Lecture 1 Introduction & Basics of Economics
Given to theGiven to theEMBA 8400 ClassEMBA 8400 Class
Classroom South #600Classroom South #600January 5, 2007January 5, 2007
Dr. Rajeev DhawanDr. Rajeev DhawanDirectorDirector
Course Objective & Teaching Philosophy
Practical Course to Comprehend the Economic Environment so that Managers can make their Decisions
Philosophy is that Micro Sectors Add Up to a Macro Environment
Optimal Blend of Economics and Real World Experience/Common Sense
Train You to Critically Evaluate and Interpret Business Press Writings
Course Layout First 2 Weeks - Basic Micro Economic
Concepts Weeks 3&4 - Macro Basics and Basic
Workings of an Economy with the Help of a “Basic” Macromodel (weeks 5-7) that can Perform Real-Life Fiscal And Monetary Experiments
Mandatory Field Trip to the Economic Forecasting Conference on Feb. 22nd
Wrap up with Model Training, Special Topics and Project Presentations
Background Articles
My Economics Why Journalists Can't Add Where Presidents Have No Power Their Money Our Strength How to Stop Relatives from Bragging About
their Big Profits in Real Estate
Grading Policy
60% 3 Quizzes in Class20% Group Presentations on a
Selected Industry20% Take Home Final Exam
–Macroeconomic Model Exercise
–Based on Field Trip
Group PresentationsThe objectives of this group project are :
1. To help you bridge the gap between the economic theory and
models discussed in class and the “real world”
2. To confront the problems of trying to find data which are
appropriate for the questions under consideration and to deal
with the problems of incomplete information
3. To showcase your oral and written communication skills
4. To identify how the problems faced and the decisions made by
other firms are similar to your own.
Suggested Industries1. Wireless Communication
2. Networking & Security Systems
3. Oil Industry
4. Healthcare Industry
5. Hospitality Industry
6. Paper & Pulp Industry
7. Utility & Power Industry
8. Consumer Products
9. Insurance
10. REIT (Real Estate Investment Trust)
Macro Framework
Households: Consume & WorkFirms: Production & InvestmentGovernment: Money Supply,
Taxes, ExpendituresForeign Sector: Exports,
Imports & Exchange Rate
Macroeconomic Model For Teaching
Section 1: A Model Simulation Approach to Macroeconomics Section 2: Classification of Equations Section 3: Glossary of Variables Section 4: Listing of Equations in the Integrated Macro Model Section 5: Flow Diagram of Integrated Macro Model Section 6: Policy Experiments with Integrated Macro Model Section 7: Guidelines to Use the Model
Variable Meaning Units
C Consumption Billions of $
EX Exports Billions of $
EXCH Exchange Rate Index
G Government Purchases Billions of $
GDP Gross Domestic Product Billions of $
GDP@FULL
GDP @ Full Employment Billions of $
GDP@ROW
GDP in Rest of the World Billions of $
I Investment Billions of $
IM Imports Billions of $
M Money supply Billions of $
NETEX Net Exports Billions of $
P Price Level Index
P% Inflation Percent
P@ROW Price Level, Rest of the World Index
R Real Interest Rate Percent
R@ROW Real Interest Rate, Rest of the World Percent
T Tax Revenues Billions of $
TAX% Tax Rate Fraction
YDP Disposable Income Billions of $
GLOSSARY OF VARIABLES
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
money
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~Typical Macro-ModelTypical Macro-Model~~
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~Typical Macro-ModelTypical Macro-Model~~
money
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~Typical Macro-ModelTypical Macro-Model~~
money
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~Typical Macro-ModelTypical Macro-Model~~
money
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~”New Economy” Macro-Model”New Economy” Macro-Model~~
money
Tech/ProfitOpportunities
STOCK MARKET
CONSUMPTION
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~”New Economy” Macro-Model”New Economy” Macro-Model~~
money
Tech/ProfitOpportunities
EUPHORIA
STOCK MARKET
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~”New Economy” Macro-Model”New Economy” Macro-Model~~
money
Tech/ProfitOpportunities
EUPHORIA
STOCK MARKET
EUPHORIA
world interest
rateworld GDP
IMPORTS
price level lag 1
worldprice
government
tax rate
capital stock lag 1
EXCHANGE RATE
INTEREST RATE
INVESTMENT
TAX REVENUES
investmentlag 1
EXPORTS
NETEXPORTS
REAL GDP
CONSUMPTION
DISPOSABLE INCOME
CAPITAL STOCK
inflationlag 1
PRICE LEVEL
INFLATION
EXPECTED INFLATION
UNEMPLOYMENT
POTENTIAL GDP
labor force
~~””New Economy” Macro-ModelNew Economy” Macro-Model~~
money
Tech/ProfitOpportunities
STOCK MARKET
EUPHORIA
Field Trip to the Forecasting
Center’s Quarterly Forecast Conference on Feb. 21nd!
