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


Lecture 2

Microeconomic T


Microeconomics Tools and AnalysesThinking Like An Economist

Supply & Demand: How Markets Work

Lecture 1

ECF 9210 Intro to International Economics


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


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


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


The Economic Problem

“You can’t always get what you want”

- M. J.


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.”


Key decisions in the economy

What to produce?

How to produce?

For whom to produce?

What is economics? KEY DECISIONS


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



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



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



People respond to incentives

• People respond to marginal changes in costs or benefits.

• Incentives affect the balance between marginal benefits and marginal costs


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.


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.


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?”


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.


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.


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


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


Main branches of economics

• Macroeconomics deals with the functioning of the whole economy

• Microeconomics focuses on individuals such as households and firms.


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.


• 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?


What Is a Market?

• Buyers determine demand.

• Sellers determine supply.


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


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


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.


Consumer income

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


Prices of related goods

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

• Complement goods• E.g. movie and popcorn


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?


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


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


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?


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?


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

42

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

43

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

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

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

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

ecf9210 2010 wk1 intro dem supp

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