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uploaded by user alliswimm Class: Lecture/Exam: School: Semester: Professor: ECO 108 Full Semester SBU Spring 2011 Xin

Empiricism; All knowledge is derived from experience. John Locke, George Burkley, David Hume. Rationalism; Prevails in continental europe. Opinions and actions should be based on reason rather than belief. Immanuel Kent. Formula of Empiricism: Observation, then use imagination to try and think of a theory. Once you have a theory you have to test it. If the test passes the next step is generalization. You compare it to other cases. Will your theory explain the same observation. All the steps before the test are called empirical evidence. The second part is part of empirical science. You can figure out why things happen. Empirical evidence is all about observation. Empirical science examines why things occur. By generalization, you can see if the theory in this observation can explain other things. Our knowledge takes on a from. A- assumption and B- Prediction. Prediction; If I release the apple it falls. For a forecast, it has to take into consideration all the information of A and B. Positive Economics Vs. Normative Positive Economics is descriptive. If we change investment rate from 15% to 30% what will happen. Trying to find out the If A than B. Normative Economics: Made to change. Empiricism Philosophy Has four steps; Observation and a theory that tries to explain why this is happening. Then you test it, and if it passes there is generalization. After generalization go through two types. If we were to normalize the tax rate, redistribute: Positive economics: Descriptive, hurts economy and produces less. Normative economics: Active, Weather we should conduct this change or not. Balance between what is good and what is bad. Contemporary political philosophy; an Introduction by Will Kymlica Utilitarianism- The greatest good to greatest number. As long as the number of people benefiting outnumber the number of people suffering. Takes majority into account. John Rawls- A theory of Justice. Responding to utilitarianism problem. What is just in this society is seen under Veil of Ignorance. (no nothing about what we will be born into). Make rules from there. Improves the well-being of the worst off person in society. Robert Nozick- Responds to theory of Justice and the Utilitarianism No one should give government the authority of taking from one person and giving to another. Made epistemological system which dealt with the Gettier problem (thought experiment, radiates knowledge) and those posed by skepticism. Libertarianism- As long as the process determining the outcome is just, the outcome is just, regardless of how unequal it appears.

Law of demand- if price goes up, demand goes down. If price goes down, you demand more. Invisible hand- Price (price Theory). Price offers you a chance to reveal your preference. Observation: Medicine price is very high in china. Firm has monopolistic power and can price whatever. Same with oil in the middle east. You dont see monopolistic power in china, lots of small firms which make fierce competition. You are supposed to have a low price with competition. Have to think about a different theory for high price. Price information; give production cost. Gives knowledge of what to buy from doctors. The doctor could be the monopoly as long as number of doctors does not increase. Doctors are picking what people buy, and where from. Firms will bribe doctors. Lecture 2- Scarcity, Competition & Constraint 1.Review 2.Scarcity 3.Competition Review Have an observation, medicine price is very high and well above the production cost. Observe there are a lot of firms trying to produce medicine, perfect competition. Problem is that the price of medicine is too high. Price= (Production cost, knowledge). Limited number of doctors have market power. Next step is to test the theory. Need a Testable Prediction. You need 2 things: 1. It must be possible for the statement to be wrong. (Tomorrow either will rain or will not)No way you can prove it wrong, cannot use these statements. 2nd If A than B, must be observable. If you cant observe it, it cannot be tested. There is no way to know what occurred. Observe that the production cost of the medicine is relatively low. Producers will bribe doctors to endorse their product. After the product is sold to the hospital, the price is risen again to be sold to the consumer. Economics is science that analyzes the order of our society. Organization Price production & Exchange --> Price mechanism on market --> Choice Theory (Scarcity and peoples behavior). Scarcity Back to price of pencil, need to know what people are thinking in order to produce efficiently. Price shows that people may prefer one thing to another. If something really wants something, they will pay a higher price. Price is a mechanism to make people express their preference. David Ricardo (late 18 Century), was the first economist to recognize the need for Scarcity- The limited nature of societies resources. Other definitions: Possessing utilities as well as commodities and deriving their exchangeable value from two sources. From scarcity and from the quantity of labor required to obtain them.

