1 INTRODUCTION TO KEY IDEAS
Macroeconomics: studies the economy as a system in which
feedbacks among sectors determine national output,
employment and prices
Microeconomics: the study of individual behaviour in the
context of scarcity
Markets: play a key role in coordinating the choices of
individuals with the decisions of business
|_ improves efficiency, trading of skills and goods
Mixed economy: goods and services are supplied both by
private suppliers and government
Model: formalization of theory that facilitates scientific enquiry
Theory: logical view of how things work through observation
|_ transform theory into model to test the theory
Opportunity cost: choice of what must be sacrificed when a
choice is made
Production Possibility Frontier (PPF): the combination of
goods that can be produced using all the resources available
For 36 hours:
Amanda = 3 fish/h & 2 vegetables/h Zoe = 2 fish/h & 4 vegetables/h
|_ 12F or 18V = 3:2 opportunity cost 18F or 9V = 1:2 opportunity cost
Vegeta ble
Fish
18
9
Amanda’s
PPF
Zoe’s PPF
Zoe specializes,
Has absolute
advantage
Amanda specialize
Has absolute
advantage
Terms of trade: 1:1
Vegeta ble
Fish
18
18
With specialization and
trade they consume
along the line joining
specialization points
Amanda initially consumes: {6,9}
Zoe initially consumes: {9, 4.5}
12 18
Amanda consumes: {8, 10}
Zoe consumes: {10, 8}
Economy-wide PPF: set of good combinations that can be
produced in the economy when all available productive
resources are in use
Vegeta ble
Fish
18
9
Amanda’s
PPF
Zoe’s PPF
12 18
27
30
With complete specialization the
economy can produce 27V or
30F
a
c 18, 18
e
Vegeta ble
Fish
ab
c
d
Opportunity
cost of
producing fish
Most efficient
fish producer
Next most efficient
fish producer
Muti Person PPF
Economy-wide PPF
Productivity of Labour: output per worker or per hour, depends on:
|_ skill, knowledge and experience of the labour force
|_ capital stock: buildings, machinery & equipment
|_ technological trends in labour force and capital stock
Economy output (Y): Y = (# of workers) x (output/worker)
Full Employment Output (Yc):
|_ Yc = (# of workers at full employment) x (output/worker)
Economic recession: output falls below the economy’s capacity
output
Economic Boom: period of high growth that raises output above
capacity output
Shift outwards =
economic boom
Shift inwards =
economic recession
2 THEORIES MODELS AND DATA
Variables: measures that can take on different values
Data: recorded values of variables
|_ time series: measurements made at different points in time
|_ high/low frequency: series with short/long intervals between
observations
|_ cross-section: values for different variables recorded at a
point in time
|_ longitudinal: follow the same units of observation through
time
Index number: value of a
variable or average of a
set of variables with
respect to the base value
Index = absolute value of current
absolute value of base x 100
Price index = (oil index x 0.6) + (natural
gas index x 0.25) + (coal index x 0.15)
Inflation rate: annual % increase in consumer price index
Deflation rate: annual % decrease in consumer price index
Consumer Price Index:
average level for consumer
goods and services
CPI = cost of basket in current year
cost of basket in base year x 100
Nominal earnings: earnings measured in current dollars
Real earnings: earnings measure in constant dollars to adjust
for changes in the general price level
Nominal Price Index: current dollar price of a good or service
Real Price Index: nominal
price index divided by the
consumer price index
Real Index = nominal index
CPI x 100
Econometrics: examining and quantifying relationships
between economic variables
Regression line: average relationship between two variables in
a scatter diagram
Intercept of a Line: height of the line on one axis when the
value of the variable on the other access is zero
