- Library Assignment: all students must use the FNU Library as a graded activity, cite at least 3 peer review articles about the art and science of economic analysis (see the power point lecture), and write 3 paragraphs about what you learned in each article, in total 6paragraphs, using APA format.
only power point 1 and 2
McEachern11e_Ch21.pptx
21
Economic Development
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Macroeconomics 11e, Ch. 21
How might programs that send subsidized food and used clothing to poor countries have the unintended consequence of retarding economic development there?
Why are some countries so poor while others are so rich?
What determines the wealth of nations?
Why do families in low-income countries have more children than those in higher-income countries?
Why have abundant natural resources such as oil or diamonds turned out to be a curse for some countries?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 21
Worlds Apart
Standard of living
Output per capita
Gross national income (GNI)
PPP adjusted
Three major groups
High-income economies
Middle-income economies
Low-income economies
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 1
Share of World Population and World Output From High-, Middle-, and Low-Income Economies as of 2014
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Developing and Industrial Economies
Developing countries
Low- and middle-income economies
Emerging market economies
Higher illiteracy rate, higher unemployment
Faster population growth
Exports of primary products
Agricultural products
Raw materials
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Developing and Industrial Economies
Developing countries
Half of the labor force works in agriculture
Farm productivity is low
2014: 82% of the world’s population, produce 48% of the world’s output
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Developing and Industrial Economies
Industrial market countries
High-income economies
Economically advanced capitalist countries of
Western Europe, North America,
Australia, New Zealand, and Japan
Developed countries
3% of the labor force works in agriculture
2014, 18% of world population, produce 52% of world output
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 2
Per Capita Income for Selected Countries in 2014
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Health and Nutrition
Developing countries
Poor health
Malnutrition
Disease: epidemics, malaria, HIV/AIDS
Lower life expectancy at birth
Greater child mortality rate
Higher infant mortality
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Health and Nutrition
Malnutrition
Poorest countries: consume only half the calories of those in high-income countries
The biggest single threat to the world’s public health, World Health Organization
Primary or contributing factor in more than half of the deaths of children under 5
In low-income countries
About a billion people on Earth don’t have enough to eat
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Health and Nutrition
Malnutrition
Diseases that are well controlled in industrial countries
Malaria, whooping cough, polio, dysentery, typhoid, and cholera
Can become epidemics in poor countries
Infant mortality rates
Much greater in low-income countries than in high-income countries
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 3
Infant Mortality Rates per 1,000 Live Births as of 2014
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
High Birth Rates
High fertility rates in developing countries
Larger families
Source of farm labor
No social security system
Declining standard of living
Population growth rates > growth rate in total production
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 4
Average Number of Births During a Woman’s Lifetime as of 2014
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Women in Developing Countries
Poverty rate
Higher for women than men, particularly women who head households
Women
Work in home and in labor market
Less educated than men
Fewer employment opportunities
Lower wages than men
Less access to other resources
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Labor productivity
Output per worker
Labor productivity depends on
The quality of labor
The amount of capital, natural resources, and other inputs that combine with labor
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
To increase labor productivity
Invest in human and physical capital
Domestic savings
Foreign funds
Poorest countries
Low income per capita
Low investment in human and physical capital
Poorly run businesses
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Technology and education
Better use for available resources
More receptive to new ideas
Inefficient use of labor
Unemployment
Can’t find jobs
Underemployment
Employed in lower-skill jobs
Work part-time
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
The cycle of poverty
Low productivity results in low income
Low income can affect worker productivity
Less saving
Less investment in human and physical capital
Poor nutrition and insufficient health care
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Natural resources
Abundant natural resource (oil)
Not enough to create industrial economy
Financial institutions
Low savings
High inflation
Small investment
Fewer credits provided by banks
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Capital infrastructure
Transport
Communication
Sanitation
Electricity
Developing countries
Serious deficiencies in their physical infrastructures
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 5
Mobile Phone Lines per 100 People for 2013
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 6
Internet Users as Percent of Population for 2013
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Entrepreneurship
Entrepreneurs who are able to bring together resources and take the risk of profit or loss
Sources of entrepreneurial experience in developing countries
McDonald’s
Other international franchises
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Rules of the game
Formal and informal institutions
Laws, customs, conventions
Stable political environment
Well-define property rights
Social capital
Shared values and trust
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Rules of the game, capitalism
Private ownership of most resources
Coordination of economic activity
Price signals generated by market forces
What, how, and for whom to produce it
Privatization
The process of turning government enterprises into private enterprises
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Productivity: Key to Development
Rules of the game, central planning
Government ownership of most resources
Allocation of resources
Central plans
Limited personal freedom
Social capital
The shared values and trust that promote cooperation in the economy
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Exhibit 7
GDP per Capita for Transitional Economies in 2014
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
The Poorest Billion
The world
One-sixth rich
Two-thirds not rich but improving
One-sixth poor
Most developing economies
A rising standard of living
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
The Poorest Billion
Extremely poor economies, “trapped”
Stagnant or getting worse
1 billion people
45 countries
30 countries in sub-Saharan Africa
Cambodia, Haiti, Laos, Myanmar, North Korea, and Yemen
750 million people – civil war
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
The Poorest Billion
Poverty traps
Civil war
High proportion of young, uneducated men, with few job prospects
Imbalance between ethnic groups
Supply of natural resources: incentive to rebel
Misuse of natural resource wealth
300 million people
Dysfunctional or corrupt government
750 million people
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Income Distribution Within Countries
Among 12 nations in chapter’s exhibits
Poorest fifth of population received
7.7% of income in high-income countries
5.8% of income in middle-income countries
7.2% of income in low-income countries
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
International Trade and Development
Trade problems for developing countries
Exports: primary products
Face wild price fluctuation
Imports: manufactured goods
Trade deficits
Restrict imports of capital goods
Face trade restrictions
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
International Trade and Development
Migration and the brain drain
Migrants: $440 billion sent home in 2014
Brain drain
Import substitution
Domestic manufacturing of products that were imported
Problems
Erased gains from specialization
Inefficiency, Retaliation
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
International Trade and Development
Export promotion
Produce for the export market
Emphasis on specialization
Efficiency
Less government intervention
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
International Trade and Development
Trade liberalization and special interests
Difficulty pursuing policies conducive to development
Gains from economic development are widespread
Beneficiaries (consumers) do not recognize their potential gains
Losers tend to be concentrated
Producers: fight reforms that might harm their livelihood
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Foreign aid
International transfer made on especially favorable terms
For the purpose of promoting economic development
Grants and loans
Money, capital goods, technical assistance, food
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Bilateral assistance
Country-to-country
Multilateral assistance
World Bank
IMF
United States, last four decades
$400 billion in aid to the developing world
U.S. Agency for International Development (USAID)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Additional purchasing power
Possibility of increased investment, capital imports, and consumption
Unclear
Supplements domestic savings
Increasing investment
Or substitutes for domestic savings
Increasing consumption
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Source of discretionary funds
That benefit not the poor but their leaders
90% of the funds distributed by USAID
To governments – whose leaders assume responsibility for distributing these funds
Bilateral funding
Tied to purchases of goods and services from the donor nation
Unintended consequences
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
1950s, U.S., Food for Peace program
Sell U.S. farm products abroad
Some recipient governments
Sold that food to finance poorly conceived projects
Low-priced food from abroad
Drove down farm prices in the developing countries
Hurting poor farmers there
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Used clothing
Donated to thrift shops and charitable organizations in industrialized countries
Wind up for sale in Africa
Low price discourages local textile production
Foreign aid
Raised the standard of living in some developing countries
But it didn’t increased their ability to become self-supporting at that higher standard of living
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Foreign Aid and Economic Development
Foreign aid
Insulated government officials
From their own incompetence
From the fundamental troubles of their own economies
Has helped corrupt governments stay in power
More than half of foreign aid now flows through private channels
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Convergence theory
Predicts that the standard of living in economies around the world
Will grow more similar over time
With poorer countries eventually catching up with richer ones
Developing countries can grow faster than advanced ones
It is easier to copy existing technology than to develop new ones
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Evidence on convergence
Some poor countries have begun to catch up with richer ones
The newly industrialized Asian economies
Hong Kong, Singapore, South Korea, and Taiwan (Asian Tigers)
Adopted the latest technology
Invested in human resources
Closed the gap with the world leaders
Are industrial market economies
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Evidence on convergence
Appear to be evidence of convergence in manufacturing productivity
Across a large group of developed and developing countries
1993 – 2012, growth in real GDP
5.4% for developing countries, more than double the average for industrial countries
1990 – 2010, living on less than $1 a day
Dropped from 43% to 21% of population
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Convergence has not begun for the poorest economies
Birthrates there are double those in richer countries
Poor economies must produce still more just to keep up with a growing population
Lack the human capital needed to identify and absorb new technology
Low education levels and low literacy rates
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Convergence has not begun for the poorest economies
Lack the stable macroeconomic environment and the established institutions needed to nurture economic growth
Reliable financial institutions
Serious deficiencies in infrastructures
Lack of a reliable source of electricity to power new technologies
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
Do Economies Converge?
Convergence has not begun for the poorest economies
Some poor countries ravaged by civil war for years
Communicating can be challenging
Nigeria: more than 400 languages are spoken by 250 distinct ethnic groups
The roots of economic development go back centuries
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Macroeconomics 11e, Ch. 33
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McEachern11e_Ch1.pptx
1
The Art and Science
of Economic Analysis
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Economics 11e, Ch. 1
Why are comic-strip and TV characters like those in FoxTrot, The Simpsons, and Family Guy missing a finger on each hand? And where is Dilbert’s mouth?
