ECODEV130
MARY MAE F. NAWANAO
Lesson 1: Ten Principles of Economics
By: Gregory Mankiw
A household and an economy face many decisions.
 Who will work?
 What Goods and how many of them should be
produced?
 What resources should be used in production?
 At what price should the goods be sold?
Society and Scarce Resources:
 The management of society’s resources is
important because resources are scarce.
 Scarcity- means that society has limited resources
and therefore cannot produce all the goods and
services people wish to have.
Economics is the study of how society manages its
scarce resources.
How people make decisions
 People face tradeoffs.
 The cost of something is what you give up to get it.
 Rational people think at the margin
 People respond to incentives.
How people interact with each other.
 Trade can make everyone better off.
 Markets are usually a good way to organize
economic activity.
 Governments can sometimes improve economic
outcomes.
The forces and trends that affect how the economy
as a whole works.
 The standards of living depends on a country’s
production.
 Prices rise when the government prints too much
money.
 Society faces a short-run tradeoff between
inflation and unemployment.
Principle #1: People Face Tradeoffs
“There is no such thing as a free lunch”
To get one thing, we usually have to give up another thing.
 Guns vs butter
 Foods vs clothing
 Leisure time vs work
 Efficiency vs equity
“Making decisions requires trading off one goal against
another.”
Efficiency vs. Equity
 Efficiency- means society gets the most that it can
from its scarce resources.
 Equity- means benefits of those resources are
distributed fairly among the members of society.
Principle #2: The Cost Of Something Is What You Give Up
To Get It.
 Decisions require comparing costs and benefits of
alternatives.
 Whether to go to college or to work?
 Whether to study or go out on a date?
 Whether to go to class or sleep in?
 The opportunity cost of an item is what you give up
to obtain that item.
Principle #3: Rational, People Think at the Margin.
 Marginal changes are small, incremental
adjustments to an existing plan of action.
“People make decisions by comparing costs and benefits at
the margin”
What does it mean?
It means to think about your next step forward. The
world “marginal” means “additional.” The first glass of
lemonade on a hot day quenches your thirst, but the next
glass maybe not so much. If you think at the margin, you are
thinking about the next or additional actions for you.
Principle #4: People Respond To Incentives.
 Marginal changes in costs or benefits motivate
people to respond.
 The decision to choose one alternative over another
occurs when that alternative’s marginal benefits
exceed its marginal costs.
Sales are incentivesfor consumers to buy because firms
know consumers generally respond to lower prices by
purchasing more.
Principle #5: Trade Can Make Everyone Better Off.
 People gain from their ability to trade with one
another.
 Competition results in gains from trading.
 Trade allows people to specialize in what they do
best.

Principle #6: Markets Are Usually A Good Way To Organize
Economic Activity.
 A market economy is an economy that allocates
resources through the decentralized decisions of
many firms and households as they interact in
markets for goods and services.
 Households decide what to buy and who to work for.
 Firms decide who to hire and what to produce.
 Adam smith made the observation that households
and firms interacting in markets act as If guided by
an “invisible hand”
Principle #7: Governments Can Sometimes Improve
Market Outcomes.
 Market failure occurs when the market fails to
allocate resources efficiently.
 When the market fails (breaks down) government
can intervene to promote efficiency and equity.
Principle #8: The Standard Of Living Depends On A
Country’s Production.
 The standard of living may be measured in different
ways.
 By comparing personal income.
 By comparing the total market value of a
nation’s production.
 Almost all the variations in living standards are
explained by differences in countries’
productivities.
 Productivity is the amount of goods and services
produced from each hour of a worker’s time.
Principle #9: Prices Rise When The Government Prints Too
MuchMoney.
 Inflation is an increase in the overall level of prices
in the economy.
 One cause of inflation is the growth in the quantity
of money.
Principle #10: Society Faces A Short-Run Tradeoff Between
Inflation and Unemployment.
 The Phillips Curve illustrates the tradeoff between
inflation and unemployment.
*Phillips Curve Illustration
SUMMARY:
 When individuals make decisions, the face
tradeoffs among alternative goals.
 The cost of any action is measured in terms of
foregone opportunities.
 Rational people make decisions by comparing
marginal costs and marginal benefits.
 People change their behavior in response to the
incentives they face.
 Trade can be mutually beneficial.
 Markets are usually a good way of coordinating
trade among people.
 Government can potentially improve market
outcomes if there is some market failure or if the
market outcome is inequitable.
 Productivity is the ultimate source of living
standards.
 Money growth is the ultimate source of inflation.
 Society faces short-run tradeoffs between inflation
and unemployment.
Lesson 2: Thinking Like Economist Our Second Model: The Production Possibilities Frontier
By: N. Gregory Mankiw  The Production Possibilities Frontier (PPF): a graph
that shows the combinations of two goods the
The Economist as Scientist economy can possibly produce given the available
 Economist play 2 roles: resources and the available technology.
1. Scientists: try to explain the world  Example:
2. Policy advisors: try to improve it  Two goods: computer and wheat
 In the first, economists employ the scientific method,  One resource: labor (measured in hours)
the dispassionate development and testing of theories  Economy has 50, 000 labor hours per month
about how the world works. available for production.