The Economic Forecasting Center at Georgia State University collects and analyzes macroeconomic data and develops procedures to forecast the national, regional and local economies.
What Products Do We Offer?The Center offers:
–Forecast ReportsGeorgia and Atlanta (Quarterly)Nation (Quarterly)Southeast Indicators (Bi-Annual)
–Quarterly Conferences– Sponsorships– Custom Consulting Services
Quarterly Conferences
Consortium of GSU Experts and the Business Executives
My Forecast! 4 Industry Speakers Forecast Reports Networking Breakfast, at
Break and at Lunch
How to Attend Our Conferences?How to Attend Our Conferences?
It Costs Money! $150 per Person Institutional Discounts Available.
BUT MY STUDENTS ARE IN FOR FREE!Check Our Website for Latest Program:
www.robinson.gsu.edu/efc
Introduction
The 10 Principles of Economics
What is Economics? Economics is the study of how we use our scarce
productive resources for consumption, now or in future.– Paul Samuelson
Resources are scarce:– Society has limited resources and therefore cannot
produce all the goods and services people wish to have
– Example: clean air & water
– Scarcity is not poverty
Basic Questions
What to produce in what quantity? How to produce them? When and where to produce? For whom? Who makes economic decisions and by
what process?
Basic Concepts
Opportunity Cost: Things are Scarce
– Next Best Alternative Ex: Party on Friday night vs. study for examsEx: Party on Friday night vs. study for exams
– Cost of Time Ex: 1 hour wait time at the dentistEx: 1 hour wait time at the dentist
Basic Concepts Marginal Concept: At the Margin
Shot SatisfactionMarginal
Satisfaction1 50
202 70
103 80
54 85
15 86
06 86
Shots of Wild Turkey
Utility: Level of Satisfaction (here, drunkenness)
Basic Concepts
Sunk/Fixed Costs: Expenditures Made that Cannot be Recovered– Example:
You bought a computer laptop for $1500 A newer, upgraded model costs $1200 The dealer will accept a trade in + $400 What do you do?
10 Principles of Economics1. People face tradeoffs :
• “No such thing as free lunch”• Give up one thing to get another –
Opportunity Cost (OC)2. Everything has an OC – whatever must be given
up to get that item3. People make decisions at the margins –
increments matter4. People respond to incentives – e.g. cigarette
laws, communism5. Free Trade is good (for everybody)
10 Principles of Economics6. Markets organize economic activity
- Adam Smith “Invisible Hand”
7. Governments can sometimes improve market outcome
8. A country’s standard of living depends upon its production power (productivity)
9. Prices rise when government prints too much money
10. Phillips curve – short run tradeoff between inflation and unemployment
Branches of Economics
Micro: The Study of One Entity (firm, business, people)
Macro: The Study of a Collection of Things (national, aggregate)
How are Theories Developed?
Decision-Makers– Firms, governments
Markets– Place where exchange takes place
Winnick’s Voyage to the Bottom of the Sea WSJ; by Andy Kessler
First Mover, FCC regulated + fixed costsRegulated utilityPrice protection
You can’t lose Traffic / use was of low economic value or
cashlessGlobal Crossing couldn't cut prices without running
the risk of either failing to cover its debt or being unable to raise more capital
Accounting Tricks…….
