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© 2007 Thomson South-Western Lecture 2 Microecon omic T © 2007 Thomson South-Western Microeconomics Tools and Analyses Dr Rebecca Valenzuela Department of Economics, Monash University [email protected] ECF 9210 Intro to International Economics Welcome
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ECF9210 2010 Wk1 Intro Dem Supp

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Page 1: ECF9210 2010 Wk1 Intro Dem Supp

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

Page 2: ECF9210 2010 Wk1 Intro Dem Supp

© 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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

The Economic Problem

“You can’t always get what you want”

- M. J.

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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

Key decisions in the economy

What to produce?

How to produce?

For whom to produce?

What is economics? KEY DECISIONS

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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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

Page 14: ECF9210 2010 Wk1 Intro Dem Supp

© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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

Page 23: ECF9210 2010 Wk1 Intro Dem Supp

© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

• 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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© 2007 Thomson South-Western

What Is a Market?

• Buyers determine demand.

• Sellers determine supply.

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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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© 2007 Thomson South-Western

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© 2007 Thomson South-Western

Consumer income

• Normal goods vs inferior goods• E.g. overseas holiday• E.g. second hand furniture

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© 2007 Thomson South-Western

Prices of related goods

• Substitute goods • E.g. movie and DVD rental

• Complement goods• E.g. movie and popcorn

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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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© 2007 Thomson South-Western

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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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© 2007 Thomson South-Western

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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44

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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45

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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46

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