Which college majors pay the most?
In what way are people who pound on vending machines relying on theory?
Why is a good theory like a California Closet?
What’s the big idea with economics?
Finally, how can it be said that in economics “what goes around comes around”?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
The Economic Problem
The economic problem
Unlimited wants
Our wants, our desires are virtually unlimited
Scarce resources
The resources available to satisfy those wants are scarce
Not freely available
Its price exceeds zero
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
The Economic Problem
Because of scarcity
You must choose from among your many wants
You must forgo satisfying some other wants
Economics
The study of how people use their scarce resources to satisfy their unlimited wants
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Goods and services are scarce
Because resources are scarce
Resources: inputs or factors of production
Used to produce the goods and services that people want
Labor
Capital
Natural resources
Entrepreneurial ability
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Labor
Physical and mental effort used to produce goods and services
We allocate our time to different uses
Sell it as labor
Spend it doing other things
Wages
Payment to resource owners for their labor
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Capital
Buildings, equipment, and human skills used to produce goods and services
Interest
Payment to resource owners for the use of their capital
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Physical capital
Human creations used to produce goods and services
Human capital
Knowledge and skill people acquire to increase their productivity
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Natural resources
All gifts of nature used to produce goods and services
Renewable
Exhaustible
Rent
Payment to resource owners for the use of their natural resources
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Renewable resource
Can be drawn on indefinitely if used conservatively
Exhaustible resource
Does not renew itself
Available in a limited amount
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Entrepreneurial ability
The talent required to dream up a new product or find a better way to produce an existing one
Comes from an entrepreneur
Profit
Reward for entrepreneurial ability
Sales revenue minus resource cost
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Resources
Entrepreneur
Profit-seeking decision maker who starts with an idea
Organizes an enterprise to bring that idea to life
Assumes the risk of the operation
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Goods and Services
Good
Tangible product used to satisfy human wants
Service
Activity, or intangible product, used to satisfy human wants
A good or service is scarce
If the amount people desire exceeds the amount available at a zero price
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Exhibit 1
Scarcity Means You Must Choose Among Options
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Goods and Services
Making choices in a world of scarcity
Means we must pass up some goods and services
Bads
We want none of them
Not even at a zero price
“The best things in life are free”
Most goods and services are scarce, not free
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Goods and Services
“There is no such thing as a free lunch”
All goods and services involve a cost to someone
May seem free to you
But it draws scarce resources away from the production of other goods and services
Whoever provides a free lunch
Often expects something in return
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Economic Decision Makers
Decision makers in the economy
Households
Firms
Governments
The rest of the world
Their interaction determines how an economy’s resources are allocated
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Economic Decision Makers
Households
As consumers
Demand the goods and services produced
As resource owners
Supply resources to firms, government, and the rest of the world
Firms, Governments, Rest of the World
Demand resources
Produce goods and services
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Markets
Market
Set of arrangements by which buyers and sellers carry out exchange at mutually agreeable terms
Product market
A market in which a good or service is bought and sold
Resource market
A market in which a resource is bought and sold
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
A Simple Circular-Flow Model
Circular-flow model
A diagram that traces the flow of resources, products, income, and revenue
Among economic decision makers
Simple circular-flow model
Shows the interaction between households and firms
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Exhibit 2
The Simple Circular-Flow Model for Households and Firms
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Households earn income by supplying resources to resource markets, as shown in the lower portion of the model.
Firms demand these resources to produce goods and services, which they supply to product markets, as shown in the upper portion of the model.
Households spend their income to demand these goods and services. This spending flows through product markets as revenue to firms.
McEachern, Economics 11e, Ch. 1
Rational Self-Interest
Individuals are rational
Make the best choice given the available information
Maximize expected benefit achieved with a given cost
Minimize expected cost of achieving a given benefit
The lower the personal cost of helping others, the more help we offer
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Choice Requires Time & Information
Rational choice
Takes time and requires information
Time and information
Are themselves scarce and therefore valuable
Rational decision makers
Willing to pay for information
Acquire information if the additional benefit expected exceeds the additional cost
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Economic Analysis Is Marginal Analysis
Comparison
Expected marginal benefit
Expected marginal cost
Marginal
Incremental, additional, extra
Rational decision maker changes the status quo
If the expected marginal benefit exceeds the expected marginal cost
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Microeconomics
Microeconomics
Study of the economic behavior in particular markets
Individual economic choices
Markets coordinate the choices of economic decision makers
Individual pieces of the puzzle
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Microeconomics
Macroeconomics
Study of the economic behavior of entire economies
Performance of the economy as a whole
Business cycles: Rise and fall of economic activity
Relative to the long-term growth trend of the economy
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
The Science of Economic Analysis
Economic theory, or economic model
A simplification of economic reality
Used to make predictions about cause and effect in the real world
A good theory
Helps us understand a messy and confusing world
Offers a helpful guide to sorting, saving, and understanding information
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
The Role of Theory
Most people don’t understand the role of theory
People may substitute their own theory for a theory they either do not believe or do not understand
All of us employ theories, however poorly defined or understood
Pounding on the Pepsi machine
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McEachern, Economics 11e, Ch. 1
The Scientific Method
Step 1
Identify the question
Define relevant variables
Variable
A measure that can take on different values at different times
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McEachern, Economics 11e, Ch. 1
The Scientific Method
Step 2: Specify assumptions
Other-things-constant assumption
Focus on the relation among key variables
Other variables remain unchanged
Ceteris paribus
Behavioral assumption
Describes the expected behavior of economic decision makers
What motivates them
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McEachern, Economics 11e, Ch. 1
The Scientific Method
Step 3: Formulate the hypothesis
How key variables relate to each other
To help make predictions about cause and effect in the real world
Hypothesis
Theory about how key variables relate
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McEachern, Economics 11e, Ch. 1
The Scientific Method
Step 4: Test the hypothesis
Compare its predictions with evidence
Test the validity of a hypothesis
Reject the hypothesis
If it predicts worse than the best alternative theory
Use the hypothesis
Until a better one comes along
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McEachern, Economics 11e, Ch. 1
Exhibit 3
The Scientific Method: Step by Step
The steps of the scientific method are designed to develop and test hypotheses about how the world works. The objective is a theory that predicts outcomes more accurately than the best alternative theory. A hypothesis is rejected if it does not predict as accurately as the best alternative. A rejected hypothesis can be modified or reworked in light of the test results.
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McEachern, Economics 11e, Ch. 1
Normative Versus Positive
Positive economic statement
Can be proved or disproved by reference to facts
‘What is’
Normative economic statement
Reflects an opinion
Cannot be proved or disproved by reference to the facts
‘What should be’
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McEachern, Economics 11e, Ch. 1
Economists Tell Stories
Economic analysis
Is as much art as science
Economists explain their theories
By telling stories about how they think the economy works
Case studies, anecdotes, parables, the personal experience of the listener, and supporting data
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McEachern, Economics 11e, Ch. 1
Predicting Average Behavior
Individual behavior
Difficult to predict
But the random actions of individuals
Tend to offset one another
Average behavior of groups
Predicted more accurately than behavior of one individual
Economists focus on typical or average behavior of people in a group
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McEachern, Economics 11e, Ch. 1
Some Pitfalls of Faulty Economic Analysis
Fallacy: an incorrect idea or belief
The fallacy that association is causation
The incorrect idea that if two variables are associated in time, one must necessarily cause the other
The fallacy of composition
The incorrect belief that what is true for the individual, or part, must necessarily be true for the group, or the whole
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McEachern, Economics 11e, Ch. 1
Some Pitfalls of Faulty Economic Analysis
The mistake of ignoring the secondary effects
Ignoring the unintended consequences
Secondary effects
Unintended consequences of economic actions that may develop slowly over time as people react to events
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McEachern, Economics 11e, Ch. 1
If Economists Are So Smart, Why Aren’t They Rich?
Some are
Earning over $25,000 per appearance on the lecture circuit
Earn $2 million a year as consultants and expert witnesses
Economists in federal cabinet posts
Secretaries of commerce, defense, labor, state, and treasury
Head the U.S. Federal Reserve System
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McEachern, Economics 11e, Ch. 1
If Economists Are So Smart, Why Aren’t They Rich?
Economics
The only social science and the only business discipline for which the prestigious Nobel Prize is awarded
Pronouncements by economists
Are reported in the media daily
Economic models
Usually do a better job of making economic sense out of a confusing world than do alternative approaches
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McEachern, Economics 11e, Ch. 1
College Major and Annual Earnings
Some factors that affect earnings among college graduates
General ability
Effort
Occupation
College attended
College major
Highest degree earned
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McEachern, Economics 11e, Ch. 1
College Major and Annual Earnings
Major in economics (bachelors)
Rank: #6 of 20 majors (Exhibit 4)
Median wage
For 0-5 years experience: $51,400
For 10-20 years experience: $97,700
Rank among top 10% of 207 majors
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McEachern, Economics 11e, Ch. 1
Exhibit 4
Median Annual Pay by College Major
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McEachern, Economics 11e, Ch. 1
Understanding Graphs
Origin
Point of departure
Horizontal axis
Straight horizontal line starting at the origin
Vertical axis
Straight vertical line starting at origin
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McEachern, Economics 11e, Ch. 1
Exhibit 5
Basics of a graph
Any point on a graph represents a combination of particular values of two variables. Here point a represents the combination of 5 units of variable x (measured on the horizontal axis) and 15 units of variable y (measured on the vertical axis). Point b represents 10 units of x and 5 units of y.
