course lecture notes - week 1

8/8/2019 Course Lecture Notes - Week 1

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WEEK ONE

Instructor Lecture: Nature of Economics

Content Author: Dr. Basma Bekdache

This week we begin our introduction to the exciting world ofeconomics. By the end of this semester, you will be able to readthe daily economic news and understand what it means, how itimpacts you, and how to analyze it using the economic way of

thinking. You may even be able to make a prediction using oneor more of the economic models that you will learn in thiscourse!

The first thing we have to do before we study a new subjectmatter is to introduce its language so that we are all on thesame page. The language of economics includes several termsthat you may also encounter in other disciplines, and some thatwill be unique to economics. In this lecture, we will discuss anddefine a number of concepts, which will be used throughout thesemester and that are central to the study of economics. First

and foremost let's define what economics is all about.

What is Economics?

Economics can be defined as the study of how we allocate scarce (or limited)resources to satisfy unlimited wants. It is the study of how people make choices.

Resources are things that we use to make goods and services that people want.Examples of resources are:

Time Materials

Labor

hours Land Capital Oil

Etc.


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Why do people have to make choices?

That's right, we have to make choices because resources are limited or scarce.Think of the resource time. What kind of choices do you have to make everydayto satisfy your wants given your limited time?

In making choices people respond to incentives, which are the rewards we receivewhen we choose to engage in particular activities.

Macroeconomics and Microeconomics

We can think of economics as consisting of two major branches: Macroeconomics andMicroeconomics.

Macroeconomics (macro for short) is the study of the economy as a whole oreconomic aggregate. Can you think of examples of topics that fall under the

subject of macroeconomics?

Correct. The unemployment rate, inflation, interest rates, the governmentbudget deficit or surplus, and GDP (Gross Domestic Product) are allexamples of topics that we study in macroeconomics.

Microeconomics (micro for short) is the study of specific markets, individuals,and firms in the economy. A few examples of microeconomic topics are:

y What determines the demand and supply for cars or pizza?y How does an individual decide how much time to spend working or taking

vacation?y How does a business decide how much to produce?

We will see later as the semester progresses that often times, we need to blend Microand Macro analyses in order to answer some questions about the economy. Forexample, to understand what determines the amount of jobs available in the economy,or unemployment, we use a demand and supply model of the labor market along withan aggregate demand and aggregate supply model of the aggregate economy's level ofproduction.


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WEEK ONE

Instructor Lecture: How Do We StudyEconomics?


Economics is often described as an empirical science. This is because we useeconomic models and test them using the scientific method. However, since people'sbehaviors determine outcomes in the economy, economics cannot be analyzed as anexact science (such as physics or chemistry), therefore, we tend to describe economicsas a mix of science and art.

We have already used the term economic model. What is a model?

A model is a simplified representation of a reality.

Can you think of examples of models that you encounter in your daily life, notnecessarily related to economics?

I can think of these models: a map is a model of roads, a clock is a model of time,and a small car prototype is a model of actual size car, etc.

Notice that in some cases (e.g., clock time, map) the model does not resemble thereality. In economics, our models will take a variety of forms that don't resemble thereality. They can be graphs (see lecture on graphs), tables, equations, and prose thatdescribe relationships among economic variables.

A variable is something that can change over time. We will refer to many of theeconomic terms we use this semester as economic variables since their values may


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change from period to period. For example prices, income or the interest rate you payon your credit card are all examples of variables. An example of an economic modelfrom macro is the relationship between household spending and income. An examplefrom micro is the relationship between the price of a good and the quantity demandedand supplied for that good.

Each model is usually based on a set ofassumptions. Assumptions are things that wetake to be true for the purpose of the model we are building. For example, let's say weare trying to model the relationship between price and the quantity that people want topurchase of a good or service. We might say that when the price of pizza decreases,people will want to buy more pizzas. This statement is based on the assumption thatpeoples' preference for pizza has not changed, and that their incomes are staying thesame. In other words, when we modeled the demand for pizza, we had to make theassumption that income and tastes were held constant. This is referred to as the ceterisparebus assumption, or "other things held constant".

