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Lecture 2
Microeconomic T
© 2007 Thomson South-Western
Microeconomics Tools and AnalysesDr Rebecca Valenzuela
Department of Economics, Monash [email protected]
ECF 9210 Intro to International Economics
Welcome
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© 2007 Thomson South-Western
Lecture 2
Microeconomic T
© 2007 Thomson South-Western
Microeconomics Tools and AnalysesThinking Like An Economist
Supply & Demand: How Markets Work
Lecture 1
ECF 9210 Intro to International Economics
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LECTURE TOPIC COVERAGEWeek Topic
1. Introduction, How Markets Work
2. Elasticities & Applications, Efficiency of Markets
3. Production, Growth & Other Macro Concerns
4. AD & AS and the World Economy
5. The Theory of Comparative Advantage
6. Tariffs
7. Midterm Test
8. Non-Tariff Barriers
9. Balance of payments & Exchange Rates
10. Exchange Rate Determination
11. XR Adjustment, BOP & Macroeconomic Policy in an Open Economy
12. Review
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What is International Economics?
International Economics is the area
of study in economics that deals with the economic and financial
interdependence of nations.
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Globalization
• Globalization - greater interdependence among countries and their citizens
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Globalization
What are the Driving Forces of Globalization?
• Technological change• Liberalization of trade and investments• Significance of global production sharing
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Globalization
• Australia: An Open Economy• Australia has become increasingly integrated
into the world economy• Trade of goods and services• Financial markets• Labor force• Ownership of production facilities• Dependence on imported material
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Why Study ECF9210?
Aim for ECF9210 student:
learn economic tools of analysis to - analyse flows of goods & services- study the impact of these flows on welfare- analyse policies that regulate these flows
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The Economic Problem
“You can’t always get what you want”
- M. J.
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What is economics?
• Lionel Robbins (1932, An Essay on the Nature and Significance of Economic Science, London: Macmillan):
Economics is “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”
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Key decisions in the economy
What to produce?
How to produce?
For whom to produce?
What is economics? KEY DECISIONS
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Economic Principles #1:
People face trade-offs
• “There’s no such thing as a free lunch”
• You cannot have your cake and eat it too
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Economic Principles #2:
The relevant cost in economics is the opportunity cost
• An opportunity cost is the best valued alternative that is given up when one makes an economic choice
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Economic Principles #3:
Rational people think at the margin
• Marginal changes are incremental adjustments to an existing plan of action.
• Marginal Benefits v Marginal Cost
eg Should you buy another pair or shoes? Should you sleep another hour in the morning? Rare commodities, plentiful commodities – implications on price
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Economic Principles #4:
People respond to incentives
• People respond to marginal changes in costs or benefits.
• Incentives affect the balance between marginal benefits and marginal costs
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Thinking Like an Economist
Economics trains you to. . . .
Think in terms of alternatives. Evaluate the cost of individual and social choices. Examine and understand how certain events and
issues are related.
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The Economist as a Scientist
The economic way of thinking . . .
Makes use of the scientific method. Uses abstract models Develops theories, collects and analyzes
data to evaluate the theories.
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Positive v Normative Analysis
• Positive Analysis• the use of theories and models to predict the impact
of a choice. “What is?”
• Normative Analysis• addresses issues from the perspective of “What
ought to be?”
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THE ECONOMIST AS POLICY ADVISOR
• When economists are trying to explain the world, they are scientists.
• When economists are trying to change the world, they are policy advisors.
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WHY ECONOMISTS DISAGREE
• They may disagree about the validity of alternative positive theories about how the world works.
• They may have different values and, therefore, different normative views about what policy should try to accomplish.
