Unit 7 International Economics PDF

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ECONOMY SUMMARY TOPIC 1. WHAT IS THE ECONOMY? INTRODUCTION AND BASIC PRINCIPLES 1.1Introduction All economic analysis is based on a set of common principles that apply to questions of everyday life. Some of these principles refer to individual choice, since the objective of economics is to analyze the decisions of individuals: to make choices among a limited number of options. Individual decisions are made in an environment conditioned by the decisions made by others, so our decisions interact. To understand the behavior of an economy, it is not only necessary to study individual decisions, but also to understand the economic interaction of the agents' decisions. Economic interactions are understood by studying the markets for different goods. The economy, as a whole, has ups and downs, so it is also necessary to study the interactions throughout the economy. It is necessary a system that coordinates well the productive and consumption activities. Economics is the social science that studies the production, distribution, and consumption of goods and services. Our economic system is based on what we call market economies: production and consumption are the result of decentralized decisions. Each producer produces what will be most profitable, and each consumer buys what he wants. In directed or centralized economies, an authority makes production and consumption decisions. Market economies coordinate production and consumption activities, and allocate scarce resources. The invisible hand: individuals, in the pursuit of their own benefit, often end up benefiting the whole of society. Microeconomics: study of how individuals make their decisions, and how these decisions interact. 

The consequences of a market economy are: 1. Sometimes, in the individual pursuit of self-interest, the interest of society as a whole is not promoted, but society worsens, this is what we call market failures. 2. The economy experiences fluctuations that study a branch of economics called macroeconomics. 3. The standard of living has increased due to economic growth, which is the ability of the economy to produce more and more goods.

1.2The individual choice 1

Every economic problem is related to making decisions. Individual decision is an individual's choice about what to do (and therefore a decision about what not to do). Every economic question implies individual choices, if there is no need to choose, there is no economy. The decision is due to the existence of scarce resources (budgets, time). Individual choice: individuals make choices from a limited number of alternatives. To understand how an economic system works, you have to understand the decisionmaking process of individuals. Individual Choice is based on four principles: 1. Resources are scarce (choose) Individuals have to make decisions because resources are scarce (limited income, limited time). Resource: that which can be used to produce another good. A resource is scarce when the quantities available are not sufficient to satisfy all the productive needs. The scarcity of resources implies that society must also make its choices. 2. The opportunity cost (moderates behavior, which we choose) Opportunity cost: what you drink to give up to get what you want. At bottom, all costs are opportunity costs. The opportunity cost is not something added, although the money paid for something is an estimate of the opportunity cost. Among different alternatives, we choose what produces a lower opportunity cost. 3. How much: a decision on the sidelines (how much do we choose) Some decisions are based on "how much." To make these decisions, the costs and benefits of doing a little more or less are compared (marginal analysis). Cost benefit analysis provided by the last unit. Marginal analysis is a central element of the economy, it allows deciding how much of any activity. 4. People seize opportunities to improve (rationality) When people are offered opportunities to improve, they usually take advantage of them. Individuals modify their behavior based on incentives. This principle is the basis for all predictions about individual behavior. Incentive: "reward" offered to people to change their behavior. Behavior change is a reaction to incentives.

1.3The interaction of individual choices Each individual's choice depends on the choices that others have made, and vice versa. To understand how a market economy works, it is necessary to understand the interaction. 2

There are five principles on which the interaction is based: 1. The exchange produces profit Trade is key to achieving a better standard of living. Commerce: individuals divide the tasks, and each offers a good or service that others demand, in exchange for other goods and services. Specialization: situation in which each individual is dedicated to a different task. The consequence is that if individuals trade, instead of being self-sufficient, they can obtain more goods and services (gains from trade). 2. Markets tend towards equilibrium A situation is a balance when no one can improve by doing something different. Every time there is a change in circumstances, the economy will move towards equilibrium. Example: checkout lines in a supermarket. BalanceIt is a situation in which no individual can improve by making a different decision. We reach equilibrium when something changes. It is necessary to be clear that, before any change, a new equilibrium situation will be reached. This assurance that the market will reach a new equilibrium is the necessary condition that we need to work. 3. Resources must be used efficiently Inefficient use of resources is undesirable. Resources are used efficiently when all opportunities for improvement that exist have been exploited. An economy is efficient if there is no chance that someone will get better without someone else getting worse. Nor is there any way to reorganize resources that implies that everyone improves. Efficiency is not the only criterion that is evaluated in an economy, there are also problems of justice or equity.