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McEachern, Economics 11e, Ch. 1
Understanding Graphs
Graph
A picture showing how variables relate
Conveys information in a compact and efficient way
Time-series graph
Shows the value of a variable over time
Functional relation
The value of the dependent variable depends on the value of the independent variable
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McEachern, Economics 11e, Ch. 1
Exhibit 6
U.S. Unemployment rate since 1900
A time-series graph depicts the behavior of some economic variable over time. Shown here are U.S. unemployment rates since 1900.
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McEachern, Economics 11e, Ch. 1
Drawing Graphs
Types of relations between variables
Positive, or direct, relation
As one variable increases, the other increases
Negative, or inverse, relation
As one variable increases, the other decreases
Independent, or unrelated, variables
As one variable increases, the other remains unchanged
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McEachern, Economics 11e, Ch. 1
Exhibit 7
Schedule Relating Distance Traveled to Hours Driven
The distance traveled per day depends on the hours driven per day, assuming an average speed of 50 miles per hour. This table shows combinations of hours driven
and distance traveled. These combinations are shown as points in Exhibit 8.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
0
4
3
2
1
Hours driven per day
5
150
100
50
200
Distance traveled per day (miles)
250
Exhibit 8
Graph Relating Distance Traveled to Hours Driven
Points a through e depict different combinations of hours driven per day and the corresponding distances traveled. Connecting these points creates a graph.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
b
c
d
a
e
McEachern, Economics 11e, Ch. 1
The Slope of a Straight Line
Slope
Change in vertical variable for a given increase in horizontal variable
Slope
Change in the vertical distance
Divided by the increase in the horizontal distance
Slope of a straight line
A constant value along the line
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McEachern, Economics 11e, Ch. 1
Exhibit 9 (a), (b)
Alternative slopes for straight lines
The slope of a line indicates how much the vertically measured variable changes for a given increase in the variable measured along the horizontal axis. Panel (a) shows a positive relation between two variables; the slope is 0.5, a positive number. Panel (b) depicts a negative, or inverse, relation. When the x variable increases, the y variable decreases; the slope is – 0.7, a negative number.
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McEachern, Economics 11e, Ch. 1
Exhibit 9 (c), (d)
Alternative slopes for straight lines
Panels (c) and (d) represent situations in which two variables are unrelated. In panel (c), the y variable always takes on the same value; the slope is 0. In panel (d), the x variable always takes on the same value; the slope is mathematically undefined but we simplify by assuming the slope is infinite.
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McEachern, Economics 11e, Ch. 1
Slopes
Value of slope
Depends on units of measurement
Measures marginal effects
Slope of a curved line
Differs along the curve
Slope of a curved line at one point
Slope of the tangent
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McEachern, Economics 11e, Ch. 1
0
Yards of copper tubing
2
1
3
$6
Total
cost
(b) Measured in yards
0
Feet of copper tubing
6
5
5
$6
Total
cost
(a) Measured in feet
Exhibit 10
Slope depends on the unit of measure
The value of the slope depends on the units of measure. In panel (a), output is measured in feet of copper tubing; in panel (b), output is measured in yards. Although the cost is $1 per foot in each panel, the slope is different in the two panels because copper tubing is measured using different units.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
1
1
Slope = 1/1 = 1
3
1
Slope = 3/1 = 3
McEachern, Economics 11e, Ch. 1
0
40
30
20
10
x
30
20
10
40
y
Exhibit 11
Slopes at different points on a curved line
The slope of a curved line varies from point to point. At a given point, such as a or b, the slope of the curve is equal to the slope of the straight line that is tangent
to the curve at the point.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
B
A
a
b
McEachern, Economics 11e, Ch. 1
0
x
y
Exhibit 12
Curves with both positive and negative slopes
Some curves have both positive and negative slopes. The hill-shaped curve (in red) has a positive slope to the left of point a, a slope of 0 at point a, and a negative slope to the right of that point.
The U-shaped curve (in blue) starts off with a negative slope, has a slope of 0 at point b, and has a positive slope to the right of that point.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
a
b
McEachern, Economics 11e, Ch. 1
Line Shifts
Change in the assumption
Changes the relationship between variables
Expressed by a line shift
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 1
Exhibit 13
Shift of line relating distance traveled to hours driven
Line T appeared originally in Exhibit 8 to show the relation between hours driven and distance traveled per day, assuming an average speed of 50 miles per hour. If the average speed is only 40 miles per hour, the entire relation shifts to the right to T, indicating that any given distance traveled requires more driving time. For example, 200 miles traveled takes 4 hours of driving at 50 miles per hour but 5 hours at 40 miles per hour. This figure shows how a change in assumptions, in this case, the average speed assumed, can shift the entire relationship between two variables.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
0
4
3
2
1
Hours driven per day
5
150
100
50
200
Distance traveled per day (miles)
250
f
T′
d
T
McEachern, Economics 11e, Ch. 1
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McEachern11e_Ch2.pptx
2
Economic Tools
and Economic Systems
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Economics 11e, Ch. 2
Why are you reading this book right now rather than doing something else?
What is college costing you?
Why will you eventually major in one subject rather than continue to take courses in various subjects?
Why is fast food so fast?
Why is there no point crying over spilled milk?
Why does common ownership often lead to common neglect?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Choice and Opportunity Cost
Because of scarcity
Whenever you make a choice
You must pass up another opportunity
You must incur an opportunity cost
Opportunity cost
The value of the best alternative forgone when an item or activity is chosen
Opportunity lost
Monetary or non-monetary aspect
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McEachern, Economics 11e, Ch. 2
The Opportunity Cost of College
Value of the best alternative forgone
Forgone income (full-time job: $20,000)
Minus income earned as student (part-time work: $10,000)
Plus direct cost of college
Tuition, fees, books ($12,000)
$20,000 – $10,000 + $12,000 = $22,000
Not included: room, board, personal expenses
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McEachern, Economics 11e, Ch. 2
Opportunity Cost Is Subjective
Opportunity cost is subjective
‘The road not taken’
Calculating opportunity cost
Requires time and information
Time: the ultimate constraint
Even the rich face the problem of scarcity
Opportunity cost varies with circumstance
Depends on the alternative
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Sunk Cost and Choice
Sunk cost
Has already been incurred
Cannot be recovered
Irrelevant for present and future economic decisions
Economic decision makers
Relevant: costs affected by the choice
Irrelevant: sunk costs
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McEachern, Economics 11e, Ch. 2
The Law of Comparative Advantage
Law of comparative advantage
The individual, firm, region, or country
With the lowest opportunity cost of producing a particular good
Should specialize in that good
Specialize
In the task that you do better
Specialization and exchange
Makes you better off
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McEachern, Economics 11e, Ch. 2
Absolute vs. Comparative Advantage
Absolute advantage
Ability to make something
Using fewer resources than other producers use
Comparative advantage
Ability to make something
At a lower opportunity cost than other producers face
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McEachern, Economics 11e, Ch. 2
The Law of Comparative Advantage
1 hour for typing papers and ironing shirts
You need half hour to type one paper and 10 minutes to iron a shirt
Your roommate needs one hour to type one paper and 12 minutes to iron a shirt
Absolute advantage
You, in both typing and ironing
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
The Law of Comparative Advantage
Comparative advantage
Your opportunity cost of typing a paper is 3 ironed shirts
Your roommate’s opportunity cost of typing a paper is 5 ironed shirts
You have comparative advantage in typing
Your roommate has comparative advantage in ironing
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Specialization and Exchange
Barter
Direct exchange of one product for another without using money
Can be used in simple economies
Few goods, little specialization
Money
Facilitates exchange
Degree of specialization
Limited by the extent of the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Exhibit 1
Specialization in the Production of Cotton Shirts
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McEachern, Economics 11e, Ch. 2
Division of Labor
Division of labor
Breaking down the production of a good into separate tasks
Increased productivity
Downside:
Repetitive
Tedious
Routine tasks – robots
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McEachern, Economics 11e, Ch. 2
Division of Labor
Specialization of labor
Takes advantage of individual preferences and natural abilities
Allows workers to develop more experience at a particular task
Reduces the need to shift between different tasks
Permits the introduction of labor-saving machinery
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economy’s Production Possibilities
PPF: production possibilities frontier
Assumptions of the PPF model
Output: consumer goods and capital goods
Production: 1 year
Resources are fixed (quantity, quality)
Technology and know-how are fixed
Rules of the game are fixed
Resources
Scarce for the economy
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economy’s Production Possibilities
PPF
A curve showing alternative combinations of goods
That can be produced when available resources are used efficiently
The boundary line between inefficient and unattainable combinations
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economy’s Production Possibilities
Resources are employed efficiently
When there is no change that could increase the production of one good
Without decreasing the production of the other good
Getting the most from available resources
Points on the PPF
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McEachern, Economics 11e, Ch. 2
Inefficient and Unattainable Production
Inefficient combinations
Do not employ resources efficiently
Points inside the PPF
Unattainable combinations
Cannot be achieved with the existing resources, technology, know-how, and rules of the game
Points outside the PPF
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Exhibit 2
The Economy’s Production Possibilities Frontier
If the economy uses its available resources and its technology and know-how efficiently to produce consumer goods and capital goods, that economy is on its production possibilities frontier, AF. The PPF is bowed out to reflect the law of increasing opportunity cost; the economy must sacrifice more and more units of consumer goods to produce each additional increment of capital goods. Note that more consumer goods must be given up in moving from E to F than in moving from A to B, although in each case the gain in capital goods is 10 million units.
