1. GSIAS – North American Economy
Economics 101

2. Lesson Overview Microeconomics Supply/Demand/Equilibrium
Govt. Policies Effect (Drugs/Min. Wage/Taxes)
Economic Models
Perfect Competition / Monopolies
Macroeconomics
GDP
Circular Flow Model
Economic Growth and Production
Interest Rates and Inflation
Open Economy Macroeconomics

3. Macro vs. Micro Economics
Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.
Prices and selection of products
Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once.
Inflation
Unemployment
Economic Growth

4. Demand
The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.
Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal
Demand comes from the behavior of buyers.
THE MARKET FORCES OF SUPPLY AND DEMAND 4

5. The Market Demand Curve for LattesP
Qd (Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6 P Q
THE MARKET FORCES OF SUPPLY AND DEMAND 5

6. Demand Curve Shifters
The demand curve shows how price affects quantity demanded, other things being equal.
These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).
Changes in them shift the D curve… P Q
THE MARKET FORCES OF SUPPLY AND DEMAND 6

7. Summary: Variables That Influence Buyers
Variable A change in this variable…
Price …causes a movement along the D curve
# of buyers …shifts the D curve
Income …shifts the D curve
Price of related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
Students should notice that the only determinant of quantity demanded that causes a movement along the curve is price. Also notice: price is one of the variables measured along the axes of the graph.
Here’s a handy “rule of thumb” to help students remember whether the curve shifts: If the variable causing demand to change is measured on one of the axes, you move along the curve. If the variable that’s causing demand to change is NOT measured on either axis, then the curve shifts.
This rule of thumb works with all curves in economics that involve an X-Y relationship. (I.e., it works for the supply curve, the marginal cost curve, the IS and LM curves, among many others, but it does not apply to curves drawn on time series graphs.)
THE MARKET FORCES OF SUPPLY AND DEMAND 7

8. A C T I V E L E A R N I N G 1 Demand Curve
Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?
A. The price of iPods falls
B. The price of music downloads falls
C. The price of CDs falls
In each case, there are only three possible answers:
- The curve shifts to the right
- The curve shifts to the left
- The curve does not shift (though there may be a movement along the curve) 8

9. Supply
The quantity supplied of any good is the amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal
Supply comes from the behavior of sellers.
THE MARKET FORCES OF SUPPLY AND DEMAND 9

10. The Market Supply CurveP
QS (Market)
$0.00
1.00 5
2.00 10
3.00 15
4.00 20
5.00 25
6.00 30 P Q
THE MARKET FORCES OF SUPPLY AND DEMAND 10

11. Supply Curve Shifters
The supply curve shows how price affects quantity supplied, other things being equal.
These “other things” are non-price determinants of supply.
Changes in them shift the S curve… P Q
“Non-price determinants of supply” simply means the things – other than the price of a good – that determine sellers’ supply of the good.
THE MARKET FORCES OF SUPPLY AND DEMAND 11

12. Summary: Variables that Influence Sellers
Variable A change in this variable…
Price …causes a movement along the S curve
Input Prices …shifts the S curve
Technology …shifts the S curve
# of Sellers …shifts the S curve
Expectations …shifts the S curve
THE MARKET FORCES OF SUPPLY AND DEMAND 12

13. A C T I V E L E A R N I N G 2 Supply Curve
Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?
A. Retailers cut the price of the software.
B. A technological advance allows the software to be produced at lower cost.
C. Professional tax return preparers raise the price of the services they provide.
“Tax return preparation software” means programs like TurboTax by Quicken and TaxCut by H&R Block. 13

14. Supply and Demand TogetherP Q
Equilibrium: P has reached the level where quantity supplied equals quantity demanded S D
We now return to the latte example to illustrate the concepts of equilibrium, shortage and surplus.
THE MARKET FORCES OF SUPPLY AND DEMAND 14

15. Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P Q
Example: If P = $5, S D
Surplus
then QD = 9 lattes
and QS = 25 lattes
resulting in a surplus of 16 lattes
THE MARKET FORCES OF SUPPLY AND DEMAND 15

16. Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting price. S D
Surplus
This causes QD to rise
and QS to fall…
…which reduces the surplus.
THE MARKET FORCES OF SUPPLY AND DEMAND 16

17. Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting price. S D
Surplus
This causes QD to rise and QS to fall.
Prices continue to fall until market reaches equilibrium.
THE MARKET FORCES OF SUPPLY AND DEMAND 17

18. EXAMPLE 2: A Shift in Supply
EVENT: New technology reduces cost of producing hybrid cars. P Q S1 S2 D1
STEP 1:
S curve shifts because event affects cost of production.
D curve does not shift, because production technology is not one of the factors that affect demand.
STEP 2:
S shifts right because event reduces cost, makes production more profitable at any given price. P1 Q1 P2 Q2
STEP 3:
The shift causes price to fall and quantity to rise.
THE MARKET FORCES OF SUPPLY AND DEMAND 18

19. EXAMPLE 3: A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces production costs P Q S1 S2 D2 D1
STEP 1:
Both curves shift. P2 Q2 P1 Q1
STEP 2:
Both shift to the right.
STEP 3:
Q rises, but effect on P is ambiguous:
If demand increases more than supply, P rises.
THE MARKET FORCES OF SUPPLY AND DEMAND 19

20. EXAMPLE 3: A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces production costs P Q S1 S2 D2 D1
STEP 3, cont. P1 Q1
But if supply increases more than demand, P falls. P2 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND 20

21. Demand for illegal drugs is inelastic, due to addiction issues.
APPLICATION: Does Drug Interdiction Increase or Decrease Drug-Related Crime?
One side effect of illegal drug use is crime: Users often turn to crime to finance their habit.
We examine two policies designed to reduce illegal drug use and see what effects they have on drug-related crime.
For simplicity, we assume the total dollar value of drug-related crime equals total expenditure on drugs.
Demand for illegal drugs is inelastic, due to addiction issues.
In the textbook, this application appears near the end of the chapter, and you can easily move these slides to the end if you wish to teach things in the same order as the book.
However, I encourage you to consider teaching this application right here - immediately after the section on price elasticity of demand. It is safe to do so, as this application only requires knowledge of price elasticity of demand. Also, putting the application here breaks up what would otherwise be a very long section of theory with a real-world example that most students find very interesting. Knowing elasticity helps us understand what might otherwise be a counter-intuitive result (that drug interdiction increases drug-related crime rather than reducing it).
ELASTICITY AND ITS APPLICATION 21

22. Policy 1: Interdiction Interdiction reduces the supply of drugs.
Interdiction reduces the supply of drugs.
new value of drug-related crime
Price of Drugs
Quantity of Drugs S2 D1 S1
Since demand for drugs is inelastic, P rises propor-tionally more than Q falls. P2 Q2
initial value of drug-related crime P1 Q1
By the time all elements have appeared on the screen, the slide will look kind of busy. I think this is okay, because the elements appear on the screen one by one, so students have time to absorb each one before the next one appears.
However, if you’d rather strip the slide down a bit, here’s a suggestion: in “Normal” view (which one uses to edit slides), you can delete the boxes that represent the initial and new values of drug-related crime, and the accompanying captions. Then, when presenting this slide in class, simply point out (with your mouse cursor, a laser pointer, or even your arms and hands) the areas that represent the initial and new values of drug-related crime.
Result: an increase in total spending on drugs, and in drug-related crime
ELASTICITY AND ITS APPLICATION 22

23. Policy 2: Education Education reduces the demand for drugs.
new value of drug-related crime
Education reduces the demand for drugs.
Price of Drugs
Quantity of Drugs D2 D1 S
P and Q fall.
initial value of drug-related crime P1 Q1
Result: A decrease in total spending on drugs, and in drug-related crime. P2 Q2
ELASTICITY AND ITS APPLICATION 23

24. The Minimum Wage Min wage laws do not affect highly skilled workers.
They do affect teen workers.
Studies: A 10% increase in the min wage raises teen unemployment by 1-3%.
unemp-loyment W L S
Min. wage $5 D
400
550 $4
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 24