Why do we use models?Since the economy and its various sectors are complicated,we use models to organize thoughts and narrow problemsdown so they are manageable and easy to understand.Models are used to analyze past situations, and understandrelationships among variables. Models are also used toforecast or predict future values of economic variables.

When we are using models for forecasting, we often assumethat economic agents are rational. Rational economic agentsuse all available information to update their models beforethey make predictions. A rational economic forecast does notrepeat the same forecasting errors, as these should be takeninto account in updating the model. Bounded rationality is analternative assumption that states that people are not fully, butnearly rational since it is impossible for people to examineevery choice available and know all information applicable tomodels.

Economists often have theories about how economic variables are related. Theoriesare statements or ideas about how things should be. However, since economics is an

empirical science, theories are not taken to be true unless the models are empiricallytested and supported by real-life data. Models and the corresponding theories areuseful only to the extent that they are representative of actual data on economicvariables. Empirical economics is the application of statistical methods to the testingof economic models.

Finally, in talking about economics we distinguish between positive and normativestatements. A positive statement is one that describes "what is" and is a pure


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description of the events or situation that are being studied. A normative statement isone that introduces individuals' opinions or judgments about the situation. It is "whatought to be" rather than "what is." As you may have guessed, economics as a scienceis consistent with using positive statements to explain and describe economic models.

Please continue to the next section of the chapter by clicking on the next item inthis week's packet.

WEEK ONE

Course Lecture 1-1: Production PossibilitiesCurve (Frontier) Lecture

Content Author: Dr. David Dieterle

"The World of Trade-offs"

This section is very important to an understanding of how "trade-offs" in economicswork in the real world. As the Production Possibilities Curve (PPC) suggests, it is agraphical illustration of the trade-offs that occur, and the choices made in the productionof goods and services. A PPC helps us see what is being given up (opportunity costs)as the trade-off in the production between two different goods or services. The PPCrepresents the resource allocation for all the combinations of outputs betweentwo goods or services.

There are several assumptions that are crucial to the interpretation of A PPC. As an

essential understanding of this important theoretical concept is important, let's keep inmind a few basic assumptions.

y All resources are fully employed.y We take a static look-meaning we are looking at an economy in "a specific

moment in time"-a snapshot look.o The quantities of inputs (factors of production) are fixed for that moment in

time.


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o Technology does not change.

It is important to keep these assumptions front and center as we look at a PPC. Theseassumptions provide the basis for the PPC current ("static") state. In a moment we willsee what happens when one, or several, of the assumptions change. But first, we need

to take a look at how we can use the PPC to determine whether an economy is beingefficient or inefficient with the allocation of its resources in the output determinations fortwo goods.

The figure below provides a good example of the locations of three points relative to aPPC.What story does each one of those points tell us about the resource allocation ofthis two good economy?Well, let's take a look----

Point A: On thecurve

full production, full

use of resources

Point B: Inside thecurve

inefficient and

incomplete use ofresources

Point C: Outside thecurve

impossible to achieve

An economy fullyutilizing all of itsresources in an efficient

An economy fallingshort of full utilization ofthe resources for

To say an economy isat a point OUTSIDE thePPC (Point C) is bit


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manner will beproducing the twogoods at a point ON thePPC (Point A).Whilethe market will

determine the relativecombination betweenthe two goods, byproducing on the curve,all of the resourcesavailable to theeconomy for theproduction of the twogoods is being fullyutilized.

producing the twogoods will be reflectedat a point INSIDE thePPC (Point B). This lessthan full utilization could

be for several reasonsassociated with ourassumptions: pooreconomy, costsassociated with thefixed quantity of inputs,and less than fullyemployed resourcesincluding technology.Whatever the reason,an economy producing

the two goods inside thecurve has a significantproblem with underutilized capacity ofinputs.

tricky. It is because aneconomy cannotfunction outside thePPC, therefore Point Cis impossible. Here is

where I like the term"frontier." If you thinkabout the term frontier,it means the far reachesof ability. (i.e., frontier ofspace, frontier of theocean, historically ourwestern frontiers) Itgives us that vision ofbeing on the edge ofpossibility -

economically being a"Production PossibilitiesFrontier."