Points inside the PPF, such as I, represent inefficient use of resources.
Points outside the PPF, such as U, represent unattainable combinations.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
10
20
30
34
43
48
50
Consumer goods (millions of units per year)
10
0
50
40
30
20
Capital goods (millions of units per year)
A
C
D
E
F
B
U
Unattainable
I
Inefficient
McEachern, Economics 11e, Ch. 2
The Shape of the PPF
Movement down along PPF
Give up some consumer goods to get more capital goods
Law of increasing opportunity costs
To produce more of one good, a successively larger amount of the other good must be sacrificed
Slope of PPF
Opportunity cost of 1 unit of capital goods
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
What Can Shift the PPF?
Economic growth
An increase in the economy’s ability to produce goods and services
Outward shift of the economy’s PPF
Changes in resource availability
Outward shift of PPF – increase in:
Size, health of labor force
Skills of labor force
Availability of other resources
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
What Can Shift the PPF?
Increases in capital stock
More output; outward shift of PPF
3. Technological change and more know-how
Employs resources more efficiently
Outward shift of PPF
Improvements in the rules of the game
Formal and informal institutions
Economic growth
Outward shift of PPF
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Exhibit 3 (a), (b)
Shifts of the Economy’s PPF
When the resources available to an economy change, the PPF shifts. If more resources become available, if technology and know-how improve, or if the rules of the game create greater stability, the PPF shifts outward, as in panel (a), indicating that more output can be produced. A decrease in available resources or an upheaval in the rules causes the PPF to shift inward, as in panel (b).
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(a) Increase in available resources, better technology, more know-how, or improvement in the rules of the game
(b) Decrease in available resources
or greater uncertainty in the rules
of the game
A
A′
F′
F
A
A″
F″
F
Capital goods
Consumer goods
Consumer goods
Capital goods
McEachern, Economics 11e, Ch. 2
Exhibit 3 (c), (d)
Shifts of the Economy’s PPF
When the resources available to an economy change, the PPF shifts. Panel (c) shows a change affecting consumer goods. More consumer goods can now be produced at any given level of capital goods. Panel (d) shows a change affecting the production of capital goods.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(c) Change in resources, technology, know-how, or rules that benefits consumer goods
(d) Change in resources, technology, know-how, or rules that benefits capital goods
A
A′
Consumer goods
F
A
F′
F
Capital goods
Consumer goods
Capital goods
McEachern, Economics 11e, Ch. 2
What We Learn from the PPF?
Efficiency
The PPF describes efficient combinations of output
Given the economy’s resources, technology and know-how, and rules of the game
Scarcity
Given the resources, technology and know-how, and rules of the game
The economy can produce only so much output per period
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
What We Learn from the PPF?
Opportunity cost
The PPF slopes downward
More of one good means less of the other good
The law of increasing opportunity cost
The PPF’s bowed-out shape
Some resources are not perfectly adaptable to the production of each type of good
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
What We Learn from the PPF?
Economic growth
A shift outward of the PPF
Choice
Selecting a particular combination determines
Not only consumer goods and capital goods available this period
But also the capital stock available next period
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economic Systems
Three questions
What goods and services are to be produced?
How are they to be produced?
For whom are they to be produced?
Economic system
Set of mechanisms and institutions
That resolve the what, how, and for whom questions
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economic Systems
Criteria used to distinguish among economic systems
Who owns the resources
What decision-making process is used to allocate resources and products
What types of incentives guide economic decision makers
Range from
Pure capitalism to pure command system
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism
Pure capitalism
There is no government
Rules of the game:
Private ownership of resources
Market distribution of products
Market system
Private property rights
An owner’s right to use, rent, or sell resources or property
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism
Unrestricted markets
Buyers and sellers make their intentions known
Market prices
Guide resources to their most productive use
Channel goods and services to the consumers who value them the most
Answer the what, how, and for whom questions
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism
Adam Smith (1723–1790)
Market forces allocate resources as if by an “invisible hand”
Unseen force that harnesses the pursuit of self-interest
To direct resources where they earn the greatest reward
Each individual pursues self-interest
“Invisible hand” of market forces promotes general welfare
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism: Flaws
No central authority
To protect property rights
To enforce contracts
To ensure that the rules of the game are followed
People with no resources to sell
Could starve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism: Flaws
Monopoly
Some producers may try to monopolize markets by eliminating the competition
Side effects for people not involved
Side effects can harm or benefit people not involved in the market transaction
No public goods
Because firms cannot prevent nonpayers from enjoying the benefits of public goods
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Capitalism: Flaws
Economic fluctuations
Alternating periods of expansions and recessions in the level of economic activity
Especially in employment and production
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Command System
Pure command system
Public ownership of resources
Centralized planning
Communism
Government planners
Central plans
Direct resources
Coordinate production
Answer the three questions
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Command System: Flaws
Resources
Are used inefficiently
Some are wasted
Each person has less incentive to employ them in their highest-valued use
Central plans
May reflect more the preferences of central planners (unelected dictators)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Pure Command System: Flaws
Government responsible for all production
Limited variety of products
Each individual
Has less personal freedom in making economic choices
No profit
Less incentive to develop better products
Less incentive to find more efficient ways to make existing products
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Mixed and Transitional Economies
Increasing role of government
In capitalist economies
Increasing role of markets
In command economies
Government
Economic activity
Regulates the private sector
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
Economies Based on Custom or Religion
Caste systems in India
Restrict occupational choices
Islamic law
Charging interest is banned
Family relations
Play significant roles in organizing and coordinating economic activity
Tradition
Some occupations are dominated by women, others by men
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 2
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McEachern11e_Ch3.pptx
3
Economic Decision Makers
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Economics 11e, Ch. 3
If we live in the age of specialization, then why haven’t specialists taken over all production?
For example, why do most of us still do our own laundry and perform dozens of other tasks for ourselves?
Why is the value of some products such as Facebook created mostly by users rather than by the suppliers?
If the “invisible hand” of competitive markets is so efficient, why does government get into the act?
And if specialization based on comparative advantage is such a good idea, why do most nations try to restrict imports?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Household
Households: starring role in a market economy
Demand for goods and services
Determines what gets produced
Supply labor, capital, natural resources, and entrepreneurial ability
Produces that output
Make all kinds of choices
What to buy, how much to save, where to live, and where to work
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Evolution of the Household
Farm household
Self-sufficient
Better technology
Increased productivity
Growth in urban factories
Increased demand for factory labor
More specialized but less self-sufficient
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Evolution of the Household
Women in the labor force
1950: 15% of women with young children
Today: 70% of women with children under 18
Rise in two-earner households
Produce less for themselves and demand more from the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Households Maximize Utility
Utility
Satisfaction received from consumption
Sense of well-being
Households attempt to maximize utility
Depends on each household’s subjective goals
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Households as Resource Suppliers
Resource suppliers
Labor, capital, natural resources, and entrepreneurial ability
To satisfy their unlimited wants
Most important: labor
To earn income
2014, personal income
More than two-thirds comes from labor earnings
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Households as Resource Suppliers
Sources of personal income, 2014
62% from wages and salaries
10% from transfer payments
9% proprietors’ income
Proprietors
People who work for themselves rather than for employers
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Households as Resource Suppliers
Transfer payments for households with few resources that are valued in the market
Cash transfers are monetary payments
Welfare benefits, Social Security, unemployment compensation, disability benefits
In-kind transfers provide for specific goods and services
Food, health care, housing
Short-term public assistance
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Households: Demanders of Goods and Services
Personal consumption
Largest spending of household personal income
Durable goods: expected to last 3 or more years
9% of personal income
Nondurable goods; 19% of personal income
Services; 55% of personal income
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exhibit 1
Where U.S. Personal Income Comes From and Where It Goes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Firm
The efficiency arising from comparative advantage
Resulted in a greater specialization among resource suppliers
A firm is the natural result of comparative advantage and specialization
Reducing transaction costs
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Evolution of the Firm
Cottage industry system
An entrepreneur supplied raw materials to rural households
18th century
Entrepreneurs organize the stages of production under one factory roof
Technological developments
Increased the productivity of each worker
Helped shift employment from rural areas to urban factories
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Evolution of the Firm
Large, centrally powered factories
Efficient division of labor
Direct supervision of production
Reduce transportation costs
Bigger machines
Industrial Revolution
Large-scale factory production
Began in Great Britain around 1750
Spread to Europe, North America, Australia
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Evolution of the Firm
Firms
Economic units formed by profit-seeking entrepreneurs
Who combine labor, capital, and natural resources to produce goods and services
Assume that firms try to maximize profit
Profit, the entrepreneur’s reward
Equals sales revenue minus the cost of production
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
Sole proprietorship
Single-owner firm
The owner
Has the right to all profits
Bears unlimited liability for the firm’s losses and debts
No partners or other investors
Most common type of business
Generate a tiny portion of all business sales
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
Partnership
Two or more owners
Combine their funds and efforts
Share the profits or losses
Bear unlimited liability for the firm’s losses and debts
Least common form of business
10% of all firms
15% of all business sales
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
Corporation
Legal entity owned by stockholders
Whose liability is limited to the value of their stock ownership
Survives if ownership changes hands
Voting board of directors
Corporate income is taxed twice
As corporate profits
As stockholder income (corporate dividends or realized capital gains)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
S corporation
Provides owners with limited liability
Profits are taxed only once
A income on each shareholder’s personal income tax return
No more than 100 stockholders
And no foreign stockholders
Corporation
19% of businesses
81% of all business sales
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exhibit 2
Percent Distribution by Type of Firm Based on Number of
Firms and Firm Sales
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
Cooperatives, co-op
People who pool their resources to buy and sell more efficiently than they could individually
Consumer cooperatives
Retail business owned and operated by some or all of its customers
To reduce costs
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Types of Firms
Producer cooperatives
Producers join forces to buy supplies and equipment and to market their output
To reduce costs and increase profits
Federal legislation allows farmers to cooperate without violating antitrust laws
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Not-for-Profit Organizations
Not-for-profit organizations
Do not pursue profit as a goal
Engage in different activities
Charitable; Educational; Humanitarian
Cultural; Professional
Not included: government agencies
Any revenue exceeding cost is plowed back into the organization
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Not-for-Profit Organizations
Not-for-profit organizations
Revenue
Voluntary contributions and service charges
E.g.: College tuition, hospital charges
Are usually exempt from taxes
1.6 million not-for-profit organizations in U.S.
