Required reading:

Ch 1,2: all, pp. 1-48

Review Session: Quiz 1

ch.1 ~ 3, 6 ~ 8
Econ 201C, Winter 2018

1
 General Tips
1. READ the QUESTION carefully!!!
2. SHOW your work! Explain your REASONING!!!
- Do NOT just write down the answer.
- You are graded by what you actually write down!
3. Remember the DEFINITION
and Make use of the CONCEPT!
4. FULLY LABEL the graph!!!
- x-axis, y-axis, name of the curve
- Initial equilibrium price and quantity,
New equilibrium price and quantity.
※ Review for the Midterm 1
1. Production Possibility Frontier
- Efficiency and Feasibility
- Opportunity cost: Slope of PPF, Increasing opportunity cost
- Economic Growth: Increase in factors, Technology
- Comparative Advantage, Gains from trade
2. Supply and Demand
- Market equilibrium, Surplus, Shortage
- Change in Supply and Demand: Factors that shift supply and demand
- Interrelated Market
i) Identify the shock, ii) Determine the relationship b/w goods,
iii) Analyze the effect: Which curve moves? Where?
3. GDP and CPI
- 3 ways to measure GDP: Final Product (Value-added), Spending, Income
- GDP per capita, Nominal/Real GDP, Real GDP growth rate
- Price index, Inflation rate
※ Review for the Midterm 1

