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
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
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
Ideas for Beyond the Final Exam
1. 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
4
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)
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
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
7
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
8
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
9
Map 1
Detailed Road Map of Los Angeles
10
Map 2
Major Los Angeles Arteries and Freeways
11
Inside the Economist’s Tool Kit
• Abstraction, simplification
– Unimportant details
– Necessary
• Understand complex economy
• Degree of abstraction
– Objective of analysis
12
Map 3
Greater Los Angeles Freeways
13
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
14
Inside the Economist’s Tool Kit
• Economic model
– Simplification - aspect of the real
economy
– Expressed
• Equations
• Graphs
• Words
• Disagreements
– Imperfect information
– Value judgments
15
APPENDIX
Using graphs: a review
• Economic graphs
– Large quantity of data - quickly
– Facilitate data interpretation & analysis
– At a glance
• Important statistical relationships
• Variable
– Measure: number
– Analysis
16
APPENDIX
Using graphs: a review
• Two-variable diagrams
• Horizontal axis
• Vertical axis
• Origin
– Abstract
– Focus
• Two variables of primary interest
17
Figure 1
6
6
5
5
4
4
P
3
Price
Price
Hypothetical demand curve for natural gas: St. Louis
a
b
2
P
3
a
b
2
D
1
1
Q
Q
0
20 40 60 80 100 120 140
Quantity
(a)
0
20 40 60 80 100 120 140
Quantity
(b)
18
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
19
APPENDIX
Using graphs: a review
• Slope of straight line
– Ratio: vertical change “rise”
– To: horizontal change “run”
• Negative slope
– One variable falls, other rises
• Positive slope
– Both variables rise
20
Figure 2
Different types of slope of a straight-line graph
Y
Y
Negative slope
Positive slope
0
X
(a)
Y
0
X
(b)
Y
Zero slope
0
Infinite
slope
X
(c)
0
X
(d)
21
APPENDIX
Using graphs: a review
• Zero slope
– Y value doesn’t change
• Infinite slope
– X value doesn’t change
• Slope of straight line
– Same numerical value
22
Figure 3
How to measure slope
Y
Y
C
11
C
9
8
Slope = 1/10 B
A
0
8
3
13
(a)
A
X
0
Slope = 3/10
3
B
13
X
(b)
23
APPENDIX
Using graphs: a review
• Slope of curved line
– Different numerical value
– At one point
• Slope of tangent (straight line)
24
Figure 4
Behavior of slopes in curved graphs
Y
Y
Positive slope
Negative slope
0
X
(a)
Y
0
X
(b)
Y
Negative
slope
Negative
slope
Positive
slope
0
X
(c)
0
Positive
slope
X
(d)
25
Figure 5
How to measure slope at a point on a curved graph
Y
r
8
D
7
6
R
t
5
F
E
C
4
T
G
r
3
M
2
1
A
t
B
X
0
1
2
3
4
5
6
7
8
9
10
26
APPENDIX
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
27
Figure 6
Rays through the origin
Y
5
Slope = +2
4
B
Slope = +1
C
3
A
2
K
1
Slope = +1/2
E
D
0
1
2
3
X
4
5
28
APPENDIX
Using graphs: a review
• Contour map (topographical map)
– Three pieces of data
• Latitude
• Longitude
• Altitude
29
Figure 7
A geographic contour map
30
APPENDIX
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
31
Figure 8
An economic contour map
Y
80
Yards of cloth per day
70
60
50
40
30
A
Z = 40
B
Z = 30
20
Z = 20
10
0
Z = 10
10 20 30 40 50 60 70 80
X
Labor hours per day
32