reduction in real interest rates (nominal interest rates corrected for inflation) not due to price level change 5. Tax decreases 6. A drop in the foreign exchange value of the dollar

Consumption Function

C = a+mpcYd A = Autonomous consumption - Spending of 0 levels of income Yd = Disposable Income MPC = Marginal Propensity to Consume - Change in Consumption / Change in Disposable Income (i.e: Change in C = 80, Change in DI = 100; 80/100 = .8 MPS = Marginal Propensity to Save - Change in Savings / Change in Disposable Income

(MPC + MPS) = 1 Spending Multiplier = 1 / (1-MPC) = 1 / MPS

Initial Change in Spending x Multiplier = Total change in Equilibrium Output Intro to SRAS (Short Run Aggregate Supply) - Relationship between total planned production and price level Sticky Wage Model (Wages set-unions/contracts) (WHY THIS IS UPWARD SLOPING) - Price Level Rises, REAL wages decrease

- Labor becomes cheaper - Firms hire more labor (more workers = more output) - Output Increases Worker-Misperception Model (Competitive Labor Markets) - Price Level Rises, REAL wages Increase - Workers provide more labor (work more = pay more) - More labor = more production (Output Increases) Price Level | / SRAS | / | / | / __________ Real GDP Recessionary Gap - Between Output of LRAS and Output Equilibrium On the actual Curve… - Horizontal part of curve = Keynesian - Vertical part of curve = Classical - Portion in the middle = Intermediate - Keynesian = Price level CONSTANT - Classical = Price level DROPS

- Consumption positive sloping if slope is positive (MPC is always positive) - Output can be… - GDP - NDP - NI - PI - DI

The Classical Model - Assumptions - pure competition exists - wages and prices are flexible - people are motivated by self-interest - people cannot be fooled by money illusion - Consequences - if role of gov’t is minimal - If pure competition prevails, all prices and wages are flexible - Problems in macroeconomy will be temporary and the market will correct itself

- Say’s Law - Producing goods and services generates the means and the willingness to purchas...