4. Unemployment
- Employment, Unemployment,
Labor force participation rate, Unemployment rate
- Discourage worker, Marginally attached worker, Underemployment
- Frictional unemployment, Structural unemployment, Natural unemployment,
Cyclical unemployment, Full employment
5. Inflation and Deflation
- Nominal vs. Real
- Shoe-leather cost, Menu cost, Unit-of-account cost
- Winner and loser from inflation
- Inflation, Deflation, Disinflation
I. Production Possibility Frontier
Production Possibility Frontier
✓ Trade-offs facing an economy that produces only two goods
✓ The maximum quantity of one good that can be produced
for any given production of the other good.
Efficiency and Feasibility
✓ On the PPF: Efficient
- All resources are used, nothing wasted
* Efficient in production, not necessarily in allocation
✓ Inside the PPF: Feasible but inefficient
I. Production Possibility Frontier
Opportunity Cost
✓ How much less good must be produced if more of the other
good is produced
✓ Slope of the PPF: Opportunity cost (downward slope)
- Linear: constant opportunity cost
- Bowed out: increasing opportunity cost
✓ Increasing opportunity cost
- Opportunity cost increases as more of one good is produced
because not all resources are equally suitable for producing
every good.
I. Production Possibility Frontier
Economic Growth
✓ PPF shifts outward.
✓ 2 basic sources
- Increase in factors of production (i.e. labor, capital, land…)
- Technology
Comparative Advantage and Gains from Trade
✓ Comparative advantage: different opportunity cost
that produce gains from specialization and trade
- Lower opportunity cost in one good → Specialize in that good
→ Trade that good for the other good
✓ Gains from Trade
- Both countries are able to produce and consume more in total
I. Production Possibility Frontier
Economic Growth
✓ PPF shifts outward.
✓ 2 basic sources
- Increase in factors of production (i.e. labor, capital, land…)
- Technology
Comparative Advantage and Gains from Trade
✓ Comparative advantage: different opportunity cost
that produce gains from specialization and trade
- Lower opportunity cost in one good → Specialize in that good
→ Trade that good for the other good
✓ Gains from Trade
- Both countries are able to produce and consume more in total
II. Supply and Demand
Demand
✓ Demand Schedule and Demand Curve: A relationship
between price of the good and quantity demanded.
* Quantity demanded: willingness to buy at given price
✓ Law of demand: As the price of a good falls, keeping other
things constant, the quantity demanded increases. (vice versa)
* Demand curve: downward sloping
Change in quantity demanded
✓ When the price of the good rises (keeping all other things
constant), the quantity demanded falls (and vice versa).
✓ Movements along the demand curve!
II. Supply and Demand
Change in Demand
✓ When a force other than the price of the good changes,
the demand behavior changes.
✓ Shift of the whole demand curve!
✓ Factors that shift demand
- Anything that changes the quantity demanded at every price,
or changes the price at every quantity demanded, or both.
- Income (normal/inferior goods),
Price of other goods and services (substitutes/compliments),
Taste/Preferences,
Demographic change
II. Supply and Demand
Supply
✓ Supply Schedule and Supply Curve: A relationship between
price of the good and quantity supplied.
* Quantity supplied: willingness to sell at a given price
✓ Supply curve: upward sloping
Change in quantity supplied
✓ When the price of the good rises (keeping all other things
constant), the quantity supplied increases (and vice versa).
✓ Movements along the supply curve!
II. Supply and Demand
Change in Supply
✓ When a force other than the price of the good changes,
the supply behavior changes.
✓ Shift of the whole supply curve!
✓ Factors that shift supply
- Anything that changes the quantity supplied at every price,
or changes the price at every quantity supplied, or both.
- Input price,
Price of related goods or services (substitutes/compliments),
Technology,
Number of producers
II. Supply and Demand
Market Equilibrium
✓ A competitive market is in equilibrium
when the price has moved to a level at which the quantity
demanded equals the quantity supplied.
- The crossing point between demand and supply curve
- Equilibrium price (=market-clearing price),
Equilibrium quantity
✓ Surplus: when the price is above the equilibrium price,
the quantity supplied exceeds the quantity demanded.
- Surplus(excess supply) → price falls to the equilibrium level
✓ Shortage: when the price is below the equilibrium price,
the quantity demanded exceeds the quantity supplied.
- Shortage(excess demand) → price rises to the equilibrium level
II. Supply and Demand
Change in Supply and Demand
✓ Increase in demand (D curve shifts to the right) → P ↑, Q ↑
Decrease in demand (D curve shifts to the left) → P ↓, Q ↓
✓ Increase in supply (S curve shifts to the right) → P ↓, Q ↑
Decrease in supply (S curve shifts to the left) → P ↑, Q ↓
✓ When both the supply and the demand curve shift,
- P and Q depend on where, how much these curves shift
and how elastic these curves are.
III. Macroeconomics: The Big Picture
Economic Growth and Business cycle
✓ Economic Growth: sustained upward trend in the economy’s
output over time.
✓ Business Cycle: short-run alternation between recessions
(contractions, busts) and expansions(prosperities, booms).
- Peak→Recession→Trough→Recovery→Expansion→Peak
- Pain of recession: workers who are unable to hold/find jobs.
- Taming the business cycle: countercyclical policies
* Monetary policy, Fiscal policy
III. Macroeconomics: The Big Picture
Inflation and Deflation
✓ Inflation: a rising overall level of prices.
✓ Deflation: a falling overall level of prices.
✓ Price stability: a situation in which the overall level of prices is
changing only slowly.
International Imbalances
✓ Open economy: an economy that trades goods, services and
assets with other countries.
✓ Trade deficit: Export < Import
Trade surplus: Export > Import
IV. GDP and CPI
National Income Account Identity
✓ Y = C + I + G + (X – M)
Y: Income received
C: Consumption
I : Investment
G: Government Purchases
X: Exports, M: Imports
✓ Expanded Circular Diagram
- 4 sectors: households, firms, government, the rest of the world
- 3 markets: factor markets, goods and services markets,
financial markets.
IV. GDP and CPI
GDP: Gross Domestic Product
✓ Definition: the total value of all final goods and services
produced in the economy during a given year
✓ 3 ways to measure GDP
① Add up the value added of all producers
② Add up all spending on domestically produced final goods
and services. → Y = C + I + G + X – M
③ Add up all income paid to factors of production
✓ Included vs. Not included
- Included: domestically produced final goods and services
new construction of structure, change to inventory
- Not included: foreign-produced final goods and services,
intermediate goods and services, inputs, used goods,
financial assets.
IV. GDP and CPI
✓ GDP per capita