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Model 1: The Circular Flow
Spending
Goods andservicesbought
Revenue
Goodsand servicessold
Labor, land,and capital
Income
= Flow of inputs and outputs
= Flow of dollars
Factors ofproduction
Wages, rent,and profit
FIRMS• Produce and sell
goods and services• Hire and use factors
of production
• Buy and consumegoods and services
• Own and sell factorsof production
HOUSEHOLDS
• Households sell• Firms buy
MARKETSFOR
FACTORS OF PRODUCTION
• Firms sell• Households buy
MARKETSFOR
GOODS AND SERVICES
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Model 2: The Production Possibilities Frontier
Productionpossibilitiesfrontier
B
D
A
Quantity of Cars
2,200
600
1,000
3000 700
2,000
3,000
1,000
Sacks of Rice
C
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Main branches of economics
• Macroeconomics deals with the functioning of the whole economy
• Microeconomics focuses on individuals such as households and firms.
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Supply & Demand: How Markets Work
• Focus on households and firms - how they make economic choices
• Supply and Demand
• Modern microeconomics is about Supply, Demand, and Market Equilibrium.
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• A market is a group of buyers and sellers of a particular good or service.
• The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.
What Is a Market?
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What Is a Market?
• Buyers determine demand.
• Sellers determine supply.
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The most famous picture in economics
Quantity
Price
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Equilibriumquantity
Equilibrium price Equilibrium
Supply
Demand
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What Is Competition?
• A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.
• Perfect Competition• Monopoly• Oligopoly• Monopolistic Competition
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Demand
• Quantity demanded is the amount of a good that buyers are willing and able to purchase.
• Law of Demand• The law of demand states that, other things equal,
the quantity demanded of a good falls when the price of the good rises.
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Consumer income
• Normal goods vs inferior goods• E.g. overseas holiday• E.g. second hand furniture
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Prices of related goods
• Substitute goods • E.g. movie and DVD rental
• Complement goods• E.g. movie and popcorn
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Other factors
• Tastes: • eg Are chocolates good for you?
• Expectations: • eg Should you enter the housing market now?
• Number of buyers• eg Why do companies sponsor the Olympic Games?
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What is the law of supply?
• a positive relationship between price and quantity supplied.• Supply of babysitting services
• What is the quantity supplied ?• Draw the supply curve
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Change in quantity supplied versus change in supply
• A change in the price of a product • Causes a change in the quantity supplied of the
product • Is illustrated by a movement along the supply curve
• A change in other factors• Cause a change in the supply of a product• Is illustrated by a shift in the supply curve
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What factors affect supply?
• Input prices: • eg The price of milk has gone up. Will Peters be
more or less willing to sell ice-cream at a given price?
• Technology: • eg what would happen to the supply of electric cars
should there be a new technology that substantially increase the energy efficiency of batteries?
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What factors affect supply?
• Expectations: • eg should you fill up your car today or tomorrow?
• Number of sellers: • eg what would happened to the supply of
accounting services in Australia if all overseas qualifications were to be recognised?
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What is a market equilibrium?
• Market equilibrium• Demand and supply jointly determine market prices
and quantity. • When the quantity supplied equals the quantity
demanded in a market, the market is said to be in equilibrium
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The most famous picture in economics
Quantity
Price
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Equilibriumquantity
Equilibrium price Equilibrium
Supply
Demand
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Markets Not in Equilibrium: SURPLUS
Price ofIce-Cream
Cone
0
Supply
Demand
(a) Excess Supply
Quantitydemanded
Quantitysupplied
Surplus
Quantity ofIce-Cream
Cones
4
$2.50
10
2.00
7
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Markets Not in Equilibrium: SHORTAGE
Price ofIce-Cream
Cone
0 Quantity ofIce-Cream
Cones
Supply
Demand
(b) Excess Demand
Quantitysupplied
Quantitydemanded
1.50
10
$2.00
74
Shortage
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
0 Quantity of Ice-Cream Cones
Supply
Initialequilibrium
D
D
3. . . . and a higherquantity sold.
2. . . . resultingin a higherprice . . .
1. Hot weather increasesthe demand for ice cream . . .
2.00
7
New equilibrium$2.50
10
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
0 Quantity of Ice-Cream Cones
Demand
Newequilibrium
Initial equilibrium
S1
S2
2. . . . resultingin a higherprice of icecream . . .
1. An increase in theprice of sugar reducesthe supply of ice cream. . .
3. . . . and a lowerquantity sold.
2.00
7
$2.50
4