Slope of a Line: ratio of the of change in variables
Positive economics (facts): objective explanation of economy
Normative economics (values): offers recommendations
Economic Equity: concerned with the distribution of well-being
among members of the economy
Economics: ideas and methods for betterment of society
|_ markets facilitate exchange and encourage efficiency
|_ incentives, humans are not purely mercenary
importance of government policy, governments can best address abuses of
monopolies. Provides a legal framework for a mixed economy. Support
efficient market function through competition policy, education, international
trade, taxes, welfare
3 CLASSICAL MARKETPLACE - DEMAND & SUPPLY
Marketplace: buyers and sellers come together to exchange
Demand: quantity of a good or service that buyers wish to purchase
at each possible price
Supply: quantity of a good or service that sellers are willing to sell
at each possible price
Quantity Demanded: amount purchased at a particular price
Quantity Supplied: amount supplied at a particular price
* All other influences on supply and demand remain the same
Equilibrium Price: price when quantity demanded equals quantity
supplied Price
10
1
4
610
Quantity
Demand
Supply
Excess
supply
above 4
Excess
demand
below 4
Demand: P = 10 - Q
Supply: P = 1 + 0.5Q
Excess supply: when quantity
supplied exceeds the quantity
demanded at the going price
Excess demand: when
quantity demanded exceeds
the quantity supplied at the
going price
Substitute goods: a price reduction/rise for a related product
reduces/increases the demand for a primary product
Complementary goods: a price reduction/rise for a related product
increases/reduces the demand for a primary product
Inferior good: demand falls in response to higher incomes
Normal good: demand increases in response to higher incomes
Influences of Demand: prices of related goods, buyer incomes,
expectations
Influences of Supply: technology, input costs, competing products
Outward shift =
increased demand
Rightward shift =
increased supply
Market Interventions
Price controls: government rules or laws that inhibit the formation of
market-determined prices
Price ceilings: suppliers
cannot legally charge more
than a specific price
Price floors: sets price above
the market clearing price
E
Q
Q
P
PE
Excess
demand at P
Price
Quantity
E
Q
P
Excess
supply at P
Price
Quantity
P
Q
Quotas: physical restrictions on output.
Reduces supply and increases price
E
Q
P
Price
Quantity
S = supply with quota
Q
Market demand: horizontal sum of
individual demands
Quantity
Price
Demand A
Demand B
Demand A + B
4 MEASURES OF RESPONSE: ELASTICITIES
Price elasticity
of demand
percentage change in quantity demanded
percentage change in price
Arc Elasticity of Demand: consumer responsiveness over a
segment or arc of the demand curve
Elasticity Variation with Linear Demand Limiting Cases of Elasticity
Price
Midpoint of D (unit elastic)
Elastic range
Inelastic range
Quantity
Price D
D
D’
Large
elasticity
Infinite
elasticity
Zero
elasticity
Point Elasticity of Demand: elasticity
computer at a point on the demand
curve
Inverted slope
of demand
curve
Use average
for these
Influences of Elasticity: tastes, ease of substituting goods, one
brand with substitutes = elastic, group of products = inelastic,
products with no substitutes = inelastic
Price
Quantity
P
P
P
P
QQQ Q
Midpoint
Elastic
Inelastic
Expenditure
is greatest
Total Expenditure = P x Q
In elastic region reducing
price increases total
expenditure
In inelastic region reducing
price decreases total
expenditure
Time horizon and inflation: long run = elastic, short run = inelastic
Cross-price
elasticity of
demand
% change in quantity demanded
% change in price of other product
Substitutes if positive, complements if negative
Income
elasticity of
demand
% change in quantity demanded
% change in income
Normal good if positive, inferior good if negative
