ECONOMICS Principles & Policy William J. Baumol & Alan S. Blinder Economics: Principles & Policy 11e Baumol & Blinder © 2009 Cengage PowerPoint slides prepared by: Andreea Chiritescu Eastern Illinois University Modified by Hui He, UHM

Chapter 1 What is Economics? Why does public discussion of economic policy so often show the abysmal ignorance of the participants? Why do I so often want to cry at what public figures, the press, and television commentators say about economic affairs? Robert M. Solow

Outline Give you some idea of the issues that economic analysis help to clarify and the solutions that economic principles suggest Introduce the tools that economists use

Ideas for Beyond the Final Exam How much does it really cost? Opportunity cost Value of next best alternative forgone (first best is your choice) Example: what is the cost to go to college? direct cost = TFRB, indirect cost=four year forgone wage

Ideas for Beyond the Final Exam 2. Attempts to repeal laws of supply & demand - Market strikes back Price ceilings (NYC rent control creates shortage and lack of maintenance of apartments) Price floors (price support of agricultural products leads to surplus)

Ideas for Beyond the Final Exam 3. Surprising principle: comparative advantage (Chapter 17) Law of comparative advantage: Even China can produce everything more cheaply, two nations can still gain from trade by specializing in relatively cheaper items

Ideas for Beyond the Final Exam 4. Trade = win-win situation Voluntary trade – all parties gain 5. Government policies - limit economic fluctuations - but don’t always succeed (Chapter 11-13) Fiscal policy: tax and Gov. spending Monetary policy: money supply and interest rates

Ideas for Beyond the Final Exam 6. Short-run trade-off between inflation & unemployment (Chapter 16) Low unemployment - high inflation High unemployment – low inflation 7. Productivity growth is (almost) everything in long run (Chapter 7) Small increase in labor productivity – higher living standard Slowdown in labor productivity – lower living standard

Inside the Economist’s Tool Kit Economics as a discipline uses Mathematical reasoning Historical study Statistics Need for abstraction Ignore many details Focus: most important elements

Map 1 Detailed Road Map of Los Angeles

Map 2 Major Los Angeles Arteries and Freeways

Inside the Economist’s Tool Kit Abstraction, simplification Unimportant details Necessary Understand complex economy Degree of abstraction Objective of analysis

Map 3 Greater Los Angeles Freeways

Inside the Economist’s Tool Kit Economic theory Deliberate simplification of reality Explain how relationships work (mechanism) Answer counterfactual experiment Statistical correlation Variables - go up or down together Need not imply causation

Inside the Economist’s Tool Kit Economic model Simplification - aspect of the real economy Expressed Equations Graphs Words Disagreements Imperfect information Value judgments

Using graphs: a review Economic graphs Variable Large quantity of data - quickly Facilitate data interpretation & analysis At a glance Important statistical relationships Variable Measure: number Analysis

Two-variable diagrams Using graphs: a review Two-variable diagrams Horizontal axis Vertical axis Origin Abstract Focus Two variables of primary interest

Figure 1 Hypothetical demand curve for natural gas: St. Louis Price 1 2 3 4 5 6 Price 1 2 3 4 5 6 D P a P a Q Q b b Quantity 20 40 60 80 100 120 140 Quantity 20 40 60 80 100 120 140 (a) (b)

Table 1 Quantities of natural gas demanded at various prices Price (per thousand cubic feet) $2 $3 $4 $5 $6 Quantity demanded (billions of cubic feet per year) 120 80 56 38 20

Using graphs: a review Slope of straight line Negative slope Ratio: vertical change “rise” To: horizontal change “run” Negative slope One variable falls, other rises Positive slope Both variables rise

Figure 2 Different types of slope of a straight-line graph Y Y Negative slope Positive slope X X (a) (b) Y Y Zero slope Infinite slope X X (c) (d)

Using graphs: a review Zero slope Infinite slope Y value doesn’t change Infinite slope X value doesn’t change Slope of straight line Same numerical value

Figure 3 How to measure slope Y Y C 11 13 C 9 8 13 8 3 3 A B B X X (a) (b)

Using graphs: a review Slope of curved line Different numerical value At one point Slope of tangent (straight line)

Figure 4 Behavior of slopes in curved graphs Y Y Positive slope Negative slope X X (a) (b) Y Y Negative slope Positive slope Negative slope Positive slope X X (c) (d)

Figure 5 How to measure slope at a point on a curved graph Y 1 2 3 4 5 6 7 8 r D R t F C E T G M A B X 1 2 3 4 5 6 7 8 9 10

Using graphs: a review Y-intercept X-intercept Ray through origin Y-intercept = zero 45° lines Rays through origin Slope = 1 Angle = 45° X=Y

Figure 6 Rays through the origin Y 1 2 3 4 5 Slope = +2 B Slope = +1 C K Slope = +1/2 E D X 1 2 3 4 5

Contour map (topographical map) Using graphs: a review Contour map (topographical map) Three pieces of data Latitude Longitude Altitude

Figure 7 A geographic contour map

Production indifference map Using graphs: a review Production indifference map Axes - quantities of two inputs Curve - given quantity of output Points on curve Different quantities of two inputs Just enough – produce given output

Figure 8 An economic contour map Y 10 20 30 40 50 60 70 80 Yards of cloth per day Z = 40 Z = 30 Z = 20 Z = 10 A B Labor hours per day 10 20 30 40 50 60 70 80 X