Walras 18 Century: I mean all things, material or immaterial that are scarce, that is to say on one hand useful to us and on the other only available to us in limited quantity. Things must be useful to us (things such as garbage is not), and it has to be limited. Robbins 1920: Economics is the science which studies human behavior as a relationship between ends and scarced means, which have alternative use. Answered what is an economic problem. Economic problem could be allocating a limited resources with multiple ends. The resource must be limited. Ends meaning it has multiple purposes. Alchian 1960: Scarcity means you wants and desires exceed what is available. May seem no different from Robbins, but the word desires shows that scarcity is not an objective problem, but is psychological. There is more scarcity in China with avg. income $3,000 than in the U.S. $30,000. As long as people still want things, there is scarcity. If something is psychological, can you observe it (scarcity). Example: A seat in the library. 1) You have to compete. If you see people compete, you can say you observed scarcity. Ex 2: Diamond Market. 2) You have to pay prices. 3) People have to make a choice. Limited amount of quantity available to you. Have to make a Trade Off to get the resource. In order to get some benefits, you have to pay the cost. Choice is affected by trying and make a balance between benefit and cost. If cost exceeds benefit, people wont make the trade off. Cost= (price of market cost, non-market cost). Robbins says an economic problem exists whenever scarce means are used to serve alternative ends. Friedman (1960), *If the means are not scarce there is no problem, there is Nirvana- transcendent state in which there is neither suffering, desire, nor sense of self. *If the means are scarce but there is only a single end, the problem of how to use the means is a technological problem. We have to study economics because we have scarcity. Scarce resource with multiple ends is an economic problem, trading off cost and benefits of certain resource. Competition more than one person desires a single good. Competition is the same as scarcity, it is observed this way. If we see people compete for something we know its scarce. How do we observe competition, what are types of competition? ViolenceEveryone against everyone, Hobbes Forest. Authority- Decides who gets what. First come first serve- self explanatory. Who desires resource most receives it- Need to make sure people tell the truth, market mechanism, you have to pay a price for the item. Do we need Rationality. Consumer theory- maximizing individual utility, people only care about themselves. Firm theory- maximizing profit. This topic is discussed in last entry of Friedman. Alchian proposed the idea of social darwinism. -You have money and open business as a gas station, can choose location, since the resource in this economy is choice, will choose location near people.

Trade Because the resource in the economy is scarce, analyze problem on how to allocate the resource if it can serve different purposes. Need a framework. PPF- Production Possibility Frontier; Given endowment, technology. the combination of output that an economy could possibly produce. There is an abstract kind of resource that can serve two ends. EX: Working hours; to produce computers and build cars. (Graph, right angle axiss with a little angle circle connecting them). Y is cars, X is computers produced. Points tell you how many of each item as been produced in the economy. Any combination beyond the curve is invisible because we dont have enough resources. Any point within the curve in inefficient, not making as much product as you could be. Pareto Efficient- If there exists no way of improving the status of one party without causing damage on the other, we say that such allocation is Pareto Efficient. Pareto Improvement- A change of allocation that improves the status of one party without causing damage on the other. Once we have efficiency, we try to find equality- P.E. has nothing to do with equality, we are not wasting resources. Opportunity Cost; what is the opportunity cost of producing cars. -In order to use the resources to serve one end, o.c is the maximum benefit you have to sacrifice among all alternatives. Final Good Market- Stores such as Walmart or meijer. Factor Market- labor is factor of production. People in this economy are put into two categories; Firm and Consumer. Firms sell things on the Final good market, Consumers buy the final good, Consumers output factors (purchase things on market, firm uses money), Uses money to purchase things for the firm. That is the inner loop of production/consumption. The outer loop; Consumer pays for the final good, that gives the firm profit, the firm pays rent and wages to factor market, and consumer gets income from the factor market. Slope: starting from (x,y), If you reduce the production of x by 1 unit, how many of y could you get. If you wish to increase the production of y by 1 unit, how many x do you have to give up? This shows the opportunity cost, what the slope tells us. Graph with Convex; decreasing marginal substitute of technology. As you are producing one thing more and more, its difficult to increase production of the other. Unbiased economic growth means you increase the whole curve, so you can make more of both. Biased economic growth (of x), the curve moves up, a lot on the x side, barely any on the y side. When we have scarcity, if people want to get something they have to pay a cost. Why are people willing to pay the cost. Absolute Advantage, Smith (1776), Beginning of 18th Century, England is exchanging cloth with Portugal wine. 1640 revolution, England developed a strong industrial sector. Assume labor is the only factor of production. If produce 1 unit of xx. How many hours of labor we need. Suppose the labor endorsement in both countries are 10 hours. England, 5 hours to cloth and port. 5 hours to wine. Either 5/2.5 or 2.5/5