Who REALLY Owns that WineryTIME Magazine; by Terry McCarthy
Consolidation is the Norm 60% of U.S. wine is produced by the top five
companies– Consolidation among distributors is squeezing out the
medium-sized producers, who make from 100,000 to 1 million cases a year
Market is not growing– Only 10% of adults drink 86% of the wine
Fixed Costs– Some wineries do not have enough volume to get a
priority from distributors
Reshuffling to scarce resources– He can make lots of money just by shifting more of his
production - and more of his customers – from 1.5L jugs of generic red that sell for less than $5 retail to smaller bottles of $7 Merlot
The Future– The higher end is where the profits and the growth are to
be found– The Italians have figured it out – how to create tastes
that suit the American palate
Who REALLY Owns that Winery TIME Magazine; by Terry McCarthy
Chapter 3
Comparative Advantage & Trade
Positive vs. Normative Economics
Positive :– Descriptive statement ( is, was)– Refer to data– Examples of positive statements:
GDP in the U.S. economy was about $7 trillion last year The New York City rent control laws have created a shortage
of housing in the city Normative:
– Value judgment (ought to be, shall, will)– Examples of normative statements:
Higher interest rates would be good for the U.S. economy in the next six months
The U.S. government should be required to balance its budget every year
The classic tale of the farmer and the rancher…or a better example if you have one.
What should each produce? Why should they trade?
Production Possibilities Frontier
Potatoes (ounces)
4
16
8
32
A
0
Meat (ounces)
(a) The Farmer’s Production Possibilities Frontier
If there is no trade, the farmer chooses this production and consumption.
Production Possibilities Frontier
FARMER:32 oz. of Potatoes in 8 hours8 oz. of Meat in 8 hours
Potatoes (ounces)
12
24
B
0
Meat (ounces)
(b) The Rancher’s Production Possibilities Frontier
48
24 If there is no trade, the rancher chooses this production and consumption.
Production Possibilities Frontier
RANCHER:48 oz. of Potatoes in 8 hours24 oz. of Meat in 8 hour
Trade Example
Without trade:
““Farmer, my friend, have I got a deal for you! I know Farmer, my friend, have I got a deal for you! I know how to improve life for both of us. I think you should how to improve life for both of us. I think you should stop producing meat altogether and devote all your stop producing meat altogether and devote all your
time to growing potatoes. According to my time to growing potatoes. According to my calculations, if you work 8 hours a day growing calculations, if you work 8 hours a day growing potatoes, you’ll produce 32 ounces of potatoes. potatoes, you’ll produce 32 ounces of potatoes.
Specialization & Trade
If you give me 15 of those 32 ounces, I’ll give you 5 If you give me 15 of those 32 ounces, I’ll give you 5 ounces of meat in return. In the end, you’ll get to eat ounces of meat in return. In the end, you’ll get to eat 17 ounces of potatoes and 5 ounces of meat every 17 ounces of potatoes and 5 ounces of meat every week, instead of the 16 ounces of potatoes and 4 week, instead of the 16 ounces of potatoes and 4
ounces of meat you now get. If you go along with my ounces of meat you now get. If you go along with my plan, you’ll have more of both foods.”plan, you’ll have more of both foods.”
How Trade Increases Consumption
Potatoes (ounces)
4
16
5
17
8
32
A
A*
0
Meat (ounces)
(a) The Farmer ’s Production and Consumption
Farmer's production & consumption without trade
Farmer's consumption with trade
Farmer's production with trade
How Trade Increases Consumption
Potatoes (ounces)
12
24
13
27
B
0
Meat (ounces)
(b) The Rancher ’s Production and Consumption
48
24
12
18
B*
Rancher's consumption with trade
Rancher's production with trade
Rancher's production and consumption without trade
Example Continued..
With trade:
Trade According to Comparative Advantage (CA) or Opportunity Cost (OC)
CA is OC of two products – whatever must be given up to obtain a product
The producer who has the smaller OC of producing a good has a CA in producing that good
– Rancher has CA in producing meat
– Farmer has CA in producing potatoes
Absolute Advantage: Rancher beats the farmer in producing both meat and potatoes
Let’s Calculate OC(Meat in terms of Potatoes)
Benefits of Trade
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.
Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.