Assumptions & Models PPF Example

 Assumptions simplify the complex world, make it easier  Producing one computer requires 100 hours labor.
to understand
 Producing one ton of wheat requires 10 hours of
 Example: To study international trade, assume two labor.
countries and two goods.
Unrealistic, but simple to learn and gives useful insights Employment of labor
Production
about the real world. hours
 Model: a highly simplified representation of a more Computer
Computers Wheat Wheat
complicated reality. s
Economist use models to study economic issues. A 50,000 50,000 500 0
B 40,000 40,000 400 1,000
Our First Model: The Circular- Flow Diagram C 25,000 25,000 250 2,500
 The Circular- Flow Diagram: a visual model of the D 10,000 40,000 100 4,000
economy, shows how dollars flow through markets E 0 50,000 0 5,000
among households and firms
 Two types of “actors”
- households and firms
 Two types of markets
- the market for goods And services
- the market for “factors of production”

Factors of Production
 Factors of production: the resources the economy uses
to produce goods and services, including labor, land,
and capital (buildings & machines used in production) Active Learning 1: Points off the PPF
A. On the graph, find the point that represents (100
Figure 1: The Circular- Flow Diagram computers, 3,000 tons of wheat), label it F. would it
Households Firms be possible for the economy to produce this
Own the factors of production, Buy/ hire factors of production, combination of two goods? Why or why not?
sell/ rent them to firms for use them to produce goods and B. Next, find the point that represents (300
income. services computers, 3,500 tons of wheat), label it G. would
Buy and consume goods & Sell goods & services it be possible for the economy to produce this
services. combination of two goods?

Active Learning 1: Answers


The PPF: What
We Know So
Far
Points on the PPF (like A-E)
 possible
 efficient: all resources are fully utilized
Points under the PPF (like F)
 possible
 not efficient: some resources underutilized (e.g.,
workers unemployed, factories idle)
Points above the PPF (like G)
 not possible
The PPF and Opportunity Cost
 Recall: The opportunity cost of an item is what
must be given up to obtain that item.
 Moving along a PPF involves shifting resources
(e.g., labor) from the production of one good to the
other.
 Society faces a tradeoff: Getting more of one good
requires sacrificing some of the other.
 The slope of the PPF tells you the opportunity cost
of one good in terms of the other.
Active Learning 2: PPF and Opportunity Cost
Active Learning 2: Answers
The PPF: A Summary
 The PPF shows all combinations of two goods that
an economy can possibly produce, given its
resources and technology.
 The PPF illustrates the concepts of
tradeoff and opportunity cost, efficiency
and inefficiency. unemployment, and
economic growth.
 A bow-shaped PPF illustrates the concept
of increasing opportunity cost.
Microeconomics and Macroeconomics
 Microeconomics is the study of how households
and firms make decisions and how they interact in
markets.
 Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment,
and economic growth.
 These two branches of economics are closely
intertwined, yet distinct - they address different
questions.
The Economist as Policy Advisor
 As scientists, economists make positive
statements, which attempt to describe the world
as it is.
 As policy advisors, economists make normative
statements, which attempt to prescribe how the
world should be.
 Positive statements can be confirmed or refuted,
normative statements cannot.
 Govt employs many economists for policy advice.
Active Learning 3: Identifying positive vs. normative
Which of these statements are "positive" and which are
"normative"? How can you tell the difference?
a) Prices rise when the government increases the
quantity of money.
b) The government should print less money.
c) A tax cut is needed to stimulate the economy. d. An
increase in the price of burritos will cause an
increase in consumer demand for video rentals.
Active Learning 3: Answers
 a) Prices rise when the government increases the
quantity of money.
Positive - describes a relationship, could use data to
confirm or refute.
b) The government should print less money.
Normative - this is a value judgment, cannot be
confirmed or refuted.
c) A tax cut is needed to stimulate the economy.
Normative - another value judgment.
d) An increase in the price of burritos will cause an
increase in consumer demand for video rentals.
Interdependence
Positive- describes a relationship. Note that a
 One of the Ten Principles from Chapter 1: Trade
statement need not be true to be positive.
can make everyone better off.
 "We now learn why people - and nations - choose
Why Economists Disagree
to be interdependent, and how they can gain from
 Economists often give conflicting policy advice.
trade.
 They sometimes disagree about the validity of
alternative positive theories about the world.
Our Example
 They may have different values and, therefore,  Two countries: the U.S. and Japan
different normative views about what policy should  Two goods: computers and wheat
try to accomplish.  One resource: labor, measured in hours
 Yet, there are many propositions about which most  We will look at how much of both goods each
economists agree. country produces and consumes
 if the country chooses to be self-sufficient
 if it trades with the other country
SUMMARY:
Production Possibilities in the U.S.
 As scientists, economists try to explain the world  The U.S. has 50,000 hours of labor available for
using models with appropriate assumptions production, per month.
 Two simple models are the Circular-Flow Diagram  Producing one computer requires 100 hours of
and the Production Possibilities Frontier. labor.
 Microeconomics studies the behavior of  Producing one ton of wheat requires 10 hours of
consumers and firms, and their interactions in labor.
markets. Macroeconomics studies the economy as
a whole.
 As policy advisers, economists offer advice or to
improve the world.