✓ Real GDP and Nominal GDP

- Nominal GDP: measured using current prices.
- Real GDP: measured using base year’s prices.
✓ Real growth rate
IV. GDP and CPI
Price Index and the Aggregate Price Level
✓ Aggregate price level: a measure of the overall level of prices
in the economy
✓ Market basket: a hypothetical set of consumer purchases of
goods and services.
✓ Price index: the ratio of the current cost of that market basket to
the cost in a base year, multiplied by 100

✓ Inflation rate: the yearly percentage change in a price index,

typically based on the Consumer Price Index, or CPI.
IV. GDP and CPI
✓ 3 measures of prices in the economy
① CPI (Consumer Price Index): a measure of the cost
of the market basket of typical urban U.S. family
② PPI (Producer Price Index): a measure of the cost
of goods purchased by producers.
③ GDP deflator:
the ratio of nominal GDP to real GDP in that year
V. Unemployment and Inflation
Unemployment Rate
✓ Employment: the number of people currently employed in the
economy, either full time or part time.
✓ Unemployment: the number of people who are actively looking
for work but aren’t currently employed.
✓ Labor force: the sum of employment and unemployment
✓ Labor force participation rate: the percentage of the population
16 or older that is in the labor force.

✓ Unemployment rate: the percentage of the total number of

people in the labor force who are unemployed.
V. Unemployment and Inflation

✓ Discouraged workers: nonworking people who are capable of

working but have given up looking for a job given the state of
the job market.
✓ Marginally attached worker: people who would like to be
employed and have looked for a job in the recent past but are
not currently looking for work.
✓ Underemployment: the number of people who work part time
because they cannot find full-time jobs.
V. Unemployment and Inflation

The nature of unemployment

✓ Frictional unemployment: unemployment due to the time
workers spend in job search. (Voluntary)
- Due to transition from the old to the new job.
✓ Structural unemployment: unemployment that results when
there are more people seeking jobs in a labor market than there
are jobs available at the current wage.
(Surplus, Excess supply → Involuntary)
- Due to skill-mismatch, new vs. old industries,
Minimum wage, Unions, Efficiency wage,
Government policies.
V. Unemployment and Inflation

- Minimum wage:
a kind of price floor imposed by government
→ Surplus of labor
- Unions: bargaining collectively
→ Higher wage than wage by bargaining individually.
- Efficiency wage: Wages that employers set above the eqm. wage
→ To motivate workers to perform better or
to attract more productive workers in the labor market.
- Side effects of public policies (i.e. unemployment insurance,
worker protection)
→ Reduce a worker’s incentive to find a job.
V. Unemployment and Inflation
The natural rate of unemployment
✓ Natural rate of unemployment: the unemployment rate that
arises from the effects of frictional and structural
unemployment.
- Natural unemployment
= Frictional unemployment + Structural unemployment
✓ Cyclical unemployment: the deviation of the actual rate of
unemployment from the natural rate of unemployment due to
downturns in the business cycle.
- Actual unemployment
= Natural unemployment + Cyclical unemployment
✓ Full employment
- When actual unemployment = natural unemployment
- When the economic is using all the resources.
V. Unemployment and Inflation
Inflation and Deflation
✓ Nominal vs. Real
- Real wage = Nominal wage / Price level
- Real income = Nominal income / Price level
- Real interest rate = Nominal interest rate – Inflation rate
✓ Shoe-leather cost: Cost which consumers bear due to inflation.
(ex. Price searching and comparing time and effort)
✓ Menu cost: Cost which firms bear due to inflation.
- The real cost of changing a listed price.
(ex. Printing new menus)
✓ Unit-of-account cost: the cost arisen from the way inflation
makes money a less reliable unit of measurement.
(ex. No prices on menus)
V. Unemployment and Inflation
Winners and losers from inflation
(higher inflation than expected)
✓ Winner: Borrowers
- The purchasing power of money borrowers repay is lower and
the real interest rate is lower. → The real wealth is higher.
✓ Loser: Lenders
- The purchasing power of money lenders receives is lower and
the real interest rate is lower. → The real wealth is lower.
Inflation, Deflation, Disinflation
✓ Inflation: a rising overall level of prices.
✓ Deflation: a falling overall level of prices.
✓ Disinflation: the process of bringing the inflation rate down.
 All the Best!

29 9/6/2011