25. CASE STUDY: Who Pays the Luxury Tax?
1990: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc.
Goal of the tax: raise revenue from those who could most easily afford to pay – wealthy consumers.
But who really pays this tax?
This case study shows students an interesting real-world example of the material they just learned.
If you’re pressed for time, it is probably safe to skip it and let students read it on their own. It does not introduce any new concepts, and most students do not find it difficult to read.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 25

26. CASE STUDY: Who Pays the Luxury Tax?
The market for yachts
Demand is price-elastic. P Q S
In the short run, supply is inelastic. D
Buyers’ share of tax burden PB
Tax
Hence, companies that build yachts pay most of the tax.
Sellers’ share of tax burden
Demand for yachts (and other luxury items) is price-elastic: if the price of yachts rises, rich consumers can easily avoid the tax by spending their millions on some other luxury item.
Supply of yachts is less elastic, especially in the short run. It is difficult for the companies that build yachts to re-tool their factories and reeducate their workers to produce some other product.
Hence, companies that build yachts pay most of the tax, and the rich pay relatively little of it.
The same is true for taxes on other luxury items. PS
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 26

27. DWL and the Size of the TaxP Q D S
Initially, the tax is T per unit.
new DWL
Doubling the tax 2T Q2
causes the DWL to more than double. T Q1
initial DWL
The new DWL is four times the initial DWL, even though the tax is just twice as large.
APPLICATION: THE COSTS OF TAXATION 27

28. Revenue and the Size of the Tax
Revenue and the Size of the Tax
The Laffer curve shows the relationship between the size of the tax and tax revenue.
The Laffer curve
Tax size
Tax revenue
The Laffer curves shown here and in the book are symmetric, and their peak occurs in the middle. You might mention to students that this need not and probably is not the case. However, we just don’t know where the peak is – it could be at a tax rate of 20% or a tax rate of 200% - and it surely varies across goods.
The textbook has some excellent discussion of the Laffer curve, President Reagan, and supply-side economics. Encourage your students to check it out.
APPLICATION: THE COSTS OF TAXATION 28

29. THE MEASUREMENT OF GROSS DOMESTIC PRODUCT
Gross domestic product (GDP) is a measure of the income and expenditures of an economy.
GDP is the total market value of all final goods and services produced within a country in a given period of time.

30. The Circular-Flow Diagram
The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firms
Two types of “actors”:
households
firms
Two markets:
the market for goods and services
the market for “factors of production”
THINKING LIKE AN ECONOMIST 30

31. FIGURE 1: The Circular-Flow Diagram
Households:
Own the factors of production, sell/rent them to firms for income
Buy and consume goods & services
Firms
Households
Firms:
Buy/hire factors of production, use them to produce goods and services
Sell goods & services
This and the following slide build the Circular-Flow Diagram piece by piece.
THINKING LIKE AN ECONOMIST 31

32. FIGURE 1: The Circular-Flow Diagram
Revenue
Markets for Goods & Services
Spending
G & S sold
G & S bought
Firms
Households
Wages, rent, profit
Factors of production
Income
Labor, land, capital
In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods & services (including services of the factors of production in the lower half of the diagram).
To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide.
You may wish to change the order in which the elements appear. To do so, look for “Custom Animation” in your version of PowerPoint.
Markets for Factors of Production
THINKING LIKE AN ECONOMIST 32

33. Y = C + I + G + NX THE COMPONENTS OF GDP
GDP (Y) is the sum of the following:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX

34. Productivity
Recall one of the Ten Principles from Chap. 1: A country’s standard of living depends on its ability to produce g&s.
This ability depends on productivity, the average quantity of g&s produced per unit of labor input.
Based on:
As in previous chapters, “g&s” is short for “goods and services.”
Physical Capital
Human Capital
Natural Resources
Technical Knowledge

35. THE MARKET FOR LOANABLE FUNDS
Financial markets coordinate the economy’s saving and investment in the market for loanable funds.
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds.