Economic Growth and PPC

Finishing up with a description of a production point OUTSIDE the Curve (Point C),leads us to a natural extension question. If Point C is impossible, given current set ofassumptions, is it possible to ever attain Point C?

And to that the answer is an emphatic YES.

As Miller states, "Over time it is possible to have more of everything." PPC can also beused to exhibit the economic growth of an economy through the changing of theassumptions; time becomes dynamic, technology changes, more resources employed,or additional inputs efficiently added and used in the production of the two goods. Thefigure below provides a good illustration of how a PPC can show the economic growthof an economy.


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So how does an economy decide which goods or services it will produce, and in whatcombinations will the inputs be used?

Comparative and Absolute Advantage

This leads us to the concepts of absolute and comparative advantage.While we aregoing to hold off on a more elaborate discussion of these for later in the course, let'sexplore for the moment at least their definitions, and how they relate to our currentdiscussion of the PPC. In a common sense sort of way, absolute advantage plainly is,"I can do something better than you" - period. Economically speaking, it just means Ican produce more outputs with the same inputs, or produce the same outputs withfewer inputs.

With comparative advantage the rubber meets the road. With comparative advantageyou might hear, "I can do something with fewer opportunity costs than others." (i.e.,comparatively) Comparative advantage focuses on the more efficient allocation of

inputs relative to the opportunity costs associated with how others allocate comparableinputs. By focusing on our comparative advantages, for example, reducing ouropportunity costs, an economy becomes more efficient.

These concepts become especially applicable when discussing trade and the globaleconomy. That is why we will be returning to them when we discuss global trade andglobalization.


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Specialization, Division of Labor, and Interdependence

The final concepts I want to present in this chapter are: specialization, division oflabor, and interdependence. These three concepts are very much related to eachother. For an economy to implement division of labor principles, the workers involved in

the economy will specialize in the production of a specific good or service. Thisspecialization by each worker means we are now interdependent with the other workersto obtain all the goods and services we choose to possess or implement.

Please watch the following 3 minute presentation.

WEEK ONE

Instructor Lecture: More on OpportunityCost


In this lecture we revisit the concepts of scarcity and opportunity cost and learn how tocompute opportunity cost in various scenarios.We will also discuss the law ofincreasing cost, which explains the shape of the Production Possibilities Curve (PPC).Finally, we will use the PPC to illustrate the choices a society makes today regarding itsproduction of consumer and capital goods and discuss its implications on futureeconomic growth.

Recall from the previous lectures, that resources, also called Factors of Productionare things that we use to produce goods and services that the society wants. Factors ofproduction generally fall into one of the following categories (more on this subject inweek 7):

Labor:

The human resource.Usually, the number ofhours worked forproduction.

Capital:

The amount of physicalcapital-plants,machines, equipment tobe used in production

Human capital:

The level ofeducation andtraining of thelabor input.

Technology:

The society's levelcombined ofknowledge.


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Since resources are scarce, there is an opportunity cost associated with using ourresources. Do you recall what we mean by scarcity?

Right, scarcity is the fact that resources are limited and are insufficient toproduce everything to satisfy the unlimited wants of society.

Since resources are scarce, when we choose to use a resource to produce good X, weare giving up the option to use the same resource for the production of another good Y.The value of good Y that could have been produced is the opportunity cost of thechoice we made to produce good X. In general, we can say that:

Opportunity cost is the highest valued, next best available alternative that must begiven up to obtain something or satisfy a want.

Let's consider a couple of examples. Suppose it takes you one hour to cut your grass. Inthe same hour you can cook one meal and do a load of laundry.What is the opportunity

cost of cutting your grass?

