ECONOMICS why study it

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ECONOMICSwhy study it?
Social Science Efficiency Scarcity
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Economics and Policy

• Positive economics (what is going on?)
• Normative economics (what should be going on?)

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efficiency

• Economic systems and fundamentals of economic
  efficiency
• What? How? And For Whom? (productive and
  allocative efficiency)
• Capitalism, Socialism, and Communism

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Frameworks of analysis within economics

• MACRO-
• Unit of analysis economy as a whole
• Variables of interest include inflation,
  unemployment, output
• MICRO-
• Unit of analysis individual economic agents
  consumers, firms
• Variables of interest include costs of
  production, individual demands, prices

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Economic cost

• Opportunity cost (just how costly is this class
  to you or to me?)
• Does the benefit of taking this class outweigh
  the cost?
• Marginal analysis

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Specialization and gains from trade

• Specialization and division of labor
• Resource composition
• Capital
• Labor
• Human capital
• Land (inclusive of natural resources)
• Production process (state of technology)
• Absolute and comparative advantage principles
• Relative cost
• Why no complete specialization?
• US trade example BEA (www.bea.gov)
• Consumer preferences
• Increasing opportunity cost (marginal cost)

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Principles of Trade

• Absolute Advantage total cost
• Comparative Advantage relative (opportunity)
  cost
• Consider two economies (A, B), each endowed with
  200 worker-hours. Consider that there are only
  two goods being produced (X, Y). Consider that in
  country A the hourly wage is A10, while in
  country B it is B20, for simplicity assume that
  AB. Table below shows costs in each country

What can be said about the absolute and
comparative advantage principles in this
case? Productivity and trade (education, physical
capital) Currency and Trade
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Should government influence our comparative
advantage? Can it do so?

• Can frequent changes in terms of trade reduce
  incentives to accumulate human capital (Can some
  of this be seen in the US economy today?)
• Asian economies of the 70s, 80s and early 90s
• Recent aid from German government to AMD

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Markets

• Defining a market
• Product definition (and competition)
• Geographical boundaries (internet, shipping cost
  reduction globalization and outsourcing)
• Market forces Buyers (demand) versus Sellers
  (supply)
• Price and quantity as the outcome

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demand

• Quantity f (price, other factors)
• Price and the Law of Demand
• Other factors
• Income (normal versus inferior)
• Related in consumption goods
• Substitutes
• Complements
• Expectations about the future
• OTHER FACTORS

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supply

• Quantity f ( price, other factors)
• Price and the Law of Supply
• Other factors
• Costs of Production (MC, and price as MB)
• Goods related in production
• Substitutes (agricultural products)
• Note, identical to costs of production since is
  based on opportunity cost concept
• Complements (like gold and silver)
• Producer expectations of future prices
• Other factors

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Market equilibrium

• Qs Qd
• Shortage and surplus as unstable states and the
  stability property of the equilibrium
• Market efficiency
• Shifts in demand and supply
• Roles of Prices
• Is the equilibrium really efficient?
• Productive and allocative efficiency

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Market example ForEx

• How can the US run a trade deficit consistently?
  Or, differently put, can one live on credit
  forever?

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• Demand for the dollar
• different economic agents that purchase the
  dollar
• Foreigners who wish to purchase US goods or
  services, foreign
• tourists who wish to travel to the US (US
  exports)
• Foreigners who wish to invest in the US (higher
  US interest rate, attractive US stock market
  returns)
• Supply of the dollar
• different economic agents that sell the dollar
• US consumers/firms that want to purchase foreign
  goods or services, US tourists who wish to travel
  abroad (US imports)
• US residents who wish to invest abroad (higher
  interest rates abroad, etc.)
• The dollar will appreciate if demand exceeds
  supply at the current exchange rate.
• Note that when you purchase a foreign made
  product, the cost of the production of that
  product is paid in foreign currency, hence
  somewhere between the production process and your
  purchase someone would have to convert your
  currency into that foreign currency in order to
  pay for the production.

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Demand and supply the USD

• US trade deficit -gt sale of USD -gtdollar
  depreciation
• US borrowing from abroad -gt purchases of USD -gt
  appreciation of the USD
• 1990s and the post 9/11framework
• US balance of payments BEA

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Who is more flexible? Elasticity of demand

• Elasticity of demand
• D(Quantity
  demanded)/D(Price)
• Elasticity as a measure of responsiveness of
  demand
• Inelastic and elastic ranges marginal revenue
• Elasticity and revenue maximization
• Comparing demands in terms of their relative
  elasticities
• What makes demand relatively less elastic?
• Gasoline here
• Health care
• Health care insurance and elasticity of demand
  (moral hazard)
• Sales Tax and elasticity of demand?
• Who really pays sales tax and why?
• Excise tax

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Elasticity long and short run

• Are our demands more flexible from the long-run
  perspective?
• Defining short and long run in economics
• Demand for gasoline
• Demand for cars (capital goods in general, like
  PCs at GSU)

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Other types of elasticity of demand

• Income elasticity of demand
• Cross price elasticities

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When Markets Fail

• Externalities (bad and good)
• Internalizing external costs through taxation
• Public goods
• Non-excludability
• Non-rivalry
• Lack of certain institutions or mechanisms
• Asymmetry of information
• Used car market
• eBay and emergence of a correcting mechanism (a
  local public good)

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Role of government in a market based economy

• INSTITUTIONS
• Just think of how many different institutions set
  up and maintained by various government levels
  make this very class possible
• Institutions at the micro and macro levels
• Property rights and well functional legal system
• Contract enforcement
• Business culture
• Negative institutions can also emerge (corruption
  is a good example)

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Consumer Behavior

• Utility function
• Assumption of rationality
• Total utility versus marginal utility
• Diminishing marginal utility
• DMU and consumption choice
• MU per dollar spent
• DMU and progressive income taxation
• What if the Law of DMU is violated?

