ECW 1101 INTRODUCTORY MICROECONOMICS
ECW1101
Assessment Assignment 1 = 5% Assignment 2 = 10% Multiple Choice test = 15% Examination = 70% due Monday 8th August 2011 due Monday 12th September 2011 conducted during week 7 (Week commencing 5th September 2011)
To pass this unit, achieve at least 50% overall and 40% on the final examination.
ECW1101
Prescribed unit materials Gans, King, Stonecash and Mankiw, (2009) Principles of Economics, 4th edn, Cengage Learning Australia Tennant and Hakes, (2009) Principles of Microeconomics 4th edn Study Guide, Cengage Learning Australia
Weekly topic program
Week 1 What is economics?
Week 2
The theory and application of demand and supply.
Consumer Behaviour: Elasticity and its applications
Week 3
Week 4
Government policy and economic incentives
Weekly topic program
Week 5 Markets and welfare
Week 6
Week 7
Economics of the public sector
Output and costs:
Multiple Choice Test
Week 8 The competitive market
Weekly topic program
Week 9 Week 10 Week 11 Week 12
Monopoly Oligopoly and Competition Policy Monopolistic Competition Linking it all together
Week one - Study Guide exercises
Tennant and Hakes, Study Guide (2009) (Available online via the Weekly Learning Guide section of the Blackboard site for each week.) Chapter1: Chapter 2: Chapter 3:
ECW1101 Week 1 What is economics?
Chapter 1: Ten lessons from economics Chapter 2: Thinking like an economist Chapter 3: Interdependence and the gains from trade
ECW1101 - Lecture Week 1
Week one Learning objectives
On completing week 1 you will be able to: explain how people make decisions demonstrate the relationship between scarcity, choice and opportunity cost differentiate between microeconomics and macroeconomics distinguish between positive and normative statements demonstrate how the relationship between economic variables can be illustrated using diagrams use the production possibility frontier to explain the importance of comparative advantage to specialisation and trade.
ECW1101 - Lecture Week 1
Week one - Reading
Gans, et.al., (2009) Chapter 1 Ten lessons from economics Chapter 2 Thinking like an economist Chapter 3 Interdependence and the gains from trade
Your note taking from each chapter should focus on making sure you have an understanding of the weekly learning objectives. Make sure you review the learning objectives and comments for each weeks work look on the MUSO site under Guide to Learning icon on the home page. This will help you structure your note taking.
ECW1101 - Lecture Week 1
Chapter 1
Ten lessons from economics
ECW1101 - Lecture Week 1
Economy
What do we mean by the word economy A household as an example of economy Who will work? What goods and how many of them should be produced? What resources should be used? Society and scarce resources Scarcity means that society has limited resources and therefore cannot produce all the goods and services people want.
ECW1101 - Lecture Week 1
Economics
Economics is the study of how society manages its scarce resources.
How then can the scarce resources be allocated to satisfy unlimited wants in a manner that will create the most benefit to society Central planning versus market forces?
ECW1101 - Lecture Week 1
Ten lessons from economics
1. People face trade-offs. 2. The cost of something is what you give up to get it. 3. Rational people think at the margin. 4. People respond to incentives.
5. Trade can make everyone better off. 6. Markets are usually a good way to organise economic activity. 7. Governments can sometimes improve market outcomes. 8. A countrys standard of living depends on its ability to produce goods and services. 9. Prices rise when the government prints too much money. 10. Society faces a short-term trade-off between inflation and unemployment.
How people make decisions
How people interact with each other
How the economy as a whole works
Lesson 1: People face trade-offs
There is no such thing as a free lunch!! To get one thing, we usually have to give up another thing.
Individuals
clothing vs. holidays leisure time vs. work
Society
guns vs. butter clean environment vs. income
Efficiency vs. Equity
ECW1101 - Lecture Week 1
Lesson 2: The cost of something is what you give up to get it
Decisions require comparing costs and benefits of alternatives.
Whether to go to university or to work? Whether to study or go to the movies? Whether to go to lectures or sleep in?
The opportunity cost of an item is what you give up to obtain that item.