Better Answer to Tough Questions WSJ; by David Wessel
“What do you say to someone…who has lost his job to someone overseas who’s being paid a fraction of what that job paid here?”
Those of us who benefit from low-cost imports – or who have well-paid export jobs that wouldn’t exist if we don’t allow imports and outsourcing – must not ask those who lose jobs to go it alone.
If trade and technology make us richer, then we can afford to help pay for health insurance and protect pensions forced to bear the cost.
Better Answer to Tough Questions WSJ; by David Wessel
That means pushing China and others to stop bending trade rules or manipulating currencies and pressing Europe and Japan to get their people spending so the U.S. Isn’t always the consumer of last resort. It means setting U.S. taxes so they cover government spending at least in good times, rewriting perverse tax laws that encourage companies to invest elsewhere and managing the unquenchable American thirst for health care without giving employers new excuses.
Discuss: wage insurance and role of education
Economic Focus – Trade Disputes (p.7)
Suppose the poor country, spurred by technical progress, improves productivity in the rich country’s export goods: think of China’s advances in semiconductors or India’s in financial services/ Then, says the theory, trade can turn entirely to the poor country's advantage. The improvement in productivity in the poor country can reduce the price of the rich country’s exports by enough to make it worse off, despite the increased availability or cheaper goods.
Europeans worried about American growth in the 1950’s for this reason, and Americans later worried about Japan.
Move of textile manufacturing to the American South may have caused net losses in the North. OR that Malaysia’s leap in rubber production may have had the same effect on Brazil . Might the new wave of outsourcing to poor countries be different, and make rich countries poorer?
Forrester Research claims that 3.4 million jobs will be outsourced by 2015, but considering that the American economy destroys 30 million jobs EACH YEAR and then creates slightly more, this dwarfs the effect of outsourcing.
Chapter 4
Demand & Supply
Some Basic Definitions
Market: a group of buyers and sellers of a particular good or service– E.g. Warren Buffet has been buying up junk
bonds– E.g. Bars, parties – informal market
Stock market – organized market
Example of Supply & Demand Hong Kong chicken flu scare? Price of chicken
Mad cow disease in US? Price of beef
Oprah bad mouths beef? Price of beef – Amarillo farmers sue her.
SARS? (Macro issue…)
DemandQuantity demanded (Q): the amount of a good that buyers are willing and able to purchase at a given price (P).
Pints of BeerPints of Beer
P QD
$10.00 07.00 15.00 34.00 62.00 110.00 19
Demand for Beer
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
0 5 10 15 20Quantity (Pints)
Pri
ce
Market Demand versus Individual Demand
Market demand refers to the sum of all individual demands for a particular good or service.
Graphically, individual demand curves are summed horizontally to obtain the market demand curve.
The Market Demand Curve
Price of Beers
Price of Beers
Price of Beers
5.00 5.00 5.00
3 4 7
4.00 4.004.00
6 7 13
Quantity of Beers Quantity of Beers Quantity of Beers
Catherine’s Demand Nicholas’s Demand Market Demand+ =
When the price is $5.00, Catherine will demand 3 beers.
When the price is $5.00, Nicholas will demand 4 beers.
The market demand at $5.00 will be 7 beers.
When the price is $4.00, Catherine will demand 6 beers.
When the price is $4.00, Nicholas will demand 7 beers.
The market demand at $4.00, will be 13 beers.
The market demand curve is the horizontal sum of the individual demand curves!
Graph Results
Demand curve/schedule is downward sloping and shows the relationship between price of a good and the quantity demanded
Why downward sloping?– Law of demand: Ceteris Paribus (all other
things being equal) the quantity demanded falls when price rises
Other Determinants of Demand
Income (I) :– I , D Normal Goods: car, Ferrari– I , D Inferior goods: bus rides, potatoes
Price of related goods– Substitutes (inversely correlated)– Compliments (directly correlated)
Other Determinants of Demand
Tastes – taken as above– You get old and prefer Lincoln Town cars to sports cars
Expectations – about future– Income potential with EMBA degree – Loss of jobs, layoffs prospects
Market Demand – More players Increase in demand
– Buy IPO’s in 90’s
Shifts in Demand Curve
Variables that shift the demand curve:
Shifts in the Demand CurvePrice of
Beer
Quantity ofBeer
Increasein demand
Decreasein demand
Demand curve, D3
Demandcurve, D1
Demandcurve, D2
0
SupplyQuantity supplied (Q): the amount of a good that sellers are willing and able to sell at a given price (P).