Employ about 12 million workers
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
User-Generated Products
Computer programming: open source
Linux – operating system
Apache – web server software
Firefox – web browser
LibreOffice – office suite
Wikipedia – information website
Facebook – social networking
YouTube – videos
Twitter – social networking
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
User-Generated Products
Older user-generated products
Radio call-in shows
New technology has increased the opportunities for users
To create new products
To improve existing products
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Why Does Household Production Still Exist?
A household performs a task
If its opportunity cost of performing the task is below the market price
People with a lower opportunity cost of time
Do more for themselves
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Why Does Household Production Still Exist?
Reasons for household production
Few skills or special resources are required
Avoids taxes
Reduces transaction costs
Technological advances increase household productivity
Information revolution: technological change spawned by the microchip and the Internet
Enhanced the acquisition, analysis, and transmission of information
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Government
Role of government
To intervene in case of market failure
Market failure
Arises when the unregulated operation of markets yields socially undesirable results
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
Establish and enforce rules of the game
Safeguard private property
Make sure that market participants abide by the rules of the game
Promote competition
Antitrust laws that prohibit
Collusion (agreement among firms to divide the market and fix the price)
Unfair business practices
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
Regulate natural monopolies
To lower price and increase output
Monopoly
Sole supplier of a product with no close substitutes
Natural monopoly
One firm that can supply the entire market at a lower per-unit cost than could two or more firms
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
Provide public goods
Funded with taxes
Private goods
Rival in consumption and exclusive
Public goods
Nonrival in consumption and nonexclusive
Once produced, are available for all to consume
Regardless of who pays and who doesn’t
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
Deal with externalities
Use taxes, subsidies, and regulations
To discourage negative externalities
To encourage positive externalities
Externality
Cost or benefit that affects neither the buyer nor seller
Affects people not involved in the market transaction
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
More equal distribution of income
Transfer payments
Fostering a healthy economy
Full employment
Price stability
Economic growth
Using fiscal and monetary policy
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Role of Government
Fiscal policy
Use of government purchases, transfer payments, taxes, and borrowing
To influence economy-wide variables (inflation, employment, economic growth)
Monetary policy
Regulation of the money supply
To influence economy-wide variables (inflation, employment, economic growth)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Government’s Structure and Objectives
National, or federal government
National security, economic stability, market competition
State government
Public higher education, prisons, highways, welfare
Local government
Primary and secondary education, police, fire protection
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Government’s Structure and Objectives
Difficulty in defining government objectives
About 89,150 government jurisdictions
1 nation with 50 states
3,000 counties
36,000 cities and towns
12,900 school districts
37,200 special districts
Not a single decision maker
Vote maximization
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Government’s Structure and Objectives
Voluntary exchange vs. coercion
Some government coercion
Enforced by the police
No market prices
Public output is usually offered at
Zero price
Or below the production cost
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Size and Growth of Government
Government outlays relative to GDP
1929: 10% of GDP
Mostly state and local
2016: 38% of GDP, mostly federal
Defense spending: decreased from half in 1960 to less than one-fifth today
Redistribution: increased to more than half of outlays
Social Security, Medicare, and welfare programs
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exhibit 3
Redistribution Has Grown and Defense Has Declined
as Share of Federal Outlays: 1960-2016
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Sources of Government Revenue
Taxes
Individual income tax (federal)
Income tax and sales tax (state)
Property tax (local)
Other sources
User charges: highway tolls, college tuition
Borrowing
Monopolize certain markets such as liquor and lotteries
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exhibit 4
Payroll Taxes Have Grown and Corporate Taxes Have Declined as a Share of Federal Revenue: 1960-2016
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
Ability-to-pay tax principle
Those with a greater ability to pay
Earning higher incomes
Owning more property
Should pay more taxes
Benefits-received tax principle
Those who get more benefits from the government program should pay more taxes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
Tax incidence
The distribution of tax burden among taxpayers
Who ultimately pays the tax
Evaluate tax incidence
Measure the tax as a percentage of income
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
Proportional taxation (flat tax)
The tax as a percentage of income remains constant as income increases
The dollar amount of taxes increases proportionately as income increases
Marginal tax rate
Percentage of each additional dollar of income that goes to the tax
If high: reduces people’s incentive to work and invest
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
Progressive taxation
Tax as a percentage of income increases as income increases
Increasing marginal tax rate
The U.S., progressive taxation
Seven marginal rates (personal income tax)
From 10 to 39.6% in 2015
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
U.S. personal income tax (progressive)
High-income households pay most of the federal income tax collected
More than 40% of all U.S. households pay no federal income tax
The top 1 percent of tax filers, based on income
Paid 38% of all income taxes collected in 2012
Their average tax rate = 23.5%
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
U.S. personal income tax (progressive)
The top 10 percent of tax filers
Paid 70% of all income taxes collected
Their average tax rate = 18.7%
The bottom 50 percent of tax filers
Paid only 2.8% of all income taxes collected
Their average tax rate = 3.0%
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exhibit 5
Top Marginal Rate on Federal Personal Income Tax
Since 1913
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Tax Principles and Tax Incidence
Regressive taxation
Tax as a percentage of income decreases as income increases
Decreasing marginal tax rate
Most U.S. payroll taxes are regressive
Social Security taxes, 2015
Levied on the first $118,500 of worker’s pay
Employees and employers each pay 6.2% (self-employed pay the entire 12.4%)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
The Rest of the World
The rest of the world
Foreign households, firms, and governments
Affects what U.S. households consume
Affects what U.S. firms produce
Affects U.S. prices, wages, and profits
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
International Trade
International trade
Occurs because of different opportunity costs of producing specific goods
The U.S. imports
Raw materials
Crude oil, bauxite, coffee beans
Finished goods
Cameras, computers, cut diamonds
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
International Trade
The U.S. exports
Sophisticated products
Computer software, aircraft, movies
Agricultural products
Wheat, corn, cotton
From 6% of GDP in 1970 to 14% today
Top 10 destinations:
Canada, Mexico, China, Japan, United Kingdom, Germany, Netherlands, South Korea, France, and Brazil
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
International Trade
Merchandise trade balance
Value of a country’s exported goods minus the value of its imported goods
Includes only goods, not services
For the last 25 years, the U.S.
Imported more goods than exported
Merchandise trade deficit
Must be offset by a surplus in one of the balance-of-payments accounts
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
International Trade
Balance of payments
Record of all economic transactions
Between residents of one country and residents of the rest of the world
During a given period
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Exchange Rates
Foreign exchange
Foreign money needed to carry out international transactions
Exchange rates
Price of one currency in terms of another
Determined in foreign exchange markets
E.g.: 1 euro exchanges for $1.10
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Trade Restrictions
Tariff
Tax on imports
Quota
Legal limit on the quantity of a particular product that can be imported or exported
Other trade restrictions
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
Trade Restrictions
Why do most countries restrict trade?
Restrictions benefit certain domestic producers that lobby governments for these benefits
Higher prices
Hurt domestic consumers
Interfere with the free flow of products across borders
Hurt the overall economy
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 3
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McEachern11e_Ch4.pptx
4
Demand, Supply, and Markets
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Economics 11e, Ch. 4
Why do roses cost more on Valentine’s Day than during the rest of the year?
Why do TV ads cost more during the Super Bowl ($4.5 million for 30 seconds in 2015) than during Nick at Nite reruns?
Why do hotel room rates double in the host city during Super Bowl weekend?
Why do surgeons earn more than butchers?