ECW1101 - Lecture Week 1
Lesson 3: Rational people think at the margin
Marginal changes are small incremental adjustments to an existing plan of action (Gans et al. (2009), p. 5). People make decisions by comparing costs and benefits at the margin. Example: What is the cost of undertaking the next additional action e.g.. Studying for one more hour for your exam (marginal cost) compared to the benefit from studying for that additional hour (marginal benefit)? A decision is rational if the marginal benefit is equal to or exceeds the marginal cost
ECW1101 - Lecture Week 1
Lesson 4: People respond to incentives The decision to choose one alternative over another occurs when that alternatives marginal benefits exceed its marginal costs. Incentives alter the marginal benefit/marginal cost of an action. Hence incentives alter the choices we make.
Example:
I include one additional benefit of studying for the exam 1 million dollars
ECW1101 - Lecture Week 1
Lesson 5: Trade can make everyone better off
People gain from their ability to trade with one another. Competition results in gains from trading. Trade allows people to specialise in what they do best.
ECW1101 - Lecture Week 1
Lesson 6: Markets are usually a good way to organise economic activity
A market economy is an economy that allocates resources through the decentralised decisions of many firms and households as they interact in markets for goods and services (Gans et al. (2009), p. 9).
Firms decide who to hire and what to produce. Households decide what to buy and who to work for.
There are other types of economies planned or central economies, however this unit focuses on the operation of a market economy.
ECW1101 - Lecture Week 1
Lesson 7: Governments can sometimes improve market outcomes
Market failure occurs when the market fails to allocate resources efficiently. Market failure may be caused by:
An externality, which is the impact of one person or firms actions on the wellbeing of a bystander. Market power, which is the ability of a single person or firm to have a substantial influence on market prices.
In case of market failure government can intervene to promote efficiency and equity.
ECW1101 - Lecture Week 1
Lesson 8: The standard of living depends on a countrys production
A countrys standard of living may be measured in different ways:
By comparing personal incomes. By comparing the total market value of a nations production.
Large differences exist in living standards:
The average Australian in 2007 had an annual income of $36 553 ($US). South Koreans had an average of $18 392 ($US). Indians had an average of $797.
Almost all variations in living standards are explained by differences in countries productivity. Productivity is the amount of goods and services produced from each hour of a workers time.
ECW1101 - Lecture Week 1
Lesson 9: Prices rise when the Government prints too much money
Inflation is an increase in the overall level of prices in the economy. One cause of inflation is the growth in the quantity of money. When the government creates large quantities of money, the value of the money falls.
ECW1101 - Lecture Week 1
Lesson 10: Society faces a short-term trade-off between inflation and unemployment
Society faces a short-term trade-off between inflation and unemployment. Inflation = Unemployment
Its a short-term trade-off!
ECW1101 - Lecture Week 1
Chapter 2
Thinking like an economist
ECW1101 - Lecture Week 1
How do economists make decisions?
Use of the scientific method
From observation develop theories Specify assumptions Develop economic models to test theories
ECW1101 - Lecture Week 1
Using economic models
Note: Two models are introduced in Chapter 2. The first model the circular flow is examined in detail in Introductory macroeconomics We focus on the second model here. The Production Possibility Frontier (PPF)
Before looking at the PPF consider the following approach to using diagrams
Economic models (diagrams)
This unit adopts a simple philosophy: use ordinary language where possible; but the exact terminology of economics will avoid misunderstandings only use mathematics or equations where it is absolutely necessary or as short-hand language introduces simple diagrams (models); the visual style makes it easier to demonstrate economic principles BUT economic models are only representative of reality
Using a diagram: an example What is this diagram telling you at present?
Vertical Axis
Diagram space
Origin
Horizontal axis
Using a diagram: an example
What assumptions are going to be built in to your diagram? One key assumption is that of ceteris paribus
all other things remaining constant. At this time, other things which may impact on the variables will not be considered. In terms of our diagram, this means that we are only looking at the relationship between the variables on each axis
Ceteris Paribus
Ceteris paribus - all other things held constant Is this a realistic assumption and does it assist to create some useful understanding? Could it actually be used in a real life situation? A practical example: choose the most important things to concentrate upon and ignore the rest when :
learning to drive a motor vehicle
ECW1101 - Lecture Week 1
Ceteris paribus: an illustration
Difficulties encountered
have to co-ordinate several actions together, concentrate upon other motor vehicles and bicycles, watch for pedestrians, etc. also surrounding environment, existing weather conditions, wind, rain, dazzling sunlight, road conditions, etc.