4. Markets often drive efficiency In most cases, the "invisible hand" of the market is responsible for obtaining efficiency. The incentive system that exists is the market economy ensures that resources are used appropriately. The fundamental intuitive reason is that individuals are free to choose what they consume and produce, given the constraints, and take every opportunity to improve. There are exceptions to this principle when there are market failures. 5. State intervention can improve social welfare 3

When markets are unable to achieve efficiency (market failures), State intervention can improve the welfare of society, through public policies that modify the use of resources. One part of training in economics is to identify in which cases the market works well and in which cases it does not. There are three cases of market failure:  

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Individual actions have collateral effects that the market ignores (externalities) ahem: pollution. One of the parties can prevent mutually beneficial exchanges from taking place in order to appropriate a greater part of the resources (market power) eg pharmaceutical companies. The nature of some goods does not allow the market to efficiently allocate resources (public goods and common resources)

1.4Interaction in the economy as a whole Basic principles of interaction: 1. An expense for one person is an income for another In market economies, people make a living by selling things to others. If some decide to increase their spending, the income of the others will increase. If they decide to reduce it, the income of others will also be reduced. I buy (spend) clothes there will be profit for the businessman 2. Total spending sometimes does not match the productive capacity of the economy The productive capacity of the economy refers to the amount of goods and services that can be produced under normal circumstances. The greater or lesser spending of people can cause companies to produce more, inflation, or less, recession, than the economy would be capable of producing. 3. Public policies can modify spending Governments have a series of instruments with which they can affect aggregate spending: monetary policy (to influence the interest rate) and fiscal policy (taxes, used for public spending). Public policies influence people's spending.

TOPIC 2. ECONOMIC MODELS 2.1 Economic models 4

What is an economic model? A model is a simplified representation of reality, which is made to obtain a greater and better understanding of real life situations, since they allow us to understand it better. Create real but simple economies and create virtual economies with computers. The so-called "given everything else." The assumption that the rest of the variables remain constant (ceteris paribus) is essential for the use of the models. It allows analyzing the effect that is derived when only one of the variables being analyzed changes. That is not possible in real situations. 

The Production Possibilities Frontier Model

Graph or equation that shows different combinations of two goods or services that companies can obtain as max, based on the number of production factors and the technology available to them. The FPP allows us to improve our understanding of the dilemmas that a society faces, the efficiency in the allocation of resources, the opportunity cost and the consequences of economic growth (displacement of the border). Not factible

The efficient points are those that are on the frontier of production possibilities

Feasible Production possibilities frontier

Set of chances of production



Comparative Advantage and the Gains of Trade

An individual has a comparative advantage in the production of a good or service if the opportunity cost of producing the good is lower for that individual than for another person. An individual has an absolute advantage in an activity if he is more productive than other people. Having an absolute advantage is not the same as having a comparative advantage. The relationship at which the goods will be exchanged (the exchange relationship) will be included between their respective opportunity cost.

2.2 Positive Analysis and Normative Analysis

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Using the models: Positive economyIt is the branch of economic analysis that describes the way the economy really works. Answers to positive economics questions are right or wrong. Normative economicsmakes recommendations about how the economy should work. The answers to Normative Economics questions imply the issuance of a value judgment. Why do economists disagree? Two reasons: 1. They may not coincide in the simplifications that must be made of the models 2. They may not coincide in their values and beliefs * economic analysis is a method not a set of conclusions

TOPIC 3. OFFER AND DEMEND 3.1 Introduction to the competitive model The market is a place where a group of producers and consumers meet to exchange a good or service. A competitive market is a market in which there are many buyers and sellers of the same completely homogeneous good or service. The supply and demand model is a model of how a competitive market works.

3.2 Demand curve. Determinants The demand plan (consumer behavior) The demand plan shows the quantity of a certain good or service that consumers want and can buy at different prices (if they cannot, there is no demand for the product). Example: coffee bean market. The relationship between the price and quantity of the coffee; the smaller the price, the more coffee beans there are. The demand curve The demand curve is the graphical representation of the demand plan: it shows the quantity of a certain good or service that consumers want and can buy at different prices. The quantity demanded is the quantity that consumers want and can buy at the current price. 6

The law of demand The law of demand states that, if everything else is held constant, a higher price of the good leads consumers to want to buy less. Demand shifts When the quantity demanded changes at any given price there is a shift in demand. Example the world population increases between the years 2002 and 2009. There are two demand plans: the demand plan for 2002 and the demand plan for 2009. Movements along the demand A movement along the demand curve is a change in the quantity demanded of the good that results from the change in its price. Convention: we will say that there is a change in demand when there is a shift in the demand curve and we will say that there is a change in the quantity demanded when there is a change in price. A shift in the demand curve is not the same as a movement (quantity reacts to price) along the demand curve. Shifts in the demand curve Reduction in demand: the quantity demanded decreases at any given price. (The demand curve shifts to the left.) Increase in demand: the quantity demanded increases at any given price. (the demand curve shifts to the right). Factors that shift the demand curve Related price changes: 

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Substitutes: if when the price of one good falls, the demand for the other decreases. (A good substitute for coffee is tea, if the price of tea increases there will be more demand for coffee) Complementary: if when the price of one good falls, the demand for the other increases. (the price of a good affects the quantity of the complementary product)