Why do economics majors earn more than most other majors?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand
Demand
The quantity consumers are willing and able to buy at each price during a given time period, other things constant
Relation between price and quantity demanded
Willing and able
Specific period
Other things constant
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Law of Demand
Law of demand
Quantity demanded varies inversely with price, other things constant
Higher price: lower quantity demanded
Consumer Demand
Not ‘consumer wants’
Not ‘consumer needs’
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Law of Demand
Substitution effect of a price change
When the price of a good falls
That good becomes cheaper compared to other goods
Consumers tend to substitute that good for other goods
Caused by a change in the relative price
Relative price
Price of a good relative to the prices of other goods
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Law of Demand
Income effect of a price change
A fall in the price of a good
Increases consumers’ real income
Consumers are more able to purchase goods
For a normal good, quantity demanded increases
The more important the item is as a share of your budget, the bigger the income effect
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Law of Demand
Money income
Number of dollars a person receives per period
Real income
Measured in terms of what it can buy
Purchasing power
Changes when price changes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand Schedule and Demand Curve
Demand can be expressed as
A demand schedule
A demand curve
Demand schedule
Lists possible prices
Along with the quantity demanded at each price
Reflects the law of demand
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand Schedule and Demand Curve
Demand curve
A curve showing the relation between the price of a good and the quantity consumers are willing and able to buy
Per period
Other things constant
Downward slope
Reflects the law of demand
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand Schedule and Demand Curve
Demand
Entire relationship between price and quantity demanded
Quantity demanded
Amount of a good consumers are willing and able to buy
Per period
At a particular price
Reflected as a point on the demand curve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 1
Market Demand Schedule and Market Demand Curve for Pizza
The market demand curve D shows the quantity of pizza demanded, at various prices, by all consumers. Price and quantity demanded are inversely related other things constant, reflecting the law of demand.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(a) Market demand schedule
(b) Market demand curve
D
Price
per
pizza
Quantity Demanded
Per week (millions)
a
b
c
d
e
$15
12
9
6
3
8
14
20
26
32
26
20
14
8
Millions of pizzas per week
32
0
9
6
3
12
Price per pizza
$15
a
b
c
d
e
McEachern, Economics 11e, Ch. 4
Demand Schedule and Demand Curve
Individual demand
Relation between the price of a good and the quantity purchased
By an individual consumer
During a given period, other things constant
Movement along the demand curve
Change in quantity demanded
Resulting from a change in the price of the good, other things constant
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand Schedule and Demand Curve
Market demand
Relation between the price of a good and the quantity purchased
By all consumers in the market
During a given period
Other things constant
Sum of the individual demands in the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
What Shifts a Demand Curve?
Variables that can affect market demand
Money income of consumers
Prices of other goods
Consumer expectations
The number and/or composition of consumers in the market
Consumer tastes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Changes in Consumer Income
Increase in consumer income
Willing and able to buy more normal goods at each price
Increase in market demand
Demand curve shifts rightward
Normal good
Demand increases as income increases
Inferior good
Demand decreases as income increases
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 2
An Increase in the Market Demand for Pizza
An increase of the market demand for pizza is shown by a rightward shift of the curve, indicating that the quantity demanded increases at each price. For example, at a price of $12, quantity demanded increases from 14 million (point b) to 20 million (point f).
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
D′
D
26
20
14
8
Millions of pizzas per week
32
0
9
6
3
12
Price per pizza
$15
b
f
McEachern, Economics 11e, Ch. 4
Changes in the Prices of Other Goods
Substitutes
An increase in the price of one good
Increases the demand for the other (rightward shift of the demand curve)
Complements – used in combination
An increase in the price of one
Decreases the demand for the other (leftward shift of the demand curve)
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McEachern, Economics 11e, Ch. 4
Changes in Consumer Expectations
Income expectations
Future income increase
Increases current demand (rightward shift)
Price expectations
Future price increase
Increases current demand (rightward shift)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Number or Composition of Consumers
Increase in number of consumers
Increases demand
Rightward shift of the demand curve
Composition of the population
Shift the demand
E.G.: a baby boom increases in the demand for car seats
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McEachern, Economics 11e, Ch. 4
Changes in Consumer Tastes
Tastes
Consumer preferences
Likes and dislikes in consumption
Assumed to remain constant along a given demand curve
Change in tastes
May shift the demand
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand
Movement along the demand curve
Change in quantity demanded
Resulting from a change in the price of the good, other things constant
Shift of the demand curve
Movement of a demand curve right or left
Resulting from a change in one of the determinants of demand
Other than the price of the good
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Supply
Supply
How much producers are willing and able to offer for sale per period at each price, other things constant
Relation between price and quantity supplied
Willing and able
Specific period
Other things constant
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Law of Supply
Law of supply
Quantity supplied is directly related to its price, other things constant
Higher the price, greater the quantity supplied
Higher reward, profit
More willing to increase quantity supplied
Can afford to cover the marginal costs
Increasing opportunity cost
More able to increase quantity supplied
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McEachern, Economics 11e, Ch. 4
Supply Schedule and Supply Curve
Supply can be expressed as
A supply schedule
A supply curve
Supply schedule
Lists possible prices
Along with the quantity supplied at each price
Reflects the law of supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Supply Schedule and Supply Curve
Supply curve
A curve showing the relation between price of a good and the quantity producers are willing and able to sell
Per period
Other things constant
Upward slope
Reflects the law of supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 3
The Market Supply Schedule and Market Supply Curve for Pizza
The market supply curve S shows the quantities of pizza supplied, at various prices, by all pizza makers. Price and quantity supplied are directly related.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(a) Market supply schedule
(b) Market supply curve
S
Price
per
pizza
Quantity Supplied
Per week (millions)
$15
12
9
6
3
28
24
20
16
12
24
20
16
12
Millions of pizzas per week
28
0
9
6
3
12
Price per pizza
$15
McEachern, Economics 11e, Ch. 4
Supply Schedule and Supply Curve
Supply
Entire relationship between price and quantity supplied
Quantity supplied
Amount offered for sale
Per period
At a particular price
A point on the supply curve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Supply Schedule and Supply Curve
Movement along the supply curve
Change in quantity supplied due to a change in price
Individual supply
Relation between the price of a good and the quantity an individual producer is willing and able to sell
Per period, other things constant
The supply of an individual producer
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Supply Schedule and Supply Curve
Market supply
Relation between the price of a good and the quantity all producers are willing and able to sell
Per period
Other things constant
The sum of individual supplies of all producers in the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
What Shifts a Supply Curve?
Factors that can affect the market supply
State of technology and know-how
Prices of resources
Prices of other goods
Producer expectations
Number of producers in the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
State of Technology and Know-How
Better technology or better production process
Production costs decrease
Increase the quantity supplied at each price
Increase in the supply
Rightward shift of the supply curve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 4
An Increase in the Market Supply of Pizza
An increase in the market supply of pizza is reflected by a rightward shift of the supply curve, from S to S’.
Quantity supplied increases at each price. For example, at a price of $12, the quantity supplied per week increases from 24 million pizzas (point g) to 28 million pizzas (point h).
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
S′
S
24
20
16
12
Millions of pizzas per week
28
0
9
6
3
12
Price per pizza
$15
h
g
McEachern, Economics 11e, Ch. 4
Changes in the Prices of Resources
Prices of resources
Employed to make the good
Affect the cost of production and therefore the supply of the good
Decrease in the price of a resources
Production costs decrease
Increase in the supply
Rightward shift of the supply curve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Changes in the Prices of Other Goods
Resources
Have alternative uses
Other goods
Use some resources employed to produce the other good
Decrease in price of other goods
Increase in the supply of the other good
Rightward shift of the supply curve of the other good
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Changes in Producer Expectations
Expected higher prices in the future
Can affect future profits
May increase the current supply
For easily stored goods
Reduce current supply (leftward shift)
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Changes in the Number of Producers
Market supply
Amount supplied at each price
By all producers
Increase in the number of producers
Increase the supply
Rightward shift of the supply curve
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Supply
Movement along the supply curve
Change in quantity supplied
Resulting from a change in the price of the good, other things constant
Shift of the supply curve
Movement of a supply curve left or right
Resulting from a change in one of the determinants of supply
Other than the price of the good
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Demand and Supply Create a Market
Markets
Sort out differences between demanders and suppliers
Reduce transaction costs
Transaction costs
Costs of time and information required to carry out market exchange
Adam Smith
The “invisible hand”
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McEachern, Economics 11e, Ch. 4
Market Equilibrium
Surplus: excess quantity supplied
Amount by which quantity supplied exceeds quantity demanded
At a given price
Puts a downward pressure on price, which
Decreases quantity supplied
Increases quantity demanded
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McEachern, Economics 11e, Ch. 4
Market Equilibrium
Shortage: excess quantity demanded
Amount by which quantity demanded exceeds quantity supplied
At a given price
Puts an upward pressure on price, which
Increases quantity supplied
Decreases quantity demanded
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Market Equilibrium
Equilibrium
Quantity demanded = Quantity supplied
Plans of buyers and sellers match
Equilibrium point
Equilibrium quantity
Equilibrium price
Market clears
No pressure on price to change
“X marks the spot”
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 5 (a)
Equilibrium in the Pizza Market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 5 (b)
Equilibrium in the Pizza Market
Market equilibrium occurs at the price where quantity demanded equals quantity supplied. This is shown at point c, where the price is $9 and the quantity is 20 million pizzas per week.
Above the equilibrium price, quantity supplied exceeds quantity demanded. This creates a surplus, which puts downward pressure on the price.
Below the equilibrium price, quantity demanded exceeds quantity supplied. The resulting shortage puts upward pressure on the price.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
S
24
20
16
14
Millions of pizzas per week
26
0
9
6
3
12
Price per pizza
$15
D
c
Shortage
Surplus
McEachern, Economics 11e, Ch. 4
Changes in Equilibrium Price and Quantity
Equilibrium
Occurs when the intentions of demanders and suppliers exactly match
Once a market reaches equilibrium
That price and quantity prevail
Until something happens to demand or supply
Changes in equilibrium price and quantity
Are due to a change in any non-price determinant of demand or supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Demand Curve
Factors that can affect market demand
Money income of consumers
Prices of other goods
Consumer expectations
The number or composition of consumers in the market
Consumer tastes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Demand Curve
Increase the demand for pizza due to:
Increase in the money income of consumers
Increase in the price of a substitute, or a decrease in the price of a complement
Change in consumer expectations that causes people to demand more pizzas now
Growth in the number of pizza consumers
Change in consumer tastes
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Demand Curve
The demand increases
Rightward shift of the demand curve
At the initial price: shortage
Puts upward pressure on p
QD decreases
QS increases
New equilibrium
Higher price and higher quantity
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 6
Effects of an Increase in Market Demand
An increase in demand is shown by a shift of the demand curve rightward from D to D’.
