SV151, Principles of Economics
K. Christ
28 November to 2 December 2011
Mankiw’s Ten Principles (Chapter 1)
How People Make Decisions
1. People face tradeoffs
2. The cost of something is what you give up to get it
3. Rational people think at the margin
4. People respond to Incentives
How People Interact
5. Trade can make everyone better off
6. Markets are usually a good way to organize economic activity
7. Governments can sometimes improve market outcomes
How the Economy as a Whole Works
8. A country’s standard of living depends on its ability to produce goods and services
9. Prices rise when the government prints too much money
10. Society faces a short-run trade-off between inflation and unemployment
Principle 8: A country’s standard of living depends on its ability to produce
goods and services
Per Capita Gross Domestic Product
Constant 1999 “International” Dollars
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
U.K.
France
U.S.
Japan
China
India
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
1890
1880
1870
1860
1850
1840
1830
1820
$0
Brazil
Source: Angus Maddison, http://www.ggdc.net/MADDISON/oriindex.htm ; 1990 International Geary-Khamis dollars (adjusted for purchasing power).
Principle 8: A country’s standard of living depends on its ability to produce
goods and services
Per Capita Gross Domestic Product
Natural Logs of Constant 1999 “International” Dollars
11.00
http://gregmankiw.blogspot.com/2009/11/
what-makes-nation-rich.html
10.50
10.00
9.50
9.00
8.50
8.00
7.50
7.00
6.50
U.K.
France
U.S.
Japan
China
India
2000
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
1890
1880
1870
1860
1850
1840
1830
1820
6.00
Brazil
Source: Angus Maddison, http://www.ggdc.net/MADDISON/oriindex.htm ; 1990 International Geary-Khamis dollars (adjusted for purchasing power).
Principle 8: A country’s standard of living depends on its ability to produce
goods and services … Really?
"Too much and too long, we seem to have surrendered personal excellence and
community values in the mere accumulation of material things. Our gross
national product -- if we should judge America by that -- counts air pollution and
cigarette advertising, and ambulances to clear our highways of carnage. It
counts special locks for our doors and the jails for those who break them. It
counts the destruction of our redwoods and the loss of our natural wonder in
chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and
armored cars for police who fight riots in our streets. It counts Whitman's rifle
and Speck's knife, and the television programs which glorify violence in order to
sell toys to our children.
"Yet the gross national product does not allow for the health of our children, the
quality of their education, or the joy of their play. It does not include the beauty
of our poetry or the strength of our marriages; the intelligence of our public
debate or the integrity of our public officials. It measures neither our wit nor
our courage; neither our wisdom nor our learning; neither our compassion nor
our devotion to our country; it measures everything, in short, except that which
makes life worthwhile. And it tells us everything about America except why we
are proud that we are Americans."
Robert F. Kennedy
Lawrence, Kansas, March 18, 1968
Ranking Counties …
by United Nation’s
Human Development Index
by per capita GDP
COUNTRY
1 Singapore
2 Norway
3 United States
4 Switzerland
5 Netherlands
6 Australia
7 Austria
8 Ireland
9 Canada
10 Sweden
11 Iceland
12 Denmark
13 Belgium
14 Germany
15 United Kingdom
16 Finland
17 France
18 Japan
19 South Korea
20 Spain
21 Italy
22 Greece
23 Slovenia
24 New Zealand
25 Czech Republic
26 Portugal
27 Slovakia
28 Poland
29 Hungary
PCGDP
56,694
51,959
46,860
41,950
40,973
39,764
39,761
39,492
39,171
38,204
36,730
36,443
36,274
36,081
35,059
34,918
33,910
33,885
29,997
29,830
29,480
28,496
28,073
27,130
24,950
23,262
22,195
18,981
18,841
COUNTRY
1 Norway
2 Australia
3 Netherlands
4 United States
5 New Zealand
6 Ireland
7 Canada
8 Germany
9 Switzerland
10 Sweden
11 Japan
12 Iceland
13 South Korea
14 Denmark
15 Belgium
16 Austria
17 France
18 Slovenia
19 Finland
20 Spain
21 Italy
22 Singapore
23 Czech Republic
24 United Kingdom
25 Greece
26 Slovakia
27 Hungary
28 Poland
29 Portugal
HDI
0.941
0.927
0.909
0.908
0.908
0.907
0.907
0.903
0.901
0.901
0.899
0.896
0.894
0.893
0.885
0.883
0.883
0.882
0.880
0.876
0.873
0.864
0.863
0.862
0.860
0.832
0.814
0.811
0.808
by New Economic Foundation’s
“Happy Planet Index”
COUNTRY
Netherlands
Singapore
Switzerland
Germany
HPI
50.6
48.2
48.1
48.1
5 Sweden
6 Austria
7 Finland
8 Belgium
9 Slovenia
10 South Korea
11 Italy
12 France
13 Slovakia
14 United Kingdom
15 Japan
16 Spain
17 Poland
18 Ireland
19 Norway
20 Canada
21 Hungary
22 Czech Republic
23 Iceland
24 Greece
25 Portugal
26 Australia
27 New Zealand
28 Denmark
29 United States
48.0
47.7
47.2
45.4
44.5
44.4
44.0
43.9
43.5
43.3
43.3
43.2
42.8
42.6
40.4
39.4
38.9
38.3
38.1
37.6
37.5
36.6
36.2
35.5
30.7
1
2
3
4
Principle 1: People face trade-offs
Principle 2: The cost of something is what you give up to get it
Using a PPF to illustrate Principles 1 and 2
Figure 1
12
Figure 1:
A
10
a.
