LECTURE 27 The Lessons and Tools of Economics May 2, 2017 Economics 2 Christina Romer Spring 2017 David Romer
LECTURE 27 The Lessons and Tools of Economics
May 2, 2017
Economics 2 Christina Romer Spring 2017 David Romer
Announcements
• Suggested answers for Problem Set 6 are available on the course website.
Final Exam Logistics
• Friday, May 12th, 7–10 p.m.
• You will be getting out late, so make plans now for getting home safely.
Final Exam Location
• We are in four rooms.
1 LeConte: Last names A – Gi
210 Bechtel: Last names Go – L
100 GPB: Last names M – Si
145 Dwinelle: Last names Sm – Z
Final Exam Format and Content
• Roughly the length of two midterms.
• Cumulative, but with one section specifically on material since the second midterm.
• Mixture of short-answer questions, problems, and multiple choice questions.
Some Advice on Taking the Final Exam
• Read questions carefully.
• Figure out what tool is appropriate.
• Watch your time.
• Think of trying to convince the person grading the exam that you understand the material.
Some Advice on Studying
• Focus on the posted slides and your lecture notes.
• Also the suggested answers to the problem sets.
• Study actively; don’t just keep reading over your notes.
• Redraw diagrams; think of different cases and examples and then work them out.
• Focus on really understanding the tools.
Places to Get Help before the Final
• Review session:
• May 5, 3:00–5:00 in 155 Dwinelle.
• Professor office hours this week and next:
• Wednesday, 1–3 in 683 Evans.
• GSI office hours:
• Your GSI will let you know their office hours during RRR and finals week.
I. OVERVIEW
II. LESSONS AND TOOLS OF MICROECONOMICS
Lesson 1
• Trade-offs are everywhere.
Production Possibilities Curve
PPC
Good y
Good x
Lesson 2
• There are gains from specialization and trade.
Production Possibilities Curve
PPC
Good y
Good x
Consumption Possibilities Curve
Good y
PPC
Good x
CPC
Lesson 3
• In a market system, prices play a crucial role.
Supply and Demand Diagram
Q
P S
D
P1
Q1
Lesson 4
• Households and firms make choices to maximize their well-being.
• Corollary: People respond to incentives.
Utility Maximization: Rational Spending Rule
MUx MUy = Px Py
Profit Maximization for a Competitive Firm
q Q
Market
D
S
P1
P P
Typical Firm
MR
MC
q1
ATC
Profits are largest at q1, where MR=MC.
Lesson 5
• A market system has many benefits.
• Allocative efficiency.
• Dynamic efficiency.
Welfare Analysis
At Q1, MB = MC.
D1,MB Q
P S1,MC
P1
Q1
Producer Surplus
Consumer Surplus
Welfare Analysis of Trade
P1US
Q1US
DUS
Q
P SUS
PWorld
Gains from Trade
QSUS QD
US Imports
Diagram for a Competitive Industry
q Q
Market
D
S
P1
P P
Typical Firm
MR
MC
q1
ATC
Lesson 6
• Interfering with the market has consequences.
Effect of a Tax
D1 Q
P S1
P1
Q1
S2
Tax
Q2
P2
P2−tax Deadweight Loss
Lesson 7
• Market failures are important, and government interventions can often improve market outcomes.
Monopoly
Q
P
D,MB
MR
P1
Q1
MC
Deadweight Loss
At Q1, MB > MC.
Negative Externality
D1,PMB1,SMB1
Q
P S1,PMC1
Q1
SMC1
Q*
External MC
Deadweight Loss
At Q1, SMB < SMC.
Lesson 8
• Market forces are a fundamental determinant of what workers are paid.
D1, MRPL1
L
W S1
W1
L1
Labor Market Diagram
III. LESSONS AND TOOLS OF MACROECONOMICS
Lesson 1
• In the long run, output is determined by the inputs to the production process.
Aggregate Production Function
(1)
(2)
(3) •
Lesson 2
• Improvements in average labor productivity are the key source of economic growth, and technological progress is the key source of improvements in average labor productivity.
Aggregate Production Function
•
Saving and Investment Diagram
r*
S*, I*
I
r1∗
I1∗
S
Lesson 3
• Changes in planned spending cause output to deviate from potential in the short run.
Keynesian Cross Diagram
Y
PAE
PAE Y=PAE
Y1
Lesson 4
• Monetary and fiscal policy affect planned spending, and so can cause or mitigate short-run fluctuations.
Keynesian Cross Diagram
Y
PAE
PAE Y=PAE
Y1
Money Market Diagram
M
i MS
M1
i1
MD
Lesson 5
• Inflation responds gradually to the deviation of output from potential, and this behavior of inflation (working through the Fed’s reaction function) brings the economy back to Y*.
The Fed’s Reaction Function
π
r
Reaction Function
Returning to Potential Output
Y2
PAE2
Y
PAE1,PAELR
PAE Y=PAE
Y*
Lesson 6
• Net exports are determined by factors affecting asset flows, not goods flows.
Foreign Exchange Market for Dollars
D Q of $ Traded
S
e1
Q1
Price of $ in Euros (€ per $1)
Balance of Payments
NX + KI = 0