36. Supply and Demand for Loanable Funds
Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.
The supply of loanable funds comes from people who have extra income they want to save and lend out.
The demand for loanable funds comes from households and firms that wish to borrow to make investments.

37. Supply and Demand for Loanable Funds
Interest rate
the price of the loan
the amount that borrowers pay for loans and the amount that lenders receive on their saving
in the market for loanable funds, the real interest rate

38. Supply and Demand for Loanable Funds
Financial markets work much like other markets in the economy.
The equilibrium of the supply and demand for loanable funds determines the real interest rate.

39. Figure 2 An Increase in the Supply of Loanable Funds
Interest
Supply, S1 S2
Rate
Demand
1. Tax incentives for
saving increase the
supply of loanable
fund
s . . . 5%
$1,200 2.
. . . which
reduces the
equilibrium
interest rat
e . . . 4%
$1,600
Loanable Funds 3.
. . . and raises the equilibrium
quantity of loanable funds.
(in billions of dollars)

40. THE FEDERAL RESERVE SYSTEM
The Federal Reserve (Fed) serves as the nation’s central bank.
Three Primary Functions of the Fed
Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices.
Acts as a banker’s bank, making loans to banks and as a lender of last resort.
Conducts monetary policy by controlling the money supply.

41. The Federal Open Market Committee
Open-Market Operations
To increase the money supply, the Fed buys government bonds from the public.
To decrease the money supply, the Fed sells government bonds to the public.

42. BANKS AND THE MONEY SUPPLY
Banks can influence the quantity of demand deposits in the economy and the money supply.

43. Money Creation with Fractional-Reserve Banking
When a bank makes a loan from its reserves, the money supply increases.
The money supply is affected by the amount deposited in banks and the amount that banks loan.
Deposits into a bank are recorded as both assets and liabilities.
The fraction of total deposits that a bank has to keep as reserves is called the reserve ratio.
Loans become an asset to the bank.

44. Money Creation with Fractional-Reserve Banking
When one bank loans money, that money is generally deposited into another bank.
This creates more deposits and more reserves to be lent out.
When a bank makes a loan from its reserves, the money supply increases.

45. THE CLASSICAL THEORY OF INFLATION
Inflation is an increase in the overall level of prices.
Hyperinflation is an extraordinarily high rate of inflation.

46. The Level of Prices and the Value of Money
The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate.
Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of exchange.
When the overall price level rises, the value of money falls.

47. Money Supply, Money Demand, and Monetary Equilibrium
The money supply is a policy variable that is controlled by the federal govt.
Through instruments such as open-market operations, the govt. directly controls the quantity of money supplied.
Money demand has several determinants, including interest rates and the average level of prices in the economy.
Bullet 2: Mankiw has removed the word, “directly”

48. Money Supply, Money Demand, and Monetary Equilibrium
People hold money because it is the medium of exchange.
The amount of money people choose to hold depends on the prices of goods and services.
In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply.

49. Figure 2 An Increase in the Money Supply
Value of
Price
Money, M1
MS1 M2
MS2 1 / P
Level, P
(High) 1
Money
demand 1
(Low)
1. An increase
in the money
supply . . . 3 /
1.33 4
decreases
the value of
mone
y . . . 3.
. . . and
increases
the price
level. A 1 / 2 2 B 1 / 4 4
(Low)
(High)
Quantity of
Money

50. Open-Economy Macroeconomics: Basic Concepts
An open economy interacts with other countries in two ways.
It buys and sells goods and services in world product markets.
It buys and sells capital assets in world financial markets.

51. The Flow of Goods: Exports, Imports, Net Exports
Net exports (NX) are the value of a nation’s exports minus the value of its imports.
Net exports are also called the trade balance.

52. The Flow of Goods: Exports, Imports, Net Exports
Factors That Affect Net Exports
The tastes of consumers for domestic and foreign goods.
The prices of goods at home and abroad.
The exchange rates at which people can use domestic currency to buy foreign currencies.