Quantity demanded exceeds quantity supplied at the original price of $9 per pizza; this shortage puts upward pressure on the price.
As the price rises, quantity supplied increases along supply curve S, and quantity demanded decreases along demand curve D’. When the new equilibrium price of $12 is reached at point g, quantity demanded once again equals quantity supplied.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
S
24
20
Millions of pizzas per week
30
0
9
$12
Price per pizza
D
c
D′
g
McEachern, Economics 11e, Ch. 4
Shifts of the Demand Curve
The demand decreases
Leftward shift of the demand curve
At the initial price: surplus
Puts downward pressure on p
QD increases
QS decreases
New equilibrium
Lower price and lower quantity
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Supply Curve
Factors that can affect market supply
State of technology and know-how
Prices of resources
Prices of other goods
Producer expectations
Number of producers in the market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Supply Curve
Increase in the supply of pizza due to
Technological breakthrough in pizza ovens
Reduction in the price of a resource
Decline in the price of another good produced with these resources
Change in expectations that encourages pizza makers to expand production now
Increase in the number of pizzerias
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Supply Curve
The supply increases
Rightward shift of the supply curve curve
At the initial price: surplus
Downward pressure on p
QD increases
QS decreases
New equilibrium
Lower price and higher quantity
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Shifts of the Supply Curve
The supply decreases
Leftward shift of the supply curve curve
At the initial price: shortage
Upward pressure on p
QD decreases
QS increases
New equilibrium
Higher price and lower quantity
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 7
Effects of an Increase in Market Supply
An increase in supply is shown by a shift of the supply curve rightward, from S to S’.
Quantity supplied exceeds quantity demanded at the original price of $9 per pizza, putting downward pressure on the price.
As the price falls, quantity supplied decreases along supply curve S’, and quantity demanded increases along demand curve D.
The new equilibrium price of $6 is reached at point d, where quantity demanded once again equals quantity supplied.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
S
26
20
Millions of pizzas per week
30
0
$9
6
Price per pizza
D
c
S′
d
McEachern, Economics 11e, Ch. 4
Simultaneous Shifts of D and S Curves
Both S and D increase:
Q increases
If D shifts more: p increases
If S shifts more: p decreases
Both S and D decrease:
Q decreases
If D shifts more: p decreases
If S shifts more: p increases
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 8
Effects of an Increase in Both Demand and Supply
When both demand and supply increase, the equilibrium quantity also increases. The effect on price depends on which curve shifts more. In panel (a), the demand curve shifts more, so the price rises. In panel (b), the supply curve shifts more, so the price falls.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(a) Shift of demand dominates
(b) Shift of supply dominates
S
p’
p
Price
D
S′
a
D′
b
Q′
Q
Units per
period
0
S
p’’
p
Price
D
S″
a
D″
c
Q′′
Q
Units per
period
0
McEachern, Economics 11e, Ch. 4
Simultaneous Shifts of D and S Curves
S increases and D decreases
p decreases
If D shifts more: Q decreases
If S shifts more: Q increases
S decreases and D increases
p increases
If D shifts more: Q increases
If S shifts more: Q decreases
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 9
Effects of Shifts of Both Demand and Supply
When the demand and supply curves shift in the same direction, equilibrium quantity also shifts in that direction. The effect on equilibrium price depends on which curve shifts more.
If the curves shift in opposite directions, equilibrium price will move in the same direction as demand. The effect on equilibrium quantity depends on which curve shifts more.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Disequilibrium
Disequilibrium
Plans of buyers do not match those of sellers
Temporary mismatch between quantity supplied and quantity demanded
As the market seeks equilibrium
As a result of government intervention, it can last a while
Price floors
Price ceilings
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McEachern, Economics 11e, Ch. 4
Disequilibrium
Price floor
Minimum legal price below which a product cannot be sold
To have an impact, the price floor must be set above the equilibrium price
Creates a surplus
Distorts a market
Reduces economic welfare
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Disequilibrium
Price Ceiling
Maximum legal price above which a product cannot be sold
To have an impact, the price ceiling must be set below the equilibrium price
Creates a shortage
Distorts a market
Reduces economic welfare
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Exhibit 10
Effects of Price Floors and Price Ceilings
A price floor set above the equilibrium price results in a surplus, as shown in panel (a). A price floor set at or below the equilibrium price has no effect. A price ceiling set below the equilibrium price results in a shortage, as shown in panel (b). A price ceiling set at or above the equilibrium price has no effect.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
(a) Price floor for milk
(b) Price ceiling for rent
S
D
$2.50
1.90
Price per gallon
19
14
Millions of gallons per month
0
24
S
D
$1,000
600
Monthly rental price
50
40
Thousands of rental units per month
0
60
Surplus
Shortage
McEachern, Economics 11e, Ch. 4
Rent Ceilings in New York City
Rent ceilings
Nearly half of the 2.1 million rental apartments
Excess demand in the rent-controlled sector raised rents in the free-market sector
Sharp drop in new construction
Wastes valuable resources
Deteriorating quality of housing stock
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Rent Ceilings in New York City
Tenants in low- and moderate-income areas
Get little or no benefit from rent control
Upscale Manhattan, three-bedroom apartment
$1,000 a month if rent controlled
$12,000 a month on the open market
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
Rent Ceilings in New York City
Who benefits from rent control?
More than 87,000 New York City households with incomes exceeding $100,000 a year
Landlords – incentive to oust a tenant
Pay $5,000 bounties to doormen who report tenants violating their lease
Hire private detectives to identify lease violators
Use professional “facilitators” to negotiate with tenants about moving out
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 4
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McEachern11e_Ch5.pptx
5
Elasticity of Demand and Supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Prepared by: V. Andreea Chiritescu, Eastern Illinois University
Reviewed by: William A. McEachern, University of Connecticut
McEachern, Economics 11e, Ch. 5
What does the supply curve look like for Cadillacs once owned by Elvis Presley?
What does the demand curve look like when price is no object?
Why would an HDTV coupled with a DVR reduce attendance at televised sporting events?
How has the Internet made consumers more price sensitive?
Why are consumers more sensitive to the price of Post Raisin Bran than to the price of cereal more generally?
Why does an abundant harvest often spell trouble for farmers?
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Price Elasticity of Demand
Elasticity
Responsiveness
Price elasticity of demand, ED
Measures how responsive quantity demanded is to a price change
Percentage change in quantity demanded divided by percentage change in price
Using the midpoint formula
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Price Elasticity of Demand
%Δq, percentage change in quantity
Calculated as change in quantity divided by the average quantity
%Δp, percentage change in price
Calculated as change in price divided by the average price
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Price Elasticity of Demand
Price elasticity of demand, ED
Law of demand
Price and quantity demanded are inversely related
ED is negative
Absolute value of ED is positive
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Exhibit 1
Demand Curve for Tacos
If the price of tacos drops from $1.10 to $0.90, the quantity demanded per day increases from 95,000 to 105,000.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
D
105
95
Thousands per day
0
0.90
Price per taco
$1.10
b
a
McEachern, Economics 11e, Ch. 5
Categories of ED
Inelastic demand: 0 < ED < 1 %∆q < %∆p The change in price has relatively little effect on quantity demanded Unit elastic demand: ED = 1; %∆q = %∆p Elastic demand: ED > 1
%∆q > %∆p
The change in price has a relatively large effect on quantity demanded
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Elasticity and Total Revenue
Total revenue, TR= p x q
TR = price x quantity demanded at this price
A lower price
Law of demand: increases quantity demanded
Increase total revenue
But producers get less for each unit sold
Decrease total revenue
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Elasticity and Total Revenue
As price decreases
If demand is elastic, TR increases
If demand is inelastic, TR decreases
If demand is unit elastic, TR constant
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McEachern, Economics 11e, Ch. 5
Price Elasticity and the Linear D Curve
Linear demand curve
Straight line demand curve
Constant slope
But varying elasticity
Demand becomes less elastic as we move downward
Upper half: elastic
Lower half: inelastic
Midpoint: unit elastic
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Total revenue
$25,000
500
Quantity per period
1,000
0
(b) Total revenue
90
60
10
70
Price per unit
$100
80
50
40
30
20
800
500
200
100
Quantity per period
1,000
0
900
(a) Demand and price elasticity
Exhibit 2
Demand, Price Elasticity, and Total Revenue
Where the demand curve is elastic, a lower price increases total revenue.
Total revenue reaches a maximum at the rate of output where the demand curve is unit elastic.
