Transcript ECONOMICS why study it? Social Science Efficiency

ECONOMICS
why study it?
Social Science
Efficiency
Scarcity
Economics and Policy
• Positive economics (what is going on?)
• Normative economics (what should be
going on?)
efficiency
• Economic systems and fundamentals of
economic efficiency
– What? How? And For Whom? (productive and
allocative efficiency)
– Capitalism, Socialism, and Communism
Frameworks of analysis within
economics
• MACRO– Unit of analysis: economy as a whole
– Variables of interest include inflation,
unemployment, output…
• MICRO– Unit of analysis: individual economic agents:
consumers, firms…
– Variables of interest include costs of
production, individual demands, prices…
Economic cost
• Opportunity cost (just how costly is this
class to you or to me?)
• Does the benefit of taking this class
outweigh the cost?
• Marginal analysis
Specialization and gains from trade
• Specialization and division of labor
• Resource composition
– Capital
– Labor
– Human capital
– Land (inclusive of natural resources)
• Production process (state of technology)
• Absolute and comparative advantage principles
– Relative cost
• Why no complete specialization?
[US trade example: BEA (www.bea.gov)]
– Consumer preferences
– Increasing opportunity cost (marginal cost)
Principles of Trade
• Absolute Advantage: total cost
• Comparative Advantage: relative (opportunity) cost
Consider two economies (A, B), each endowed with 200 worker-hours. Consider
that there are only two goods being produced (X, Y). Consider that in country
A the hourly wage is $A10, while in country B it is $B20, for simplicity assume
that $A=$B. Table below shows costs in each country:
A
B
X
1 ($A10)
1
($B20)
Y
3 ($A30)
2
($B40)
What can be said about the absolute and comparative advantage principles
in this case?
Productivity and trade (education, physical capital…)
Currency and Trade
Should government influence our
comparative advantage? Can it do so?
• Can frequent changes in terms of trade
reduce incentives to accumulate human
capital (Can some of this be seen in the
US economy today?)
• Asian economies of the 70’s, 80’s and
early 90’s
• Recent aid from German government to
AMD
Markets
• Defining a market
– Product definition (and competition)
– Geographical boundaries (internet, shipping
cost reduction – globalization and
outsourcing)
• Market forces: Buyers (demand) versus
Sellers (supply)
– Price and quantity as the outcome
demand
• Quantity = f (price, other factors)
• Price and the Law of Demand
• Other factors
– Income (normal versus inferior)
– Related in consumption goods
• Substitutes
• Complements
– Expectations about the future
– OTHER FACTORS ………
supply
• Quantity = f ( price, other factors)
• Price and the Law of Supply
• Other factors
– Costs of Production (MC, and price as MB)
– Goods related in production
• Substitutes: (agricultural products)
– Note, identical to costs of production since is based on
opportunity cost concept
• Complements: (like gold and silver)
– Producer expectations of future prices
• Other factors…
Market equilibrium
• Qs = Qd
• Shortage and surplus as unstable states
and the stability property of the equilibrium
• Market efficiency
• Shifts in demand and supply
• Roles of Prices
• Is the equilibrium really efficient?
– Productive and allocative efficiency
Market example: ForEx
• How can the US run a trade deficit
consistently? Or, differently put, can one
live on credit forever?
Demand for the dollar
different economic agents that purchase the dollar:
•Foreigners who wish to purchase US goods or services, foreign
tourists who wish to travel to the US (US exports)
•Foreigners who wish to invest in the US (higher US interest rate,
attractive US stock market returns)
Supply of the dollar
different economic agents that sell the dollar:
•US consumers/firms that want to purchase foreign goods or services,
US tourists who wish to travel abroad (US imports)
•US residents who wish to invest abroad (higher interest rates abroad,
etc.)
The dollar will appreciate if demand exceeds supply at the current exchange rate.
Note that when you purchase a foreign made product, the cost of the production of that
product is paid in foreign currency, hence somewhere between the production process
and your purchase someone would have to convert your currency into that foreign
currency in order to pay for the production.
Demand and supply: the USD
• US trade deficit -> sale of USD ->dollar
depreciation
• US borrowing from abroad -> purchases of
USD -> appreciation of the USD
• 1990’s and the post 9/11framework
• US balance of payments: BEA
Who is more flexible? Elasticity of
demand
• Elasticity of demand =
%D(Quantity demanded)/%D(Price)
• Elasticity as a measure of responsiveness of demand
• Inelastic and elastic ranges; marginal revenue
• Elasticity and revenue maximization
• Comparing demands in terms of their relative elasticities
• What makes demand relatively less elastic?
– Gasoline here
– Health care
– Health care insurance and elasticity of demand (moral hazard)
• Sales Tax and elasticity of demand?
– Who really pays sales tax and why?
– Excise tax
Elasticity long and short run
• Are our demands more flexible from the
long-run perspective?
– Defining short and long run in economics
– Demand for gasoline
– Demand for cars (capital goods in general,
like PCs at GSU)
Other types of elasticity of demand
• Income elasticity of demand
• Cross price elasticities
When Markets Fail
• Externalities (bad and good)
– Internalizing external costs through taxation
• Public goods
– Non-excludability
– Non-rivalry
• Lack of certain institutions or mechanisms
– Asymmetry of information
• Used car market
• eBay and emergence of a correcting mechanism (a local
public good)
Role of government in a market
based economy
• INSTITUTIONS…………
– Just think of how many different institutions
set up and maintained by various government
levels make this very class possible…
– Institutions at the micro and macro levels
• Property rights and well functional legal system
• Contract enforcement
• Business culture
– Negative institutions can also emerge
(corruption is a good example)
Consumer Behavior
• Utility function
– Assumption of rationality
– Total utility versus marginal utility
– Diminishing marginal utility
• DMU and consumption choice
– MU per dollar spent
• DMU and progressive income taxation
• What if the Law of DMU is violated?