Correct, the opportunity cost of cutting your grass is one meal and one load oflaundry because that is what you give up if you decide to spend your time cuttinggrass.

Suppose that your hourly wage is $20/hour. You have a choice to pursue a collegedegree but classes are only offered during the day when you can be working. If theclass takes up two hours a day, what is your the opportunity cost (per day) of makingthe choice to take the class, everything else held constant?

You got it. The opportunity cost of taking the class is $40.

Think about how your answer would change if you can take classes after work.Whatwould be the opportunity cost of taking the class then?

The concept of opportunity cost is very important to economic analysis. You will see asthe semester progresses that it applies to almost everything we study, from the decisionof an individuals of how much to decision to consumer or save to a firm's decision ofhow much to spend on capital good s to be used for production.We will discuss moreapplications later, but for now let's review the PPC.

Law of Increasing Opportunity CostLet's return to the example of digital cameras and pocket PCs that you considered in thelast lecture to illustrate the PPC. In panel (a ) we can see the production possibilitiesthat are plotted in panel (b). The fact that the PPC is downward sloping shows that thereis a tradeoff or opportunity cost which occurs due to scarcity. If we want to producemore pocket PC's (as in moving from combination B to C) we have to give up someproduction of digital cameras.


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(Reprinted from Roger LeRoy Miller, Economics Today, 14th edition)

Specifically, looking at the table or the graph, what is the opportunity cost of producingthe first 10 pocket PCs (going from 0 to 10)? What about the next 10 PCs (going from10 to 20), and the next 10 etc? What is happening to the opportunity cost of producingpocket PCs as we produce more and more pocket PC's?

The opportunity cost of the first 10 PC's is 2 digital cameras (50-48); the next 10 is3 digital cameras (48-45); the next 10 is 5 digital cameras (45-40) etc. Theopportunity cost of producing more and more PCs, as measured by how manydigital cameras we have to give up producing, is increasing as we produce moreand more PCs. This is called the Law of increasing costs.

The law of increasing costs refers to the fact that the more we produce of a good, theopportunity cost of that good generally increases. It is the reason why the PPC is bowedout (decreasing slope) as illustrated in the graph below.


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(Reprinted from Roger Le Roy Miller, Economics Today, 14th edition)

Why does this happen?Using the goods in this example, as we produce more and more PC's, we have to useto resources that were specialized in producing digital cameras and adapt them to theproduction of PC's. This raise the opportunity cost of producing PC's. If resources areeasily adaptable to the production of any good, then the PPC will be less bowed out.The more specialized the resources, the more bowed out the PPC (reflecting greaterincrease in opportunity costs).


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WEEK ONE

Instructor Lecture: More on Saving andEconomic Growth


This section illustrates the role of saving in economic growth. Consider the PPC for anexample where the society has to choose to produce from one of two categories ofgoods: consumer goods and capital goods. Consumer goods are goods produced for

personal satisfaction while capital goods are goods that are used to produce othergoods.

If a society produces more capital goods today, it will have more capital available forproduction in the future, which implies it can produce more of everything in the future.We called this economic growth and it is shown as a shift to the right in the PPC.


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We can see that if we choose to consume less today (or save) as in point C (andcompared to points A or point B), we can achieve greater economic growth since bychoosing more capital goods today, the capital stock will increase, allowing us toproduce more in the future.

WEEK ONE

Instructor Lecture: More on ComparativeAdvantage and Specialization


Earlier in this week, we defined comparative advantage as being the ability to producea good or a service at lower opportunity cost. Let's see if we can apply this conceptto decide how one should spend their resources. Let's consider a simple example.


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Suppose...

Who has the comparative advantage in the production of chairs?

To answer this question, we have to calculate and compare the opportunity cost of

producing a chair for both Bob and Ted individually.

To produce one chair, Bob has to give up the production a quarter of a table, which iswhat Ted can produce in 1 hour if he does not make the chair. For Ted, making onechair means giving up making two-thirds of a table. Who has the comparativeadvantage in making chairs?