Active Learning 1: Derive Japan’s PPF

Lesson 3: Interdependence and Gains from Trade

By: N. Gregory Mankiw
Use the following information to draw Japan’s PPF.
 Japan has 30,000 hours of labor available for
production, per month.
 Producing one computer requires 125 hours of
labor.
 Producing one ton of wheat requires 25 hours of
labor.
Your graph should measure computers on the horizontal
axis.

Basic international trade terms

 Exports:
goods produced domestically and sold abroad
To export means to sell domestically produced
goods abroad.
 Imports:
goods produced abroad and sold domestically
Consumption With and Without Trade
 Without trade,
1. U.S. consumers get 250 computers and
2500 tons wheat.
2. Japanese consumers get 120
computers and 600 tons wheat.
 We will compare consumption without trade to
consumption with trade.
 First, we need to see how much of each good is
produced and traded by the two countries.
To import means to purchase goods produced in
Active Learning 2: Production under Trade other countries.
1. Suppose the U.S. produces 3400 tons of wheat.
Active Learning 3: Consumption under trade
How many computers would the U.S. be able to
Suppose the U.S. exports 700 tons of wheat to Japan, and
produce with its remaining labor? Draw the point
imports 110 computers from Japan.
representing this combination of computers and
(So, Japan imports 700 tons wheat and exports 110
wheat on the U.S. PPF.
computers.)
2. Suppose Japan produces 240 computers. How many
 How much of each good is consumed in the U.S.?
tons of wheat would Japan be able to produce with
Plot this combination on the U.S. PPF.
its remaining labor? Draw this point on Japan's PPF.
 How much of each good is consumed in Japan? Plot
this combination on Japan's PPF.
  Comparative advantage: the ability to produce a
good at a lower opportunity cost than another
producer
 Which country has the comparative advantage in
computers?
 To answer this, must determine the opp. cost of a
computer in each country.

 The opp. cost of a computer is

 10 tons of wheat in the U.S., because
producing one computer requires 100 labor
hours, which instead could produce 10 tons of
wheat.
 5 tons of wheat in Japan, because producing
one computer requires 125 labor hours, which
instead could produce 5 tons of wheat.
 So, Japan has a comparative advantage in
computers. Lesson: Absolute advantage is not
necessary for comparative advantage!

Comparative Advantage and Trade

Where Do These Gains Come From?
 Gains from trade arise from comparative
 Absolute advantage: the ability to produce a good
advantage (differences in opportunity costs).
using fewer inputs than another producer
 When each country specializes in the good(s) in
 The U.S. has an absolute advantage in wheat:
which it has a comparative advantage, total
producing a ton of wheat uses 10 labor hours in the
production in all countries is higher, the world's
U.S. vs. 25 in Japan.
"economic pie" is bigger, and all countries can gain
 If each country has an absolute advantage in one from trade.
good and specializes in that good, then both
 The same applies to individual producers (like the
countries can gain from trade.
farmer and the rancher) specializing in different
goods and trading with each other.
 Which country has an absolute advantage in
computers?
Active Learning 4: Absolute & Comparative advantage
 Producing one computer requires
Argentina and Brazil each have 10,000 hours of labor per
125 labor hours in Japan,
month.
but only 100 in the U.S.
 The U.S. has an absolute advantage in both goods! In Argentina,
 producing one pound coffee requires 2 hours
So why does Japan specialize in computers? Why do both producing one bottle wine requires 4 hours
countries gain from trade? In Brazil,
 producing one pound coffee requires 1 hour
Two Measures of the Cost of a Good  producing one bottle wine requires 5 hours
 Two countries can gain from trade when each
specializes in the good it produces at lowest cost. Which country has an absolute advantage in the production
of coffee? Which country has a comparative advantage in
 Absolute advantage measures the cost of a good in
the production of wine?
terms of the inputs required to produce it.
 Recall:
Another measure of cost is opportunity cost.
 In our example, the opportunity cost of a computer
is the amount of wheat that could be produced
using the labor needed to produce one computer.

Active Learning 4: Answers

Opportunity Cost and Comparative Advantage
Brazil has an absolute advantage in coffee: Markets and Competition
 Producing a pound of coffee requires only one
labor-hour in Brazil, but two in Argentina. Market
Argentina has a comparative advantage in wine:  A group of buyers and sellers of a particular good
 Argentina's opp. cost of wine is two pounds of or service
coffee, because the four labor-hours required to - Can be highly organized
produce a bottle of wine could instead produce two E.g.: agricultural commodities
pounds of coffee. - Can be less organized
 Brazil's opp. cost of wine is five pounds of coffee. E.g.: ice cream, espresso carts, Freemont Sunday
market

SUMMARY: Market Types

1. Perfect Competition
 Interdependence and trade allow everyone to No individual buyer/seller has a significant
enjoy a greater quantity and variety of goods & influence on market price
services. 2. Monopoly
 Comparative advantage means being able to Single producer of good; chooses output (quantity
produce a good at a lower opportunity cost. supplied) that max'es profit
Absolute advantage means being able to produce 3. Oligopoly
a good with fewer inputs. Small number of suppliers; may "collude" to set
 When people - or countries - specialize in the price like a monopolist
goods in which they have a comparative 4. Monopolistic Competition
advantage, the economic "pie" grows and trade Compete on both price and quality against several
can make everyone better off. producers

Perfectly competitive market

 Each buyer/seller has a negligible impact on market
price
 Why? (Key assumptions)
- Goods offered for sale - exactly the same
- Buyers and sellers - numerous
 No single buyer or seller has any influence
over the market price
 Must accept the price determined in the
market
 Price takers
- At the market price
 Buyers - buy all they want

Demand
Basic Vocabulary
 Quantity demanded
- Amount of a good purchased at a given price
- A point on the demand curve
 Demand
- The entire schedule (curve)
- Quantity demanded at various prices
 Difference between a change in quantity demanded
and demand
- Movement along the Demand Curve (change in
price) versus movement of the D Curve

 Demand schedule - a table

Lesson 4: Market Forces of Supply and Demand - Relationship between
 - Price of a good - Increase in Demand
- Quantity demanded  Any change that increases the quantity demanded
 Demand curve - a graph at every price
- Relationship between  Entire Demand curve shifts right
- Price of a good - Decrease in Demand
- Quantity demanded  Any change that decreases the quantity demanded
 Individual demand vs Market Demand at every price
- One individual vs all people in buying the good  Entire Demand curve shifts left

Market demand
- Sum of all individual demands for a good or service

Market demand curve

- Sum - individual demand curves horizontally
- Total quantity demanded of a good varies
 As the price of the good varies
 All other factors that affect how much consumers
want to buy are hold constant

Variables that can shift the demand curve

 Income
 Prices of related goods
 Tastes
 Expectations
 Number of Buyers

Change/Shift in Demand
Shifts in demand (not quantity demanded)
 - Prohibition of cigarette advertising on television
• If successful
- Shift demand curve to the left