53. The Flow of Goods: Exports, Imports, Net Exports
Factors That Affect Net Exports
The incomes of consumers at home and abroad.
The costs of transporting goods from country to country.
The policies of the government toward international trade.

54. The Flow of Financial Resources: Net Capital Outflow
Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
A U.S. resident buys stock in the Toyota corporation and a Mexican buys stock in the Ford Motor corporation.

55. The Flow of Financial Resources: Net Capital Outflow
When a U.S. resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S. net capital outflow.
When a Japanese residents buys a bond issued by the U.S. government, the purchase reduces the U.S. net capital outflow.

56. The Flow of Financial Resources: Net Capital Outflow
Variables that Influence Net Capital Outflow
The real interest rates being paid on foreign assets.
The real interest rates being paid on domestic assets.
The perceived economic and political risks of holding assets abroad.
The government policies that affect foreign ownership of domestic assets.

57. The Equality of Net Exports and Net Capital Outflow
For an economy as a whole, NX and NCO must balance each other so that:
NCO = NX
Why?
When a nation is running a trade surplus (NX>0), it is selling more goods/services to foreigners than it is buying. What is it doing with the foreign currency received? Must be buying foreign assets. Capital is flowing out of the country (NCO>0).
When a nation is running a trade deficit (NX<0), it is buying more goods and services from foreigners than it is selling. How is it financing the purchase? It must be selling assets abroad. Capital is flowing into the country (NCO<0).

58. Saving, Investment, and Their Relationship to the International Flows
National saving (S) equals Y – C – G so:
S = I + NX or
Saving
Domestic Investment
Net Capital Outflow = + S I
NCO = +

59. International transactions are influenced by international prices.
THE PRICES FOR INTERNATIONAL TRANSACTIONS: REAL AND NOMINAL EXCHANGE RATES
International transactions are influenced by international prices.
The two most important international prices are the nominal exchange rate and the real exchange rate.

60. Nominal Exchange Rates
The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.

61. Real Exchange Rates
The real exchange rate is the rate at which a person can trade the goods and services of one country for the goods and services of another.

62. Figure 1 The Market for Loanable Funds
Real
Interest
Rate
Supply of loanable funds
(from national saving)
Demand for loanable
funds (for domestic
investment and net
capital outflow)
Equilibrium
quantity
real interest
rate
Quantity of
Loanable Funds

63. Figure 3 How Net Capital Outflow Depends on the Interest Rate
Real
Interest
Rate
Net capital outflow
is negative.
Net capital outflow
is positive.
Net Capital
Outflow

64. The Market for Foreign-Currency Exchange
Real
Exchange
Rate
Supply of dollars
(from net capital outflow)
Demand for dollars
(for net exports)
Equilibrium
quantity
real exchange
rate
Why does demand slope downward? Why is the Equil. Qty vertical?
Quantity of Dollars Exchanged
into Foreign Currency

65. The Effects of Government Budget Deficit
1. A budget deficit reduces
the supply of loanable funds . . .
(a) The Market for Loanable Funds
(b) Net Capital Outflow
Real
Real
Interest S S
Interest
Rate
Rate r2 B r2 E1 r A
which
increases
the real
interest
rate . . .
which in
turn reduces
net capital
outflow.
Demand
NCO
Quantity of
Net Capital
Loanable Funds
Outflow
Real
Exchange S S
Rate
4. The decrease
in net capital
outflow reduces
the supply of dollars
to be exchanged
into foreign
currency . . . E2
which
causes the
real exchange
rate to
appreciate.
Demand
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange

66. The Effects of an Import Quota
(a) The Market for Loanable Funds
(b) Net Capital Outflow
Real
Real
Interest
Interest
Supply
Rate
Rate r r
3. Net exports,
however, remain
the same.
Demand
NCO
Quantity of
Net Capital
Loanable Funds
Outflow
Real
Exchange
Supply
Rate D
1. An import
quota increases
the demand for
dollars . . . E2
and
causes the
real exchange
rate to
appreciate. E D
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange