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Economics Dr.

Sauer

Lecture Chapter 1: The Power of Markets The _________________ aligns incentives in a way such that __________________ working in ________________ leads to a ____________ standard of living for ___________ as a whole.

1. The Invisible Hand Adam Smith (1723 1790) is often referred to as the founder of _________________ economics. He was actually a Scottish philosopher of morality who got famous for writing The Theory of Moral Sentiments (1759). - people decide using sympathy, not just selfishness He was an example of the absent minded professor. He studied astronomy. - liked the idea that even though planets moved in their own orbit, there was a natural harmony with the rest of the planets He thought that ___________ could also move in different paths and yet harmonize with one another.

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. - from An Inquiry into the Nature and Causes of the Wealth of Nations (1776) Smith doesnt say that people are motivated ONLY by ________________. He says that self-interest motivates more powerfully and consistently than things like ___________ or ___________________. The concept of the invisible hand appeared in Moral Sentiments before appearing his now more famous work, The Wealth of Nations. He said that if each person seeks to promote their self-interest, then _______________________. he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Smith never took nor taught an economics course. ECONOMICS DIDNT EXIST!!!! Until the 19th century, academics considered economics a part of ____________________. 1

2. Basic Economic Assumptions A. How Individuals Behave Individuals attempt to make themselves as __________________ as possible, given their individual _______________________. maximize utility This is not the same thing as being selfish. Ex:

Every decision we make involves a ____________________. Examples of a tradeoff involving: - a present activity and future activity

- work vs leisure/family time

- two desirable activities in the present

Whenever we make a decision, we are _____________________ the benefits and costs of the action. - can be things other than money - often include money The higher the _____________associated with an action, the higher the ______________ need to be to get you to take the action.

B. How Firms Behave The goal of a firm is to maximize _________________. Firms have 5 main decisions to make. 1) 2) 3) 4) 5) A market economy will direct resources to their most __________________ use. Prices will ____________ information about the most valuable use.

3. The Market and Prices A. Demand The Law of Demand says that there is an _______________ relationship between price and quantity demanded (keeping other things constant income, etc). - as price _________, the quantity demanded __________ - as price _________, the quantity demanded __________ This is why (in general) the demand curve slopes downward. Demand represents consumers _____________________________________ for a good or service. B. Supply The Law of Supply says that there is a __________________ relationship between price and quantity supplied (holding other things constant like the price of raw material inputs). - as price ___________, the quantity supplied ____________ - as price ___________, the quantity supplied ____________ This is why (in general) the supply curve slopes upward. Supply represents producers _____________________. C. Market Equilibrium The Law of Supply & Demand says that the _____________________________ to bring the quantity supplied and quantity demanded into equality.

________________________________________________________________________________ If the price were higher than If the price were lower than equilibrium: P1 equilibrium: P2 Qs Qd Qs Qd __________ ____________ price will _________ price will _________

Surpluses put downward pressure on price. Shortages put upward pressure on price. At P* Qd = Qs no shortage, no surplus price is stable equilibrium price

D. Changes to Equilibrium a. Market For Heroin Example

The Market for Opium:

Favorable weather conditions resulted in a bumper crop of opium. This would shift the supply curve to the _____. The price of Opium _____ and the quantity ______.

The Market for Heroin:

Opium is an input to Heroin. Since the price of Opium fell, the supply of Heroin will ______. The supply curve for Heroin shifts _______. The price of Heroin ______ and the quantity _______.

b. Market for Tuna Example In the past decade Americans have really taken a liking to sashimi tuna, so it is ordered more often at restaurants. When the demand for tuna increases, the demand curve shifts to the _______________. The price _______. The quantity ________.

But how are there magically more fish being caught? Prices _______________ information. When the price of tuna increases, this is a _______________ to fishermen. They will be getting paid more for their catch. - keep boat in water longer - some switch from salmon fishing to tuna fishing The quantity of tuna caught rises.

c. Market for Wheat Example Pakistan is the worlds 9th largest producer of wheat. In 2010, Pakistan experienced widespread flooding that devastated the wheat crop. When the supply of wheat decreases, the supply curve shifts to the _____________. The price __________. The quantity ___________.

d. Market for Oil Example OPEC is well-known as the organization that controls the world supply of oil. From time to time, OPEC will restrict oil production in order to drive up its price. China is currently experiencing major economic growth. The middle class is increasingly able to afford major purchases like automobiles. The consumption of oil in China has dramatically increased in recent years. 5

OPEC restricts production of oil

Chinese consume more oil

________________________________________________________________________________ Markets and competition are good for consumers. Markets are amoral. Economics assumes that people act __________________. - act in a way that makes them better off, not worse off __________________________________________________________________________________ Summary: Adam Smith is the founder of modern economics. Economists Assume - individuals maximize utility - firms maximize profits Demand represents the inverse relationship consumers have with price and quantity demanded. Supply represents the positive relationship with price and quantity supplied. Price will adjust to bring the market into equilibrium. World events will change equilibrium price and quantity in various markets.