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**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

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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 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

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**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

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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) 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

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**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

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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

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Map 1 Detailed Road Map of Los Angeles

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Map 2 Major Los Angeles Arteries and Freeways

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**Inside the Economist’s Tool Kit**

Abstraction, simplification Unimportant details Necessary Understand complex economy Degree of abstraction Objective of analysis

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Map 3 Greater Los Angeles Freeways

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**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

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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

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**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

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**Two-variable diagrams**

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

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**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)

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**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

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**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

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**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)

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**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

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**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)

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**Using graphs: a review Slope of curved line Different numerical value**

At one point Slope of tangent (straight line)

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**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)

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**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

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**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

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**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

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**Contour map (topographical map)**

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

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Figure 7 A geographic contour map

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**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

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**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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