Production
firms
• Assumption of profit maximization
• Do firms really maximize profits?
– Principal-agent problem and the size of the
firm
• Conflict of interests and correcting mechanisms
– Stocks and options as reward to workers/executives
– External debt
Production
• Production function or Total Product
Output = f (inputs, technology) = TP
• Marginal Product – change in output resulting
from a change in an input
– MPL, MPK
• Diminishing Marginal Product
– Choice of the combination of inputs
• MP of input per dollar (long-run production)
• Long-run versus Short-run (assumption about
capital, why not labor?)
Production and costs in the shortrun
• Cost of labor – Wage (w)
• Cost of capital - ?
– Defining user cost of capital (r)
• Total cost of production
TC (Q) = w L + r K
Other inputs can be included (oil, land… furthermore we
assume homogeneous labor and capital)
• Fixed cost versus variable cost
• Sunk cost (stock price at the time of purchase)
Costs of production in short-run
• Average costs
ATC = AVC + AFC
• Marginal cost
Change in total cost of change in output
Marginal cost as a function of Marginal product of labor
(in our simple case)
– diminishing marginal product and rising marginal
cost
• AVC = wage / APL
• Relationship between MC and ATC, AVC
Profit maximization
In equilibrium, a profit maximizing firm will select to
produce the level of output at which the wage
rate is equal to the value of the marginal product
of labor, in other words the marginal cost of a
unit of labor (wage) is equal to the marginal
benefit of that unit of labor expressed as the
change in total revenues.
Production and costs in the long-run
• Full flexibility
• LRAC (to LRAC from S-R AC)
– Deriving LRAC from SR AC
– Economies of scale
• Increased specialization
• Use of indivisible inputs (trade mark…)
– Constant returns to scale
– Diseconomies of scale
• Principal-agent problem and size of business
• Possible increase in input costs due to increased demand
• Long term cost improvements
– Technological progress
– Learning by doing
market structure
oligopoly
monopoly
mc
Perfect
competition
Perfect competition and the internet
Assumptions:
-
number of firms
Ease of entry and exit
Perfect information
Identical transaction costs
Homogeneous good
Consequences of these assumptions:
- Competition along one dimension – the price
- Lack of collusion
- Horizontal demand and MR – price taking behavior
- MC as the supply curve
Shut down and break even price levels – cost diagram in the short-run
- K-Mart example
Long-run and cost structure of the industry
Market Supply Curve
• Individual firm’s supply curve – MC
– Recall that P=MR, and profit maximization requires
MR=MC
• Market supply curve is the horizontal summation
of individual curves
Adjustment to a change in demand
Industry Demand Increases
SHORT-RUN
– Each firm expands output
– The number of firms remains the same
• Recall that changing the number of firms requires changes in
capital stock
LONG-RUN
– Positive economic profits attract entry: number of
firms increases
• Entry of new firms and the impact on costs of
production
– Does building more fast food restaurants around the
campus change the cost of low-skilled labor?
– Does an increased demand for computer
programmers change the cost of training a software
engineer?
Note that MC, ATC, AVC are all functions of input costs
(if labor is the only variable input then: MC =
wage/MPL, and AVC = wage/APL)
Increasing Cost Industry
– Industry expansion rises the demand for inputs, and as a result
the cost of those inputs increases, and thus the price
(equilibrium) at which the firms earn zero economic profits also
increases
• Diseconomies of scale in the production of inputs
• Inelastic supply of inputs
• Lack of substitutability of inputs
Decreasing Cost Industry
– Industry expansion rises the demand for inputs, and as a result
the cost of those inputs declines, and thus the price at which the
firms earn zero economic profits decreases
• Economies of scale in the production of inputs (adjustments in the
educational system in the 1990 as a result of increased demand for
software engineers)
Constant Cost Industry
– Industry expansion does not affect input costs
MONOPOLY
•
•
•
•
Monopoly diagram and profit maximization
Social costs of monopoly
Price discrimination
Natural monopoly
Monopolistic Competition
• Product differentiation
• Large number of firms differentiated
products
• Entry/Exit
• Diagram and equilibrium outcome
OLIGOPOLY
• Barriers to entry and formation of
oligopolies
• Strategic interdependence
• Understanding an Oligopoly
– Kinked Demand Model
– Cournot Duopoly Model
– Game Theoretical Approach
Game Theory
• Modeling decisions as strategies in an
interactive game
• Simultaneous move games and matrix
form
– Nash Equilibrium and Best Response
Strategies
– Dominant Strategies
• Sequential move games and tree form
approach
– Entry deterrence game
Monopoly, Oligopoly and Antitrust
• Sherman Act
• Clayton Act
• http://www.usdoj.gov/atr/foia/divisionmanu
al/ch2.htm
• Price discrimination
Public Sector
Government role in the economy:
• Institutional support
• Provision of public goods and services
• Correction of externalities
• Economic policies (stabilization and
development)
General government final consumption expenditure (% of GDP)
30.00
26.91
25.00
23.40
21.27
21.52
20.00
16.67
15.00
14.23
General government final consumption
expenditure (% of GDP)
10.00
5.00
0.00
United States
Sw eden
Russian
Federation
Data for 2001, source: World Bank
Norw ay
Finland
France
How do we pay for the
government?
• Taxes and user fees
– Income tax
– Sales tax
• Excise tax
– Property tax
– Value added tax
• Fiscal Federalism: US example
Taxes and Incentives
• Income tax
– Marriage neutrality
– Labor force participation
– Impact on revenues of government
– Impact on population growth
– Savings and investment (capital gains
taxation and IRAs)