2. Try to raise the price of cigarettes

- Tax the manufacturer
- Much of tax - passed to consumers (high
prices)
- Movement along demand curve
- 10% increase in price → 4% decrease in
smoking
Income - Teenagers: 10% increase in price → 12%
- Normal good decrease smoking
 Other things constant - Demand for cigarettes vs. demand for marijuana
 An increase in income - Appear to be complements
- Increase in demand
- Inferior good Supply
 Other things constant Quantity supplied
 An increase in income - Amount of a good
- Decrease in demand - Sellers are willing and able to sell

Prices of related goods Law of supply

- Substitutes - two goods - Other things equal
 An increase in the price of one - When the price of the good rises
 Leads to an increase in the demand for the other • Quantity supplied of a good rises
- Complements - two goods
 An increase in the price of one Supply Schedule – a table
 Leads to a decrease in the demand for the other - Relationship between
• Price of a good
Tastes • Quantity Supplied
- Change in tastes - changes the demand
Supply Schedule – a graph
Expectations about the future (income, prices) - Relationship between
- Affect current demand • Price of a good
• Quantity Supplied
Number of buyers – increase
- Market demand - increases Individual Supply
- Supply of one seller

Two ways to reduce the quantity of smoking demanded

1. Shift the demand curve for cigarettes and other tobacco
products
- Public service announcements
- Mandatory health warnings on cigarette packages
Market Supply - Technology
- Sum of the supplies of all sellers for a good or service Advance in technology – increase in supply
- Expectations about future
Market supply curve Affect current supply
- Sum – individual supply curves horizontally - Number of sellers – increase
- Total quantity supplied of a good varies Market supply – increase
 As the price of the good varies
 All other factors that affect how much suppliers
want to sell are hold constant

Supply and Demand Together

Equilibrium - a situation
- Market price has reached the level:
• Quantity supplied = quantity demanded

Equilibrium price - the price:

- Balances quantity supplied and quantity demanded

Equilibrium quantity
- Quantity supplied and the quantity demanded at the
equilibrium price

Shifts in Supply
- Increase in Supply
 Any change that increases the quantity supplied at
every price
 Supply curve shifts right
- Decrease in Supply
 Any change that decreases the quantity supplied at
every price
 Supply curve shifts left

Surplus
- Quantity supplied > quantity demanded
- Excess supply
- Downward pressure on price

Shortage
- Quantity demanded > quantity supplied
- Excess demand
- Upward pressure on price

Variables that can shift the supply curve

- Input Prices
Supply – negatively related to prices of inputs
 Example: A change in market equilibrium due to a shift in
supply
- One summer - a hurricane destroys part of the sugarcane
crop
 Price of sugar - increases
- Effect on the market for ice cream?
1. Change in price of sugar - supply curve
2. Supply curve - shifts to the left3. Higher equilibrium price;
lower equilibrium quantity

Law of supply and demand

- The price of any good adjusts
• Bring the quantity supplied and the quantity
demanded into balance
- In most markets
• Surpluses and shortages are temporary

Three steps to analyzing changes in equilibrium

1. Decide: the event shifts the supply curve, the demand
curve, or both curves
2. Decide: curve shifts to right or to left
3. Use supply-and-demand diagram
 Compare initial and new equilibrium
 How the shift affects equilibrium price and quantity
Supply and Demand Together
Example: A change in market equilibrium due to a shift in
demand
- One summer - very hot weather
- Effect on the market for ice cream?
1. Hot weather - demand curve (tastes)
2. Demand curve shifts to the right
3. Higher equilibrium price; higher equilibrium quantity
Example: shifts in both supply and demand
- One summer: hurricane and heat wave
1. Heat wave - shift demand curve; hurricane –
shift supply curve
2. Demand curve shifts to the right; Supply curve
shifts to the left
3. Equilibrium price raises
- If demand increases substantially while supply
falls just a little: equilibrium quantity -rises
-If supply falls substantially while demand rises just
a little: equilibrium quantity falls

Shifts in curves versus movements along curves

- Shift in the supply curve
 Change in supply
- Movement along a fixed supply curve
 Change in the quantity supplied
- Shift in the demand curve
 Change in demand
- Movement along a fixed demand curve
 Change in the quantity demanded