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Productionfirms

• Assumption of profit maximization
• Do firms really maximize profits?
• Principal-agent problem and the size of the firm
• Conflict of interests and correcting mechanisms
• Stocks and options as reward to
  workers/executives
• External debt

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Production

• Production function or Total Product
• Output f (inputs, technology) TP
• Marginal Product change in output resulting
  from a change in an input
• MPL, MPK
• Diminishing Marginal Product
• Choice of the combination of inputs
• MP of input per dollar (long-run production)
• Long-run versus Short-run (assumption about
  capital, why not labor?)

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Production and costs in the short-run

• Cost of labor Wage (w)
• Cost of capital - ?
• Defining user cost of capital (r)
• Total cost of production
• TC (Q) w L r K
• Other inputs can be included (oil, land
  furthermore we assume homogeneous labor and
  capital)
• Fixed cost versus variable cost
• Sunk cost (stock price at the time of purchase)

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Costs of production in short-run

• Average costs
• ATC AVC AFC
• Marginal cost
• Change in total cost of change in output
• Marginal cost as a function of Marginal product
  of labor (in our simple case)
• diminishing marginal product and rising marginal
  cost
• AVC wage / APL
• Relationship between MC and ATC, AVC

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Profit maximization

• In equilibrium, a profit maximizing firm will
  select to produce the level of output at which
  the wage rate is equal to the value of the
  marginal product of labor, in other words the
  marginal cost of a unit of labor (wage) is equal
  to the marginal benefit of that unit of labor
  expressed as the change in total revenues.

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Production and costs in the long-run

• Full flexibility
• LRAC (to LRAC from S-R AC)
• Deriving LRAC from SR AC
• Economies of scale
• Increased specialization
• Use of indivisible inputs (trade mark)
• Constant returns to scale
• Diseconomies of scale
• Principal-agent problem and size of business
• Possible increase in input costs due to increased
  demand
• Long term cost improvements
• Technological progress
• Learning by doing

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market structure

oligopoly
mc
monopoly
Perfect competition
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Perfect competition and the internet

• Assumptions
• number of firms
• Ease of entry and exit
• Perfect information
• Identical transaction costs
• Homogeneous good
• Consequences of these assumptions
• - Competition along one dimension the price
• - Lack of collusion
• - Horizontal demand and MR price taking
  behavior
• - MC as the supply curve
• Shut down and break even price levels cost
  diagram in the short-run
• K-Mart example
• Long-run and cost structure of the industry

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Market Supply Curve

• Individual firms supply curve MC
• Recall that PMR, and profit maximization
  requires MRMC
• Market supply curve is the horizontal summation
  of individual curves

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Adjustment to a change in demand

• Industry Demand Increases
• SHORT-RUN
• Each firm expands output
• The number of firms remains the same
• Recall that changing the number of firms requires
  changes in capital stock
• LONG-RUN
• Positive economic profits attract entry number
  of firms increases

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• Entry of new firms and the impact on costs of
  production
• Does building more fast food restaurants around
  the campus change the cost of low-skilled labor?
• Does an increased demand for computer programmers
  change the cost of training a software engineer?
• Note that MC, ATC, AVC are all functions of input
  costs (if labor is the only variable input then
  MC wage/MPL, and AVC wage/APL)

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• Increasing Cost Industry
• Industry expansion rises the demand for inputs,
  and as a result the cost of those inputs
  increases, and thus the price (equilibrium) at
  which the firms earn zero economic profits also
  increases
• Diseconomies of scale in the production of inputs
• Inelastic supply of inputs
• Lack of substitutability of inputs
• Decreasing Cost Industry
• Industry expansion rises the demand for inputs,
  and as a result the cost of those inputs
  declines, and thus the price at which the firms
  earn zero economic profits decreases
• Economies of scale in the production of inputs
  (adjustments in the educational system in the
  1990 as a result of increased demand for software
  engineers)
• Constant Cost Industry
• Industry expansion does not affect input costs

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MONOPOLY

• Monopoly diagram and profit maximization
• Social costs of monopoly
• Price discrimination
• Natural monopoly

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Monopolistic Competition

• Product differentiation
• Large number of firms differentiated products
• Entry/Exit
• Diagram and equilibrium outcome

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OLIGOPOLY

• Barriers to entry and formation of oligopolies
• Strategic interdependence
• Understanding an Oligopoly
• Kinked Demand Model
• Cournot Duopoly Model
• Game Theoretical Approach

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Game Theory

• Modeling decisions as strategies in an
  interactive game
• Simultaneous move games and matrix form
• Nash Equilibrium and Best Response Strategies
• Dominant Strategies
• Sequential move games and tree form approach
• Entry deterrence game

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Monopoly, Oligopoly and Anti-trust

• Sherman Act
• Clayton Act
• http//www.usdoj.gov/atr/foia/divisionmanual/ch2.h
  tm
• Price discrimination

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Public Sector

• Government role in the economy
• Institutional support
• Provision of public goods and services
• Correction of externalities
• Economic policies (stabilization and development)

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Data for 2001, source World Bank
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How do we pay for the government?

• Taxes and user fees
• Income tax
• Sales tax
• Excise tax
• Property tax
• Value added tax
• Fiscal Federalism US example

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Taxes and Incentives

• Income tax
• Marriage neutrality
• Labor force participation
• Impact on revenues of government
• Impact on population growth
• Savings and investment (capital gains taxation
  and IRAs)