SV151, Principles of Economics K. Christ 28 November to 2 December 2011

Transcription

1 SV151, Principles of Economics K. Christ 28 November to 2 December 2011

2 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

3 Principle 8: A country s standard of living depends on its ability to produce goods and services $35,000 Per Capita Gross Domestic Product Constant 1999 International Dollars $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 U.K. France U.S. Japan China India Brazil Source: Angus Maddison, ; 1990 International Geary-Khamis dollars (adjusted for purchasing power).

4 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 what-makes-nation-rich.html U.K. France U.S. Japan China India Brazil Source: Angus Maddison, ; 1990 International Geary-Khamis dollars (adjusted for purchasing power).

5 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

6 Ranking Counties by per capita GDP COUNTRY PCGDP 1 Singapore 56,694 2 Norway 51,959 3 United States 46,860 4 Switzerland 41,950 5 Netherlands 40,973 6 Australia 39,764 7 Austria 39,761 8 Ireland 39,492 9 Canada 39, Sweden 38, Iceland 36, Denmark 36, Belgium 36, Germany 36, United Kingdom 35, Finland 34, France 33, Japan 33, South Korea 29, Spain 29, Italy 29, Greece 28, Slovenia 28, New Zealand 27, Czech Republic 24, Portugal 23, Slovakia 22, Poland 18, Hungary 18,841 by United Nation s Human Development Index COUNTRY HDI 1 Norway Australia Netherlands United States New Zealand Ireland Canada Germany Switzerland Sweden Japan Iceland South Korea Denmark Belgium Austria France Slovenia Finland Spain Italy Singapore Czech Republic United Kingdom Greece Slovakia Hungary Poland Portugal by New Economic Foundation s Happy Planet Index COUNTRY HPI 1 Netherlands Singapore Switzerland Germany Sweden Austria Finland Belgium Slovenia South Korea Italy France Slovakia United Kingdom Japan Spain Poland Ireland Norway Canada Hungary Czech Republic Iceland Greece Portugal Australia New Zealand Denmark United States 30.7

7 Principle 1: People face trade-offs Principle 2: The cost of something is what you give up to get it Good y Good y Using a PPF to illustrate Principles 1 and 2 Figure 1 Figure 1: a. List all points that are efficient. b. List all points that are possible but inefficient A D B E C c. 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. 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? f. Why do we normally presume that an allocation such as point E is superior to an allocation such as point A? Figure 2: 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? F G H I Good x Figure 2 B A C Good x

8 Principle 3: Rational people think at the margin Level of Activity Total Benefits Total Costs Net Benefits Marginal Benefits Marginal Costs Total Costs Total Benefits Level Level Net Benefits Marginal Costs Level Marginal Benefits

9 The Stimulus Debate, 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.

10 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 Mark Zandi Moody s Analytics: The Economic Stimulus Act of 2008 worked Taylor, John B The Lack of an Empirical Rationale for a Revival of Discretionary Fiscal Policy. American Economic Review Papers and Proceedings 99 (May): Zandi, Mark Perspectives on the Economy. Testimony before the House Budget Committee, July 1. * Christina D. Romer, What do we know about the effects of fiscal policy? Separating Evidence from Ideology Talk given at Hamilton College, November 7, Available at:

11 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.

12 Disagreeable Economists

13 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.

14 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 Lester Thurow MIT Edward Prescott Arizona State

15 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)

16 Interdependence and Gains from Trade Technology and Opportunity Cost: Production Requirements Meat Potatoes An Illustration of Comparative Advantage and Gains from Trade Opportunity Cost 1 Unit of Meat 1 Unit of Potatoes Farmer Rancher 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 Meat Potatoes Meat Consumption Potatoes Farmer Rancher 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 Consumption Meat Potatoes Meat Potatoes Farmer Rancher 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.

17 Comparative Advantage and International Trade An Illustration of Comparative Advantage and Gains from Trade Technology and Opportunity Cost: Production Requirements Opportunity Cost Tractors Yams 1 Tractor 1 Yam Eq. Guinea United States 200,000 hours 200 hours 5 hours 1 hour 40,000 yams 200 yams 1/40,000 tractor 1/200 tractor Tractors United States Expanded consumption possibilities made possible by trade Equitorial Guinea Tractors Yams Equatorial Guinea s opportunity cost: 1 tractor = 40,000 yams U.S. opportunity cost: 1 tractor = 200 yams Yams

18 Comparative Advantage and International Trade An Illustration of Comparative Advantage and Gains from Trade Technology and Opportunity Cost: Production Requirements Opportunity Cost Tractors Yams 1 Tractor 1 Yam Eq. Guinea United States 200,000 hours 200 hours 5 hours 1 hour Production and Consumption without Trade: Tractors Production Yams 40,000 yams 200 yams Tractors Consumption 1/40,000 tractor 1/200 tractor Yams Eq. Guinea United States ,000 2,000, ,000, ,000 2,000, ,000,000 Production Assumptions: 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 Tractors Production Yams Tractors Consumption Yams Eq. Guinea United States 0 505,000 4,000,000 99,000, ,900 2,000, ,000,000 Trading price: 20,000 yams = 1 tractor. Pattern of Trade: Eq. Guinea exchanges 2 million yams for 100 tractors from the U.S.

19 Significance of International Trade in the U.S. Economy, % 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Exports as a Percentage of GDP Imports as a Percentage of GDP Source: Bureau of Economic Analysis,

20 Trade Position of the U.S. Economy, % 4% 2% 0% -2% -4% -6% Net Exports as a Percentage of GDP (Left Scale) Source: Bureau of Economic Analysis,