Cloth England Port 1 2 2 1


Absolute Advantage The reason we trade with each other. Two countries and each of them has absolute advantage on something. Countries will export things they have absolute advantage in and import things they have absolute disadvantage in. 1. Who do we trade with. 2. What has been traded. 3. How do they trade. (relative price in trade). David Ricardo; Britain is more efficient in producing almost everything composed to portugal but Britain still buys win from Portugal. Comparative Advantage, the best way to compare wine and cloth is by examining the opportunity cost. The unit labor requirement for both countries changes over time. Cloth England Portugal 2 6.1 1 1.5 Wine

Portugal has become poorer. Assume Labor endowment is 30 hours in both countries. Also assume the marginal rate of technological substitution is constant. Means the shape of the frontier is constant slope, strait line. For England to produce 1 unit more cloth, they need 2 more hours, which requires a reduction in wine production for 2 units. The opportunity cost of producing 1 cloth evaluated in win is 2 wines. For portugal; To produce 1 cloth 6 hours, we need 4 wines reduction. The Opportunity cost for portugal to produce 1 cloths is 6 wines. For England; To produce 1 unit more wine, 1 hours, reduce 6.5 units of cloth. The opportunity cost for producing one unit of wine is 0.5 cloth. Portugal; To produce 1 unit of wine, 1.5 hours, .25 cloth in opportunity cost. Portugal is more efficient in producing wine, in this instance. Now to discuss what will happen after trade. Assume cloth/wine = 3. Cloth is more expensive than wine. If England reallocates 1 hour from wine production to cloth production, England can produce .5 more cloth. If they use this .5 cloth into the market, they could get 1.5 wines since price is 3:1. Trade is profitable for england. If portugal reallocates 1 hours from cloth to wine. Portugal exports 1.5 wine and trades back .5

cloth. .5 cloth produced at home requires 3 hours, with that 3 hours, they can produce 2 wines. Trade is beneficial because they sacrifice less wine. Assume cloth/wine = 1. The opportunity cost of trading for 1 cloth is 1 wine. Opportunity cost of production: England gets 2 wine per hour. Portugal gets 4 wine per hour. This price does not work for trade, better to produce at home. Assume cloth/wine = 5. The O.C. of trading 1 wine is .2 cloth. The O.C. for production, england- .5 and portugal .25. For england, if they are producing at home, sacrifice .5, but if they trade they sacrifice .2. If portugal does it at home, they sacrifice .25 but if they trade they sacrifice .2. Price does not work. If price keeps increasing/decreasing it wont work. Price has to be between 1 and 5. Number of buyers and sellers matter a lot in the global market. Take the market of walmart, where we are buyers and the store is the seller. We are price takers, meaning we dont bargain over the price. If the price goes down, people tend to buy more (demand goes up). Take market of Craigslist, there is a seller and buyer. Selling car for $7,000 dollars and price is negotiable. Prices go back and forth. If there is only one seller, and lots of buyers, seller could ignore the low prices. Number of buyers and sellers matter. Price is only one dimension of market. Quality of products, differentiation, etc. Market: (Mankim) A group of buyers and sellers of a particular good or service. (Samuelson) A mechanism which gathers buyers and sellers together to determine the trading price and quantity of some particular good or services. (R. Coase) Market is institutions that exist to facilitate exchange in order to reduce the cost of carrying out exchange transactions. Market Structure Numbers of sellers, product feature, and price and behavior differentiate the market. Perfect Competition is when the number of sellers is continuum. The product feature is Identical (Homogeneous). In pricing behavior there is an observed price or price taker. Monopolistic Competition still continuum of firms, but differential product (heterogeneous), can set price, neglect other sellers behavior. Oligopoly has finite number of sellers, with identical or slightly different products, price setter, consider competition behavior. Monopoly one firm, doesnt matter what product, sets price. Demand Price taker on quantity. Quantity Demand, the amount of a good that buyers are willing and able to purchase. (Question, Can we observe?) Law of Demand, Other things equal, the quantity demand of a good falls, when price increases.