Pints of BeerPints of Beer
P QS
$10.00 127.00 75.00 44.00 32.00 10.00 0
Supply of Beer - Neighbors
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
0 2 4 6 8 10 12Quantity (Pints)
Pri
ce
Supply
Supply graph for another bar
Supply of Beer - Hand in Hand
$0.00$1.00$2.00$3.00$4.00$5.00$6.00$7.00$8.00$9.00
$10.00
0 2 4 6 8 10 12Quantity (Pints)
Pri
ce Pints of BeerPints of Beer
P QS
$10.00 87.00 55.00 44.00 32.00 10.00 0
Determinants of Supply
Your own Price Input Prices
– Cost of bottle of beer: labor, capital, rent
Technology – Smoking laws separation of smoking &
drinking
Expectations– Future outlook
Shifts in The Supply Curve
Variables that shift the supply curve:
Shifts In Supply CurvePrice of
Beer
Quantity ofBeer0
Increasein supply
Decreasein supply
Supply curve, S3
curve, Supply
S1Supply
curve, S2
Equilibrium
Equilibrium: the price where quantity supplied is equal to quantity demanded
Market for Beer
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
0 5 10 15 20Quantity (Pints)
Pri
ce
Equilibrium
6
Markets Not In Equilibrium
Price ofBeer
0
Supply
Demand
Excess Supply
Quantitydemanded
Quantitysupplied
Surplus
Quantity ofBeer
2
$6.50
10
4.00
6
Markets Not In EquilibriumPrice of
0
Supply
Demand
Excess Demand
Quantity ofBeer
Beer
0Quantitysupplied
Quantitydemanded
2.50
10
$4.00
62
Shortage
Changes in Equilibrium Decide whether the event shifts the supply or demand
curve (or both). Decide whether the curve(s) shift(s) to the left or to the
right. Use the supply-and-demand diagram to see how the shift
affects equilibrium price and quantity.
Changes in Equilibrium
Price ofBeer
0 Pints of Beer
Supply
Initialequilibrium
An increase in wealth
increases demand for beer
0
Demand
Newequilibrium
Initial equilibrium
S1
S2
An increase in the
price of hops reduces
the supply of beer
4.00
6
$6.50
2
D1
Price ofBeer
D2
Pints of Beer
4.00
6
New equilibrium
$6.50
10
Market for Beer
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
0 5 10 15 20Quantity (Pints)
Pri
ce
S2
S1
One bar closes…New
Equilibrium
4
$5.00
Market and Federal Govt. have given energy customers enough incentives to use natural gas. But, Oil and Gas Industry has got little encouragement to produce more.
Fed’s efforts to promote clean air and US energy independence meant surge in demand of Natural Gas.
Increase in oil prices has curtailed oil and gas exploration. Thus, there has been an increase in imports of natural gas, mainly from Canada. Net result is prices go from $2.17 to $8 per million BTUs
– Nation’s record long economic expansion – accompanying surge in energy consumption
– Cold winter weather over much of US (2001)
Article: Federal Policies, Industry Shifts Produced Natural-Gas Crunch WSJ; by: Barrionuevo, Fialka, Smith
Federal govt. ordered the pipeline companies to become “open access” carriers. The move lowered the prices, which was a boon to the customers but a nightmare for the producers
Marketers emerged as a new breed of middlemen that took more profits without boosting gas production. As a result of narrow margins, some producers were forced to close and others to consolidate.
– Seasonal Relief– Crackdown on Coal– Bankers Balk
Drilling for natural gas exploration, prohibited by federal agencies.
Alaskan producers pushing for a pipeline to continental US, but it will take another decade for that to materialize.
Article: Federal Policies, Industry Shifts Produced Natural-Gas Crunch WSJ; by: Alexi Barrionuevo, Fialka, Smith