How could this experience be improved by thinking about the term of ceteris paribus
ECW1101 - Lecture Week 1
ECW1101 - Lecture Week 1
We want to focus in only one of the factors (usually the most important) affecting our decisions.
ECW1101 - Lecture Week 1
The PPF
The Production Possibilities Frontier (PPF) is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology (Gans et al. (2009), p. 24).
ECW1101 - Lecture Week 1
The PPF
How can we use a diagram to illustrate the concept of a production possibility frontier? We need to think about what goods the economy is producing What variables would be placed on the vertical and horizontal axis? We only have two axis limits our choice to two products.
The PPF
How does the assumption of ceteris paribus come into the diagram? By choosing only two products we are simplifying our model. We assume: these are the only two products the level of technology is fixed at any point on the PPF, the economy is using all of its available factors of production to produce these products the economy is using its resources efficiently
Production Possibility Frontier
Beef
Two goods produced here are beef and lamb.
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Beef
What does point A tell us? What does point E tell us? What about points C and D?
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Point A all available resources are being used to produce Beef Point E all available resources are being used to produce lamb Points C and D- resources allocated between each product in different C combinations
Beef
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
How does this model help us understand the concepts of choice and opportunity cost? The economy must choose Between points along the PPF.
Beef
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Assume we are initially at point C What is the opportunity cost of choosing to move to point D?
Beef
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Assume we are initially at point C What is the opportunity cost of choosing to move to point D? To gain L2 minus L1 of lamb, we give up B1 minus B2 of beef
Beef
B1
C Loss of Beef
B2
D Gain of lamb E
L1
L2
Lamb
Production Possibility Frontier
Beef
B1
Add a point to the diagram to indicate scarcity. Any point outside the PPF represents an unattainable Combination due to scarce resources
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Beef
Add a point to the diagram to indicate an inefficient use of resources.
B1
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Beef
B1
Add a point to the diagram to indicate an inefficient use of resources. Any point inside the PPF represents an inefficient use of resources.
B2
D
E
L1
L2
Lamb
Production Possibility Frontier
Beef
B1
What shocks to the model would cause the PPF to shift Inwards Outwards?
B2
D
E
L1
L2
Lamb
The economist as policy adviser
When economists are trying to explain the world, they are scientists When economists are trying to improve the world, they are policy advisers
ECW1101 - Lecture Week 1
Positive versus normative analysis
Positive statements are claims that attempt to describe the world as it is.
Called descriptive analysis.
Normative statements are claims that attempt to describe how the world should be.
Called prescriptive analysis.
ECW1101 - Lecture Week 1
Positive versus normative analysis
Positive or normative statements?
An increase in the minimum wage will cause a decrease in employment among the least skilled. The income gains from a higher minimum wage are worth more than any slight reductions in employment.
ECW1101 - Lecture Week 1
Chapter 3
Interdependence and the gains from trade
ECW1101 - Lecture Week 1
Practical examples
Consider your typical day:
You wake up to an alarm clock made in Korea. You pour yourself coffee from beans grown in Indonesia. You watch the news on a TV made in Japan. You drive to uni in a car made of parts manufactured in half a dozen different countries.
and you havent been up for more than two hours yet!
ECW1101 - Lecture Week 1
Interdependence and the gains from trade
Individuals and nations rely on specialised production and exchange as a way to address problems caused by scarcity. But this gives rise to two questions:
Why is interdependence the norm? What determines production and trade?
ECW1101 - Lecture Week 1
Comparative advantage, an example:
Imagine... ...only two goods (meals and laundry) ...only two people (Rachel and Monica) What should each produce? Why should they trade?
ECW1101 - Lecture Week 1
The production opportunities of Rachel and Monica
Hours needed to make:
1 meal Rachel Monica 2 1/2 1 basket 4 3
Amount produced in 12 hours:
Meals 6 24 Baskets 3 4
Self-Sufficiency
By ignoring each other:
Each consumes what they each produce. The production possibilities frontier is also the consumption possibilities frontier. Without trade, economic gains are diminished.
