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

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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

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

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Ideas for Beyond the Final Exam 1.How much does it really cost? –Opportunity cost next best 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 4

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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)

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

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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 7

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Ideas for Beyond the Final Exam trade-off 6.Short-run trade-off between inflation & unemployment (Chapter 16) –Low unemployment - high inflation –High unemployment – low inflation 7.Productivity growth 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 8

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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 9

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Detailed Road Map of Los Angeles Map 1 10

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Major Los Angeles Arteries and Freeways Map 2 11

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

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Greater Los Angeles Freeways Map 3 13

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Inside the Economist’s Tool Kit Economic theory –Deliberate simplification of reality mechanism –Explain how relationships work (mechanism) –Answer counterfactual experiment Statistical correlation –Variables - go up or down together –Need not imply causation 14

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

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APPENDIX Using graphs: a review Economic graphs –Large quantity of data - quickly –Facilitate data interpretation & analysis –At a glance Important statistical relationships Variable –Measure: number –Analysis 16

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

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Hypothetical demand curve for natural gas: St. Louis Figure 1 18 Quantity Price b Q P (a) Quantity Price Q P (b) a D a b

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Quantities of natural gas demanded at various prices Table 1 19 Price (per thousand cubic feet)$2$3$4$5$6 Quantity demanded (billions of cubic feet per year)

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APPENDIX Using graphs: a review Slope of straight line –Ratio: vertical change “rise” –To: horizontal change “run” Negative slope –One variable falls, other rises Positive slope –Both variables rise 20

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Different types of slope of a straight-line graph Figure 2 21 (a) Y X 0 (b) Y X 0 (c) Y X 0 (d) Y X 0 Negative slope Positive slope Zero slope Infinite slope

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APPENDIX Using graphs: a review Zero slope –Y value doesn’t change Infinite slope –X value doesn’t change Slope of straight line –Same numerical value 22

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How to measure slope Figure 3 23 (a) Y X 0 (b) Slope = 1/ A C B Y X 0 Slope = 3/ A C B

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

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Behavior of slopes in curved graphs Figure 4 25 (a) Y X 0 (b) Y X 0 (c) Y X 0 (d) Y X 0 Negative slope Positive slope Positive slope Negative slope Negative slope Positive slope

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How to measure slope at a point on a curved graph Figure 5 26 E X Y r r T R G M t t B F A C D

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APPENDIX 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 27

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Rays through the origin Figure 6 28 X Y A B K E D C Slope = +1 Slope = +1/2 Slope = +2

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

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A geographic contour map Figure 7 30

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APPENDIX 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 31

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An economic contour map Figure 8 32 Labor hours per day X Y Yards of cloth per day Z = 10 Z = 20 Z = 40 Z = 30 A B

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