Suppose that Bob can make either four chairs or one table in an hour and Ted canmake either three chairs or two tables in an hour.

Who has the comparative advantage in the production of chairs?

Correct. Since Bob has the lower opportunity cost (2/3 > 1/4), he has thecomparative advantage in making chairs.

Using similar reasoning we can show that Ted has the comparative advantage inproducing tables.

So why do we care about who has the comparative advantage?


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We do because we can show that if someone (or nations) specialize in the production ofthe good in which they have a comparative advantage, total production will be greaterwhich benefits everyone.

Using the same example, let's compare the total number of

chairs and tables produced in one hour if Bob and Ted specialize(i.e. they produce only the good in which they have acomparative advantage) to the total production when Bob andTed split their time between the production of chairs and tables(e.g. if they do not specialize). Let's assume they each spend ahalf hour on each good.

In the case of specialization:

TOTAL PRODUCTION IS: 4 chairs, 2 tables.In one hour Bob produces 4 chairs and Ted produces 2 tables.

In the case of no specialization:

In a half hour, Bob can produce 2 chairs.In the second half hour, Bob can produce table.

In a half hour, Ted can produce 1.5 chairs.In the second half hour Ted can produce 1 table.

TOTAL PRODUCTION IS: 3.5 chairs and 1.5 tables.

This is less than the production that can be attained if theyspecialize which is 4 chair and 2 tables.

The concept ofcomparative advantage is applicable to trade between nations.When nations specialize in their comparative advantage and trade with the rest of theworld, economic output increases leading to a higher average standard of living.

WEEK ONE

Course Lecture 1-2: Consumer Choice

Content Author: Dr. David Dieterle


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There are four critical concepts you will need to become familiar with for futurediscussions:

1. Utility2. Marginal analysis

3. Diminishing marginal utility4. The difference between total and marginal

While "utility" is the term used in economics to define a consumers satisfaction, tomeasure this utility it is important to understand the difference between whateconomists mean by the term, "marginal", and "marginal analysis".

When economists study human behavior, they are most concerned with what happensto the utility, or production (producer side which we will discuss later), when one moreunit is consumed (or produced). Therefore, the economists view of human action is tostudy the results of adding one more unit; marginal analysis. Economists are always

interested in what happens "at the margin" (adding one more unit). Marginal utility canbe calculated by dividing the change in total utility by the change in number of unitsconsumed. The key to understanding marginal analysis is that we are studying behavioror production changes with the addition of ONE ADDITIONAL UNIT. Contrary to"normal" thinking, total utility is irrelevant in marginal analysis. We will look at therelationship between marginal and average later on.

The last major concept of this chapter is diminishing marginalutility (DMU). Take your time with this concept. DMU is theidea that as utility increases with the continued consumption ofa good, a point will be reached when the utility of the additional

unit will be less then the one before it. For most of us, a goodexample of this is eating pizza. The first piece of pizza goesdown well, tastes great, and satisfies completely. So we haveanother. Again, complete total satisfaction. So we have a third.Now, suddenly, we eat it a little slower, the taste not have thezip it did with the first two, and our satisfaction level is less. Itcan be said the third piece was where we reached DMU; thetotal climbs, but we have reached maximum satisfaction. Even

if we go on and eat three more pieces, for a total of six!

Conclude your initial introduction to marginal analysis and DMU with a review of DMUand the diamond-water paradox of Adam Smith.

WEEK ONE


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Course Lecture 1-3: Interpreting Graphs

Content Author: Dr. LindaWiechowski

Please watch and listen to the following 7 minute VoiceOver PowerPoint for adiscussion of graphs. You will learn how to plot points on a graph, how to calculate theslope of a line, as well as create a formula for the line.

For a printable version of this powerpoint, click Here.

You have two examples that you can work through. Both of the examples show youstep-by-step how to solve for the equation of a line.


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Four more practice problems are shown that you can try. Only the answer is given forthese problems. You will need to work through the problems using the same steps asthe previous sample problems.


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course lecture notes - week 1

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