Causes of demand shifts Changes in rent  

Normal goods: if demand increases as income increases, it shifts to the right Inferior goods: if as income increases, demand decreases

Changes in tastes: changes in demand due to fashions, beliefs, cultural changes, etc. Changes in expectations: about future price, about future income, etc. 7

Changes in the number of consumers

3.3 Supply curve. Determinants The offer plan (behavior of an economic agent) The offer plan shows how much of a certain good or service is wanted and can be sold at different prices. Example: coffee bean market, if the price is 1 the sellers want to sell 10. Supply curve The supply curve is the graphic representation of the supply plan: it shows the quantity of a certain good or service that sellers want and can sell at different prices. The quantity supplied is the quantity that sellers want and can sell at the current price. The law of supply The law of supply states that, if everything else is held constant, a higher price of the good leads sellers to want to sell a greater quantity.

Offer shifts When the quantity supplied changes for any price, a supply shift occurs. Example: entry of new coffee producing countries in the world market. There are two supply plans: the supply plan prior to the entry of new producers and the subsequent supply plan. Movements throughout the offer A movement along the supply curve is a change in the quantity supplied of the good that results from the change in its price. Convention: we will say that there is a change in supply when there is a shift in the supply curve and we will say that there is a change in the quantity supplied when there is a change in price. A movement along the supply curve is not the same as a shift in the supply curve. Shifts in the supply curve Reduction in supply: the quantity supplied decreases at any given price (the supply curve shifts to the left) Increase in supply: the quantity supplied increases at any given price (the supply curve shifts to the right)

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Factors that shift the supply curve Changes in the prices of inputs: an increase in the price of an input makes the production of the final good more expensive, therefore, producers will want to offer less of the good for each price, shifting the supply curve to the left.

Inputs = factors of production Output = what is produced

Changes in the prices of related goods and services: the quantity of one of the goods that is available for each price, depends on the prices of the other goods that it produces. The producer does more than one good. Changes in technologyBetter technology reduces production costs, shifting the supply curve to the right. Changes in expectations: an increase in the expected price of a good reduces the present supply of the good, shifting the supply curve to the left. Changes in the number of producers

3.4 Equilibrium in the market A competitive market will be in equilibrium when the quantity supplied and the quantity demanded of the good are equal. The price at which the quantity demanded and supplied are equal is called the equilibrium price. The quantity bought and sold at that price is called the equilibrium quantity. 

Balance

 Equilibriu m price

Where supply and demand equals We came to this thanks to the invisible hand

Equilibrium quantity

In an organized competitive market all sales and purchases will be made at approximately the same price. All buyers pay and all sellers receive roughly the same price: the market price. In a competitive market the market price will decrease if it is above the equilibrium price. By not selling as much as you want, sellers are driven to lower prices. The market price will move towards equilibrium. Surplus of the good.

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In a competitive market the market price will increase if it is below the equilibrium price. By not selling as much as you want, sellers are driven to lower prices. The market price will move towards equilibrium. Shortage of good.

3.5 Changes in balance In the analysis of the changes in equilibrium, we will follow the following steps:   

Identify the curve that will be affected by the event. who is affected? Identify how the curve affected by the death will be shifted (increase or decrease). How does it shift? Identify how the equilibrium will be changed by the event (changes in the equilibrium price and in the equilibrium quantity) I compare the new equilibrium with the previous one.

Shifts in demand It will affect the demand The demand curve will shift The equilibrium price and quantity will increase or decrease

Displacements in the offer

Shifts in supply and demand

Will affect the offer The supply curve will shift

TOPIC 4. THE CONSUMER AND PRODUCER SURPLUS 4.1 Introduction In competitive markets, the price adjusts to match supply and demand. But is the equilibrium quantity produced and consumed "correct" in any sense? Main conclusions: the equilibrium price in competitive markets means that there are no unrealized mutually beneficial exchanges and, therefore, society obtains the highest possible “welfare”.

4.2 Consumer Surplus and the Demand Curve What is consumer surplus? Basic concepts: 10

 

The willingness to pay for a good is the maximum price that a consumer would be willing to pay to buy it. Individual consumer surplus is the net profit that an individual consumer makes from purchasing a good.

E x c n t e c o n m i d

There can be no negative surpluses

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D i s p o s i c ió n a P a g a r

P r e c i o d e M e r c a d o

The total consumer surplus is the sum of the individual surpluses of each of the consumers who buy the good. It is equal to the area that is below the demand curve and above the market price.

4.3 Producer Surplus and the Supply Curve Basic concepts: 

There can be no negative surpluses

E t P o

The cost of a seller is the lowest price at which he would be willing to sell a good. The individual producer surplus is the net profit that an individual producer makes from selling a good.

x c e d e n e d e l r o d u c t r

P r e c io ( d e l b ie n ) d e M e r c a d o

C ( v d

o s d e e n o r

t e l d e )

The total producer surplus is the sum of the ...