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Economic Principles

Economic Principles

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Published by Carlos Ferreira
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Published by: Carlos Ferreira on Feb 18, 2009
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03/04/2013

 
REVIEW QUESTIONSCHAPTER 1
1.What is the difference between microeconomics and macroeconomics?
Micro and macroeconomics are both branches of economics, but have different objects of study. Microeconomics is concerned with the behaviour of individual economic agents(decision makers), such as consumers, workers, firms, managers, households, industries,markets, labour unions or trade associations. In doing so, it provides a framework toanalyse the impact of government actions on the economy and the role of government inthe economy.Macroeconomics, on the other hand, is concerned with how an entire economy performs.It studies other variables, of a more aggregate nature, such as the level of income andemployment, the relation between interest rates and prices, inflation and business cycles.
2.Why is economics often described as the science of constrained choice?
It is believed that human wants are unlimited: all human beings always desire more.However, the resources available to produce the desired good and services are finite –scarce –, so their supply is limited. As a result, human beings are constrained to choosebetween which wants to satisfy, and in doing so, allocate resources to satisfy demand.Since it is economics that deals with the allocation of scarce resources to satisfy unlimitedhuman wants, economics is considered the science of constrained choice.
3.How does the tool of constrained optimization help decision makers makechoices? What roles do the objective function and constraints play in a modelof constrained optimization?
The tool of constrained optimization helps decision makers make choices by taking intoaccount all possible restrictions and limitation on those choices. To do that, it has twocomponents: the constraints (restrictions and limitations) and an objective function.The objective function is the relationship the economic agent wants to either maximise of minimise. It is, in fact, what the agent cares about. So, constrained optimization points outto the relationship to be maximised or minimised, while accounting for possible limitationsand restrictions.
4.Suppose the market for wheat is competitive, with an upward-sloping supply
 
curve, a downward-sloping demand curve, and an equilibrium price of $4.00per bushel. Why would a higher price (e.g., $5.00 per bushel) not be anequilibrium price? Why would a lower price (e.g., $2.50 per bushel) not be anequilibrium price?
If the market is in equilibrium at a price of $4.00 per bushel, a higher price ($5.00) wouldresult in excess supply (Q4-Q2), with producers wanting to sell more wheat (Q4) than at$4.00 per bushel, but consumers wanting to buy less wheat (Q2). Conversely, at a price of $2.50 per bushel, consumers would want to buy more wheat (Q5), but producers would bewilling to sell less wheat (Q1) there would be excess demand (Q5-Q1). In either situation, the market does not clear.
5.What is the difference between an exogenous variable and an endogenousvariable in an economic model? Would it ever be useful to construct a modelthat contains only exogenous variables (and no endogenous variables)?
An exogenous variable is one whose value is taken as given in a model. It is therefore,determined by some process outside the model being examined. An endogenous variable,on the other hand, is a variable whose value is determined within the model being studied.The objective of any model is to represent relationships between endogenous variablesgiven values of the exogenous variables. So it makes no sense to have a modelconstructed simply with given values; it would show no meaningful relationships.
6.Why do economists do comparative statics analysis? What role doendogenous variables and exogenous variables play in comparative statics
PriceQuantity4.005.002.50Q*Q1Q2 Q4 Q5SupplyDemand
 
analysis?
Economists do comparative statics analysis to study the impact a change in an exogenousvariable has in the level of an endogenous variable. So, the endogenous variablesrepresent the objective function and the exogenous variables represent the constraints.The objective of the model is to represent is the behaviour and relationships of endogenous variables given the values of the exogenous variables.
7.What is the difference between positive and normative analysis? Which of thefollowing questions would entail positive analysis, and which normativeanalysis?a) What effect will Internet auction companies have on the profits of localdealerships?b) Should the government impose special taxes of merchandise made over the Internet?
In an economics setting, positive analysis attempts to explain how an economic modelsworks and how it will change over time (answers explanatory and predictive questions),while normative analysis attempts to answer prescriptive questions, such as how to act inorder to obtain a certain outcome – typically related to social welfare.Question a) is a matter of positive analysis, because it entails a prediction of what willhappen should a certain policy be put in practice. Question b), on the other hand, is amatter of normative analysis, because it attempts to answer a prescriptive question –should a policy be put in place –, one imagines in order to obtain a certain social welfareoutcome.

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