Where the demand curve is inelastic, a drop in price reduces total revenue.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
D
b
a
d
e
Total
revenue
Unit elastic, ED =1
Elastic, ED >1
Inelastic, ED <1 c McEachern, Economics 11e, Ch. 5 Constant-Elasticity Demand Curves Perfectly elastic demand curve Horizontal line Any price increase would reduce quantity demanded to zero ED = ∞ Consumers are so sensitive to price changes that tolerate no price increases © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Constant-Elasticity Demand Curves Perfectly inelastic demand curve Vertical line Any price change has no effect on quantity demanded ED = 0 ‘Price is no object’ © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Constant-Elasticity Demand Curves Unit-elastic demand curve Everywhere along the demand curve % Δp causes an equal but offsetting %Δq Total revenue remains the same ED = 1 Constant-elasticity demand curve Price elasticity is the same everywhere along the curve Elasticity value is unchanged © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Exhibit 3 Constant-Elasticity Demand Curves The three panels show constant-elasticity demand curves, so named because the elasticity value does not change along the demand curve. Along the perfectly elastic, or horizontal, demand curve of panel (a), consumers demand all that is offered for sale at price p, but demand nothing at a price above p. Along the perfectly inelastic, or vertical, demand curve of panel (b), consumers demand amount Q regardless of price. Along the unit-elastic demand curve of panel (c), total revenue is the same for each price-quantity combination. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 0 Quantity per period Price per unit p ED = ∞ (a) Perfectly elastic D Price per unit ED′= 0 (b) Perfectly inelastic ED = 1 (c) Unit elastic D′ 0 Quantity per period Q Price per unit $10 6 0 Quantity per period 60 100 D″ a b McEachern, Economics 11e, Ch. 5 Exhibit 4 Summary of Price Elasticities of Demand © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Determinants of Price Elasticity of D Price elasticity of demand, ED, is greater: The greater the availability of substitutes, and the more similar the substitutes The more narrow the good is defined The more important the item as a share of the consumer’s budget The greater is the income effect of a change in price The longer the period of adjustment (time) © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Exhibit 5 Demand Becomes More Elastic Over Time Dw is the demand curve one week after a price increase from $1.00 to $1.25. Along this curve, quantity demanded per day falls from 100 to 95. One month after the price increase, quantity demanded has fallen to 75 along Dm. One year after the price increase, quantity demanded has fallen to 50 along Dy. At any given price, Dy is more elastic than Dm, which is more elastic than Dw. The more time buyers have to adjust to a change in price, the greater the price elasticity of demand. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Dw Price per unit $1.25 1.00 Dm Quantity per day 95 100 75 50 0 Dy e McEachern, Economics 11e, Ch. 5 Elasticity Estimates Short run Consumers have little time to adjust Long run Consumers can fully adjust to a price change Demand is more elastic in the long run Because consumers have more time to adjust © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Exhibit 6 Selected Price Elasticities of Demand (Absolute Values) © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Price Elasticity of Supply Elasticity Responsiveness Price elasticity of supply, ES Responsiveness of quantity supplied to a price change Percentage change in quantity supplied divided by percentage change in price Using the midpoint formula © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Price Elasticity of Supply %Δq, percentage change in quantity Calculated as change in quantity divided by the average quantity %Δp, percentage change in price Calculated as change in price divided by the average price © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Price Elasticity of Supply Price elasticity of supply, ES Law of supply Price and quantity demanded are directly related ES is positive © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. McEachern, Economics 11e, Ch. 5 Exhibit 7 Price Elasticity of Supply If price increases from p to p′, quantity supplied increases from q to q′. Price and quantity supplied move in the same direction, so price elasticity of supply is a positive number. © 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. S Price per unit p p′ Quantity per period q q′ 0 McEachern, Economics 11e, Ch. 5 Categories of ES Inelastic supply: ES < 1 %∆q < %∆p The price change has relatively little effect on quantity supplied Unit elastic supply: ES = 1; %∆q = %∆p Elastic supply: ES > 1
%∆q > %∆p
The price change has a relatively large effect on quantity supplied
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McEachern, Economics 11e, Ch. 5
Constant Elasticity Supply Curves
Perfectly elastic supply curve, ES = ∞
Horizontal line
Any price decrease drops quantity supplied to zero
Unit-elastic supply curve, ES = 1
%∆p causes an identical %∆q
Straight line from the origin
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Constant Elasticity Supply Curves
Perfectly inelastic supply curve, ES = 0
Vertical line
A price change has no effect on quantity supplied
Goods in fixed supply
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McEachern, Economics 11e, Ch. 5
Exhibit 8
Constant-Elasticity Supply Curves
In each of the three panels is a constant-elasticity supply curve, so named because the elasticity value does not change along the curve. Supply curve S in panel (a) is perfectly elastic, or horizontal. Along S, firms supply any amount of output demanded at price p, but supply none at prices below p. Supply curve S′ is perfectly inelastic, or vertical. S′ shows that quantity supplied is independent of price. In panel (c), S″, a straight line from the origin, is a unit-elastic supply curve. Any percentage change in price results in the same percentage change in quantity supplied.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
0
Quantity
per period
Price per unit
p
ES = ∞
(a) Perfectly elastic
S
Price per unit
ES′ = 0
(b) Perfectly inelastic
ES″ = 1
(c) Unit elastic
S′
0
Quantity
per period
Q
Price per unit
$10
5
0
Quantity
per period
10
20
S″
McEachern, Economics 11e, Ch. 5
Determinants of Supply Elasticity
The elasticity of supply, ES, is greater:
If the marginal cost rises slowly as output expands
The longer the adjustment period under consideration
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McEachern, Economics 11e, Ch. 5
Exhibit 9
Supply Becomes More Elastic Over Time
The supply curve one week after a price increase, Sw, is less elastic, at a given price, than the supply curve one month later, Sm, which is less elastic than the supply curve one year later, Sy. Given a price increase from $1.00 to $1.25, quantity supplied per day increases to 110 units after one week, to 140 units after one month, and to 200 units after one year. The more time that sellers have to adjust to a price change, the greater the price elasticity of supply.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Sw
Price per unit
1.00
$1.25
Quantity per day
110
200
0
100
140
Sm
Sy
McEachern, Economics 11e, Ch. 5
Income Elasticity of Demand
Income elasticity of demand
Demand responsiveness to a change in consumer income
Percentage change in demand divided by the percentage change in income that caused it
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McEachern, Economics 11e, Ch. 5
Income Elasticity of Demand
Inferior goods
Negative income elasticity
Normal goods
Positive income elasticity
Income inelastic, necessities
Elasticity between 0 and 1
Income elastic, luxuries
Elasticity > 1
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Exhibit 10
Selected Income Elasticities of Demand
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
The Market for Food and the “Farm Problem”
The demise of the family farm
1948: 10 million farmers
Today: fewer than 3 million
Despite decades of federal support and billions of tax dollars spent on various farm-assistance programs
Can be traced to
The price and income elasticities of demand for farm products
Technological breakthroughs that increased supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
The Market for Food and the “Farm Problem”
Demand for farm products
Price inelastic: total revenue for farmers falls when output increases
Income inelastic: demand increases by less than the increase in income
Supply of farm products
Technological improvements sharply increased the supply
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
The Market for Food and the “Farm Problem”
Increased supply
More sophisticated machines, better fertilizer, and healthier seeds
Increased farm output per hour of labor 11- fold since 1950
Using GPS: farmers can seed at night using a 32-row planter
New strains of pest-resistant plants
Decrease insecticide applications from seven per season to one or even none
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Exhibit 11
The Demand for Grain
The demand for grain tends to be price inelastic. As the market price falls, so does total revenue.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
D
5
10
11
Billions of bushels per year
0
Price per bushel
$5
4
3
2
1
McEachern, Economics 11e, Ch. 5
Exhibit 12
The Effect of Increases in Demand and Supply of Grain on Farm Revenue
Over time, technological advances in farming have sharply increased the supply of grain. In addition, increases in consumer income over time have increased the demand for grain. But because increases in the supply of grain exceed increases in demand, the combined effect is a drop in the market price and a fall in total farm revenue.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
S′
D′
D
5
10
14
Billions of bushels per year
0
Price per bushel
$8
4
S
McEachern, Economics 11e, Ch. 5
Cross-Price Elasticity of Demand
Cross-price elasticity of demand
The percentage change in the demand of one good, divided by the percentage change in the price of another good
Positive for substitutes
Negative for complements
Zero for unrelated goods
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McEachern, Economics 11e, Ch. 5
Price Elasticity and Tax Incidence
Tax incidence: who pays the tax
Depends on the price elasticities of demand and supply
Consumers: high price
Producers: lower net-of-tax receipt
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McEachern, Economics 11e, Ch. 5
Price Elasticity and Tax Incidence
Tax on sellers
Decrease in supply by the amount of tax
Buyers and sellers are affected
The more price elastic the demand:
The more tax producers pay and the less tax consumers pay
Total tax revenue declines more when demand is more elastic
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Exhibit 13
Effects of Price Elasticity of Demand on Tax Incidence
The imposition of a $0.20-per-ounce tax on tea shifts the supply curve leftward from S to St. In panel (a), which has a less elastic demand curve, the market price rises from $1.00 to $1.15 per ounce and the market quantity falls from 10 million to 9 million ounces per day. In panel (b), which has a more elastic demand curve, the same tax leads to an increase in price from $1.00 to $1.05; market quantity falls from 10 million to 7 million ounces per day. The more elastic the demand curve, the more the tax is paid by producers in the form of a lower net-of-tax receipt.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
St
S
D′
St
S
D
$0.20 Tax
Price per ounce
$1.15
1.00
0.95
Millions of
ounces per day
10
9
0
$0.20 Tax
Price per ounce
$1.05
1.00
0.85
(a) Less elastic demand
(b) More elastic demand
10
7
Millions of
ounces per day
McEachern, Economics 11e, Ch. 5
Price Elasticity and Tax Incidence
The more elastic the supply:
The less tax producers pay
The more tax consumers pay
The less elastic the demand and the more elastic the supply
The greater the share of the tax paid by consumers
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
Exhibit 14
Effects of Price Elasticity of Supply on Tax Incidence
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
McEachern, Economics 11e, Ch. 5
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