(Luxury good) (Necessity)
* all of this applies to elasticity of supply
Elasticities and Tax Incidence
Specific tax: involves a fixed dollar levy per unit of good sold
Ad Valorem: percentage tax
Tax Incidence with Elastic Supply Tax Incidence with Inelastic Supply
Price
Quantity
P
P
P
QQ
Producer
Buyer Supplier increases
price Supplier pays P
Buyer pays P
Incidence is on
buyer
Price
Quantity
Supplier pays P
Buyer pays P
Incidence is on
supplier
P
P
P
QQ
5 WELFARE ECONOMICS AND EXTERNALITIES
Welfare economics: how well the economy allocates its scarce resources
in accordance with the goals of efficiency and equity
Equity: how society’s goods and rewards are distributed among members
Efficiency: how well the economy resources are used and allocated
Consumer surplus (demand): excess of consumer willingness to pay over
the market price
Producer surplus (supply): excess of market price over the reservation
price of the supplier
Quantity
Rent
$900
$500 CS=400 CS=300 CS=200 CS=100
PS=200 PS=150 PS=100 PS=50
Gladys
Heward
Ian Jeff
Kirin
Frank
Lynn
Evan
Don
Cathy
Brian
Alex
Equilibrium
$300
Demand: P = 1000 - 100Q
Supply: P = 250 + 50Q
Measuring Surplus
Quantity
Rent
$900
$500
Gladys
Heward
Ian Jeff
Kirin
Frank
Lynn
Evan
Don
Cathy
Brian
Alex
$300
Efficient market: maximizes the sum of producer and consumer
surpluses. (Marginal benefit (demand) = marginal cost (supply))
Tax Wedge: difference between consumer and producer prices
Revenue Burden: amount of tax revenue raised by tax
Excess Burden/Deadweight Loss: the component of consumer and
producer surpluses forming a net loss to the whole economy
The efficiency cost of taxation
Price
Quantity
Tax wedge
Taxation and labour supply
Quantity
Wage
Depends on
elasticity
Externality: benefit or cost falling on people other than those involved in
the activity’s market. It can create a difference between private costs or
values and social costs or values
Negative Externalities and Inefficiency
Full social
supply cost
Private
supply cost
Additional
cost
* Fix: corrective tax: direct the market towards a more efficient output
Positive Extenalities
Price
Quantity
Private value
Full social
cost Subsidy
Other Market Failures: profit seeking monopolies, public goods i.e. radio,
national defence, health, international externalities
Environmental Policy and Climate Change
Greenhouse Gases: accumulate excessively in the earth’s atmosphere
prevent heat from escaping
Kyoto Protocol: committed themselves to reducing GHG emissions
relative to 1990 by 2012, Canada’s target of 6% reduction in GHGs
Economic Policies for Climate Change
Three ways to control polluters: direct controls (warn big emitters),
incentives (pollution taxes) or tradable “permits” to pollute
Marginal Damage Curve: costs to society of an addition unit of pollution
Marginal abatement curve: costs to society of reducing quantity of
pollution by one unit
Marginal
abatement
cost
Pollution cost
Pollution
quantity
Optimal level of
pollution
A can ask for
permits from B =
‘cap and trade’
system
In an ideal world permits could be traded internationally between developed and
developing countries
Corrective taxes are called Pigovian taxes = tax package reform, reduce taxes
in other sectors of the economy to main revenue neutral impact
Marginal Damage
DSt
DSt + s S
8
++
6ts
+
S5
o
5
.
o.
4
sz
s
t o t o
•
(1,900 ),(2,800 )
p= 805.9101=-100 Qtb
.b=lO00→P= 1000 -IOOQ
1 2 3 4 5 6
Cs= 5.5200=511250
{efficient ps= 5.2250=15625
use S
+Cfs f
)•
°
c
•
°
f•.
c.
aPS D
.
.
.
1 2 3 4 5 6
C0f0
g
:0
St
qoS
CS
EtD
Pt
Po tbauxrden Dwi
EO
wag§°Yevenue|pwL
Pts .Dtax D+
PS
Lt
pQt Qo
{D= %
=
po p
.
✓.DQ=0→o Sf S
%DP
e= -9
f3p0÷o→o (
p* ,
5Po
E=-1 h1Df
Po 1
•
,to
1p*
1
.
total
cost
1
E= -0.11
of trade 1
+
benefit of trades that do
,
.not occur
Q* QO Qo Q*
ED= of .dQ- ←
DP
B
C
E
A B C E
MACA&B
{d(x,y)=%DQx
%DPY Ca
La
•CbMACBMACA
'1. DQ
Md= %DI
a