ECW1101 - Lecture Week 1
The production possibilities frontier
(a) Rachels production possibilities frontier Meals
If there is no trade, Rachel chooses this production and consumption.
Laundry (baskets)
ECW1101 - Lecture Week 1
Copyright2003 Southwestern/Thomson Learning
The production possibilities frontier
(a) Monicas production possibilities frontier
Meals
24
If there is no trade, Monica chooses this production and consumption. A 12
Laundry (baskets)
ECW1101 - Lecture Week 1
Copyright2003 Southwestern/Thomson Learning
Specialisation and trade
Monica and Rachel should specialise and trade
Each would be better off if they specialised in producing the product they are more suited to produce, and then trade with each other.el should cook the meals.
ECW1101 - Lecture Week 1
How trade expands the set of consumption opportunities
(a) Rachels production possibilities frontier Meals
6
Rachels consumption with trade .
A* A
5 4
Rachels consumption without trade .
1 11/2
Laundry (baskets)
ECW1101 - Lecture Week 1
Copyright2003 Southwestern/Thomson Learning
How trade expands the set of consumption opportunities
(a) Monicas production possibilities frontier
24
Meals
Monicas consumption with trade
A* A
13 12
Monicas consumption without trade
2 21/2
Laundry (baskets)
ECW1101 - Lecture Week 1
Copyright2003 Southwestern/Thomson Learning
The gains from trade: A summary
Without trade:
Production and consumption Production
With trade:
Gains from trade
Trade gets 5 meals
for 112 baskets gives 5 meals for 112 baskets
Consumption 5 meals
112 baskets
Rachel
4 meals
0 meals
1 meal
12
1 basket
3 baskets
basket
Monica
12 meals
18 meals
13 meals 212 baskets
1 meal
12
2 baskets
1 basket
basket
The principle of comparative advantage
Differences in the costs of production determine the following:
Who should produce what? How much should be traded for each product?
ECW1101 - Lecture Week 1
The principle of comparative advantage
Differences in costs of production Two ways to measure differences in costs of production:
The number of hours required to produce a unit of output (for example, one meal). The opportunity cost of sacrificing one good for another.
ECW1101 - Lecture Week 1
Absolute advantage
The comparison among producers of a good according to their productivityabsolute advantage
Describes the productivity of one person, firm, or nation compared to that of another The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good
ECW1101 - Lecture Week 1
Absolute advantage
Monica needs only three hours to do a basket of laundry, whereas Rachel needs four hours. Monica needs only half an hour to produce a meal, whereas Rachel needs two hours.
Monica has an absolute advantage in the production of laundry and meals.
ECW1101 - Lecture Week 1
Opportunity cost and comparative advantage
Compares producers of a good according to their opportunity cost.
Whatever must be given up to obtain some item.
The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
ECW1101 - Lecture Week 1
Comparative advantage and trade
Who has the absolute advantage?
Monica or Rachel? Monica
Who has the comparative advantage?
Monica or Rachel? Rachel (laundry) and Monica (meals)
ECW1101 - Lecture Week 1
The opportunity cost of meals and laundry
Opportunity cost of 1:
Meal (in terms of baskets given up) Rachel Monica 12 16 Basket (in terms of meals given up) 2 6
ECW1101 - Lecture Week 1
Comparative advantage and trade
Monicas opportunity cost of a meal is only 1/6 of a basket of laundry, whereas Rachels opportunity cost of a meal is of a basket of laundry.
Rachels opportunity cost of a basket of laundry is only 2 meals, while Monicas opportunity cost of a basket is 6 meals ...
ECW1101 - Lecture Week 1
Comparative advantage and trade
so, Monica has a comparative advantage in cooking but Rachel has a comparative advantage in doing the laundry.
ECW1101 - Lecture Week 1
Comparative advantage and trade
Comparative advantage and differences in opportunity costs are the basis for specialised production and trade Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade
ECW1101 - Lecture Week 1
Week One - Summary
10 principles of economics Economists use of economic models The assumption of ceteris paribus Use of Diagrams and PPF Trade can improve economic well being The concepts of Absolute advantage, Comparative advantage based and Opportunity Comparative advantage allows trade even when there is no absolute advantage.
ECW1101 - Lecture Week 1
