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ECONOMICS Principles & Policy

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1 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

2 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

3 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

4 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

5 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)

6 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

7 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

8 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

9 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

10 Map 1 Detailed Road Map of Los Angeles

11 Map 2 Major Los Angeles Arteries and Freeways

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

13 Map 3 Greater Los Angeles Freeways

14 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

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

16 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

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

18 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)

19 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

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

21 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)

22 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

23 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)

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

25 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)

26 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

27 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

28 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

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

30 Figure 7 A geographic contour map

31 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

32 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

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