B
List all points that are efficient.
C
b.
c.
List all points that are possible but inefficient.
Good y
8
If the current allocation is {10,7}, what is the
opportunity cost of a 4 unit increase in x?
e.
If the current allocation is {10,4}, what is the
opportunity cost of a 3 unit increase in y?
6
G
F
4
If allocations are denoted as {x,y}, and the current
allocation is {6,9}, what is the opportunity cost of an
4 unit increase in x?
d.
E
D
H
2
I
0
2
4
6
8
10
12
14
16
12
14
16
Good x
Figure 2
14
B
12
Why do we normally presume that an allocation
such as point E is superior to an allocation such as
point A?
10
Good y
f.
A
C
8
6
Figure 2:
4
g.
If an economy is initially at point A (on the black
PPF) and economic growth occurs as indicated in
the y sector of the economy, what is the
opportunity cost of a movement from A to C?
2
0
2
4
6
8
Good x
10
Principle 3: Rational people think at the margin
Level of
Activity
Total
Benefits
Total
Costs
Net
Benefits
Marginal
Benefits
Marginal
Costs
50
Total
Costs
40
Total
Benefits
30
20
0
0
0
0
1
12
4
8
12
4
2
22
8
14
10
4
3
30
12
18
8
4
25
4
36
16
20
6
4
20
5
40
20
20
4
4
10
6
42
24
18
2
4
5
7
42
28
14
0
4
8
40
32
8
-2
4
9
36
36
0
-4
4
15
10
30
40
-10
-6
4
10
10
Level
0
0
1
2
3
4
5
6
7
8
9
10
-5 0
1
2
3
4
5
6
7
8
9
10
15
Level
0
-10
-15
Marginal
Costs
Level
5
0
0
-5
-10
Net
Benefits
1
2
3
4
5
6
7
8
9
10
Marginal
Benefits
The Stimulus Debate, 2008 – 2009
Washington, February 13, 2008:
President Bush, surrounded by
members of Congress and Cabinet
members, signs the Economic Stimulus
Act of 2008, a $150 billion package of
tax rebates that centered on rebate
checks of $600 to $1,800 for most
taxpayers.
Denver, February 17, 2009:
President Obama signs the American
Recovery and Reinvestment Act, a
$787 billion fiscal stimulus package
comprised of tax cuts and new shortterm spending intended to help pull
the U.S. economy out of recession.
Thinking Like an Economist
“The essential lesson from this example is that you can’t deduce the effect of a tax rebate or some other
policy by just looking at outcomes. You have to think hard about what else was going on, and where the
economy was heading in the absence of policy.”*
John Taylor, Stanford University:
The Economic Stimulus Act of 2008 did not work
Taylor, John B. 2009. “The Lack of an Empirical
Rationale for a Revival of Discretionary Fiscal Policy.”
American Economic Review Papers and Proceedings 99
(May): 550-555.
Mark Zandi Moody’s Analytics:
The Economic Stimulus Act of 2008 worked
Zandi, Mark. 2010. “Perspectives on the Economy.”
Testimony before the House Budget Committee, July 1.
http://www.economy.com/mark-zandi/
* Christina D. Romer, “What do we know about the effects of fiscal policy? Separating Evidence from Ideology” Talk given
at Hamilton College, November 7, 2011. Available at:
http://www.econ.berkeley.edu/~cromer/Written%20Version%20of%20Effects%20of%20Fiscal%20Policy.pdf
Congressional Budget Office: Estimated Impact of the American Recovery and Reinvestment
Act (ARRA) on Employment and Economic Output as of September 2009 (November 2009)
CBO estimates that in the third quarter of calendar year 2009, an additional 600,000 to 1.6 million people were employed in
the United States, and real (inflation-adjusted) gross domestic product (GDP) was 1.2 percent to 3.2 percent higher, than
would have been the case in the absence of ARRA. Those ranges are intended to reflect the uncertainty of such estimates
and to encompass most economists’ views on the effects of fiscal stimulus.
Disagreeable Economists
Economic Methodology
Models:
Simplified
Representations
of Reality
Abstract thinking
Observation and data collection
Econometrics:
Application of
Statistical Methods
to Economic Questions
Testing and analysis
Microeconomics: The study of how agents make
decisions and how they interact in markets.
Macroeconomics: The study of economy-wide
phenomena, such as economic growth, cyclical
fluctuations, price behavior and resource employment.
Tradeoffs, Incentives, Economic and Sociological Explanations, …
August 15, 2002: “Take August Off”
Average Number of Paid
Holidays and Vacation Days per Year
Sweden
France
Japan
United States
Orvar Löfgren
Lunds University
32
30
25
16
Lester Thurow
MIT
Edward Prescott
Arizona State
Two Contrasting Approaches to Social Science Inquiry
Methodological Individualism
“…every complex social situation,
institution, or event is the result of a
particular configuration of individuals, their
dispositions, situation, beliefs, and physical
resources and environments … we shall not
have arrived at rock-bottom explanations of
such large-scale phenomena until we have
deduced an account of them from
statements about the dispositions, beliefs,
resources and interrelations of individuals.”
J.W. N. Watkins
“Historical Explanation in the Social Sciences”
(1957)
“All social or collective phenomena, such as
institutions, are to be endogenized and
explained in terms of individual human
action.”
Malcom Rutherford
Institutions in Economics (1994)
Holism
(i)
“Society is the ‘whole’ which is more
than the sum of its parts”;
(ii) “Society affects the individual’s
aims”; and
(iii) “the social set up influences and
constrains the individual’s behavior”
Joseph Agassi
“Methodological Individualism”
British Journal of Sociology (1960)
“… holism is concerned with the social
influences that bear on individual action.
The individual is seen as socialized, as
having internalized the norms and values
of the society he inhabits. The holist
focuses attention on how social ‘forces’
(institutions, social conventions, etc.)
condition individual behavior.”
Malcom Rutherford
Institutions in Economics (1994)
Interdependence and Gains from Trade
An Illustration of
Comparative Advantage
and Gains from Trade
“Technology” and Opportunity Cost:
Production Requirements
Farmer
Rancher
Opportunity Cost
Meat
Potatoes
1 Unit of Meat
1 Unit of Potatoes
60 min./oz.
20 min./oz.
15 min./oz.
10 min./oz.
4 units potatoes
2 units potatoes
¼ unit meat
½ unit meat
Production and Consumption without Trade:
Production
Farmer
Rancher
Consumption
Meat
Potatoes
Meat
Potatoes
4
12
16
24
4
12
16
24
Assumes 8 hours of production and perfect diversification in production (4 hours devoted to the production of each good.
Production and Consumption with Trade based upon Comparative Advantage
Production
Farmer
Rancher
Consumption
Meat
Potatoes
Meat
Potatoes
0
18
32
12
5
13
17
27
Trading price: 3 units of potatoes = 1 unit of meat.
Pattern of Trade: Farmer exchanges 15 units of potatoes for 5 units of meat from the rancher.
Comparative Advantage and International Trade
An Illustration of Comparative Advantage and Gains from Trade
“Technology” and Opportunity Cost:
Production Requirements
Eq. Guinea
United States
Opportunity Cost
Tractors
Yams
1 Tractor
1 Yam
200,000 hours
200 hours
5 hours
1 hour
40,000 yams
200 yams
1/40,000 tractor
1/200 tractor
United States
Equitorial Guinea
Tractors
Tractors
Expanded
consumption possibilities
made possible
by trade
Yams
Equatorial Guinea’s opportunity cost:
1 tractor = 40,000 yams
Yams
U.S. opportunity cost:
1 tractor = 200 yams
Comparative Advantage and International Trade
An Illustration of Comparative Advantage and Gains from Trade
“Technology” and Opportunity Cost:
Production Requirements
Eq. Guinea
United States
Opportunity Cost
Tractors
Yams
1 Tractor
1 Yam
200,000 hours
200 hours
5 hours
1 hour
40,000 yams
200 yams
1/40,000 tractor
1/200 tractor
Production and Consumption without Trade:
Production
Tractors
Yams
Eq. Guinea
United States
Production Assumptions:
50
500,000
2,000,000
100,000,000
Consumption
Tractors
50
500,000
Yams
2,000,000
100,000,000
Eq. Guinea distributes 20 million hours equally between production of tractors and yams.
U.S. distributes 200 million hours equally between production of tractors and yams.
Production and Consumption with Trade based upon Comparative Advantage
Production
Eq. Guinea
United States
Consumption
Tractors
Yams
0
505,000
4,000,000
99,000,000
Tractors
100
504,900
Trading price: 20,000 yams = 1 tractor.
Pattern of Trade: Eq. Guinea exchanges 2 million yams for 100 tractors from the U.S.
Yams
2,000,000
101,000,000
Significance of International Trade in the U.S. Economy, 1929 – 2007
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
Exports as a Percentage of GDP
Source: Bureau of Economic Analysis, http://www.bea.doc.gov
Imports as a Percentage of GDP
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
1977
1974
1971
1968
1965
1962
1959
1956
1953
1950
1947
1944
1941
1938
1935
1932
1929
0%
Trade Position of the U.S. Economy, 1929 – 2007
6%
4%
2%
0%
-2%
-4%
Net Exports as a Percentage of GDP (Left Scale)
Source: Bureau of Economic Analysis, http://www.bea.doc.gov
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
1977
1974
1971
1968
1965
1962
1959
1956
1953
1950
1947
1944
1941
1938
1935
1932
1929
-6%