Demand Schedule, A table that shows the relationship between the price of a good and the quantity demanded. Demand Curve Individual demand schedule. As price of ice cream goes up, quantity of demand goes down. Income Increases: Normal good- Income goes up, quantity goes up. Inferior Good- Income goes up, quantity goes down. Gifton Good- Price goes up, quantity goes up. Broccoli & Ranch Complimentary goods- Two goods for which an increase in the price of one thing, leads to a decrease in the consumption of another. Price of substitute goes up, shifts right. Consumption goes up, price shifts left. Market Equilibrium- A situation in which the market price has reached the level at which quantities supplied equals quantity demanded. Price Elasticity Market Equilibrium- Equilibrium is a situation in which the market price has reached the level at which quantity supplied is equal to quantity demanded. Equilibrium Price- The price that balances quantity demanded/supplied. Property of Competitive Equilibrium; The equilibrium is stable. Whenever you are deviating from the equilibrium point, market mechanism will try to ring the economy back. Price Elasticity Measures the percentage change in quantity demanded results from the percentage i price. Elastic if is more than 1. Inelastic if less than 1. Elasticity (uses greek letter epsilon). % change in quantity demanded / % change in price. If item goes from $10 to $11, price increases by 10%. If demand of item goes from 10 to 8, demand goes down 20%. So 20% goes over 10% = 2 elasticity. What affects elasticity; 1)Whether there are close substitutes. If the price of Dannon yogurt in creases, demand changes to Activia. If price gas increases, no other choices, so it has a low elasticity. Closer the substitute, higher elasticity. 2)Necessities or Luxuries. If Tomato prices goes up, no other options so its a Necessity. A Luxury is a coach purse.

3)Definition of Market. Tomatoes have a low elasticity, if thought of vegetable, but if thought of a food, it could be high elasticity. If you change demand in tomatoes to rice, very narrow market. A narrow market restricts peoples choice, so they cannot change demand, low probability of substitutes. If they have more choices, expand definition of market. 4)Time Horizon. 1 month is gasoline, 2 years is hybrid. The first in the most important factor in elasticity. Computing Elasticity Point A. Pa = 4, Qa = 120 Point B. Pb = 6, Qb = 80 Elasticity from A to B Elasticity = ([80-120] / 120) / ([6-4] / 4) = One third / one half = 2/3 Elasticity from B to A Elasticity = (120-80] / 80) / ([4-6] / 6) = 1 half / 1 third = 1.5 Midpoint Method Eab = ([80 - 120] / 100) / ([6-4]/5) = 40% / 40% = 1 Continuous case, focus on Elasticity at a specific point. If points are very close together, if there is any difference, numerically they are negligible. ([Qa-Qb] / Qa) / ([Pa - Pb] / Pa) = (Change Q / Qa) / (Change P / P) = lim (Change Q / ChangeP) (P/Q)= dQ / dP Derivative = d Vertical line graph; Elasticity = 0. Horizontal line graph; Elasticity is Infinite. Linear line graph (steep); Inelastic. Linear line graph (small slope); Elastic Exponential function growing larger both sides, elastic towards 0, inelastic as it grows. Total Revenue and Elasticity Profit on Y axis, Quantity on X axis. Change from B1 to B2 (y axis) and from A1 to A2 (x axis). Profit = PQ E1 to E2 Didnt finish. If elasticity is greater than 1, reduce the price will increase profit. If elasticity is less than one, increase the price will increase the profit. If elasticity = 1, change of price will not change profit.

(inelastic demand)Demand slope and supply slope, looking at elasticity. If the change in price is more than change in quantity,. (elastic demand) If change in price is smaller than change in demand. If the demand is inelastic, it is profitable to increase price. If demand is elastic, it is profitable to decrease price. Opec Cartel; 1970s Opec increased the oil price. Inelastic demand slope. If the change in supply goes up, huge increase in price. 1980s Opec cartel collapsed. There is elastic demand, if opec tries to increase price, they majorly reduce the quantity. Where does Market come from? Apple example with demand schedule. The more apples you want to purchase, the smaller the value becomes. Sellers Surplus- The difference between two prices in a product. Consumers Surplus- Difference between the maximum amount youre willing to pay and the actual price you have paid. When the number of buyers and sellers is finite, the trading price is undeterminable. When there are more sellers in a market, more buyers are benefitted. More buyers benefit sellers. Market is an institution created by buyers and sellers in order to compete for the common rent (public domain). When either there are infinite buyer/sellers market price shrinks to a spot price. The position of the price depends on the competition on both sides. The essence of market mechanism is to eliminate the asymmetry in information. The more intense the competition, the more information revealed. Market Efficiency: It is the most efficient way of collecting information. Average fixed cost decreases as production expands. Marginal cost is increasing variable/ average variable cost. is increasing. Reason: Diminishing marginal products. Average total cost first decreases and then increases. ATC = AFC + AVC AFC goes down the more cakes you make, AVC goes up. ATC goes down. Marginal cost curve crosses average total cost curve at its lowest point. Typically we observe U-Shape MC for decreasing part. You have economic of scale. For increasing part, we have the coordination problem.