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ECO1000EconomicsSemester One, 2004
Lecture Twelve
A Few Notes on the Assignment Little things that must be improved:
Internet site referencing Clip art and decorations 1st person Dot points Presentation (try fully (left and right) justifying
text) Do not ask rhetorical questions
A Few Notes on the Assignment More Serious Things:
References/research Structure Answering the question/fulfilling the objectives Working together/ paraphrasing other works Effort
How to Improve Your Writing There is only one way and it takes time and
effort. To improve your writing you must read
more. By reading you learn how to structure
paragraphs and arguments. In addition, you improve your vocabulary which enables you to express yourself better.
Time Table For Next Week Next week, we have scheduled three 2-
hour revision tutorials plus three 2-hour revision student-led sessions.
You are requested to attend the session being undertaken by your regular tutor/student leader.
You may choose another session if you have a time table clash.
Structure of the Revision Sessions Including this lecture, you have the opportunity to
participate in 6 hours of revision. This should save you a lot of time.
Tutors will summarise the course and work through some relevant exercises/problems.
Student leaders will possess all the exam advice and will help you prepare for the examination. (If you want to hear my exam advice, you must go to one of the student-led sessions).
Revision
This is not necessarily an indication of what will be, or won’t be in the
exam. This is an overview of main concepts & diagrams.
General Suggestions
Review main definitions At the side of text pages or the glossary at the back
Know how to recognise definitions when phrased as a scenario
Characteristics of key economic situations eg market structures, money market
Identify main themes of the modules/chapters 10 principles of economics help to do this
Identify key diagrams & explanations that go with those diagrams
Revision Sources Review past few exams for structure
(2002 and 2003) Review study guide exercises Set yourself practice questions or re-do
those from the tutorials and student led sessions.
Exam Technique
Keep in mind the relative weightings Don’t bog down on multiple choice questions
Be prepared to move on and come back to questions you find difficult
Extended response 1. content most important 2. answer the specific question, especially in the
conclusion 3. keep writing. It increases your chances of making a
point that is worth marks
Study Technique Read your text over and over again. You do not
even have to sit down to deliberately study. Just read your text casually (at lunch, when you have a few spare minutes etc.)
You should by now have realised the importance of constructing an initial scenario (usually using a diagram) and then showing what happens when circumstances change.
Module OnePart One: Introductory Concepts
Introductory Concepts Explain each of the principles of
economics Describe and discuss the circular flow as
a model and definitions of components Identify and explain the difference
between positive and normative statements
Know about the nature and purposes of economic models
Module OnePart Two: Opportunity Cost
Opportunity Cost The cost of something is what you give up to get
it. We all face opportunity costs. However, we do not face them equally. This opens up the opportunity to specialise in the
production of a good in which we have a high cost and trade some of the surplus for a good in which our costs are higher.
Correct Calculation & Expression of Opportunity Cost
Food 10 8 6 4 2 0
Cloth 0 3 6 9 12 15Opp. Cost ofincreasingcloth prod.
2/3= 0.66kgs/wkof food
2/3= 0.66kgs/wkof food
2/3= 0.66kgs/wkof food
2/3= 0.66kgs/wkof food
2/3= 0.66kgs/wkof food
Comparative Advantage Whoever has the lower opportunity cost in
the production of a particular good is said to have a comparative advantage in the production of that good.
We would recommend specialisation in the good in which one has a comparative advantage.
What Combinations of Production Are Possible and Not Possible?
Information gigabytes/yr
Textilescu m/yr
Possible but inefficient
Possible and efficient
Impossible
Recognise the Increased Consumption Possibilities With Trade
Food(Kgs/wk)
Cloth (m/wk)
9
6
3 6 9 15
3
12
12
Utopia
Euphoria
*
Consumption Possibilities With Trade
What causes shifts in the PPF?
Information gigabytes/yr
Textilescu m/yr
What Policy/Social Decisions Cause Shifts Within the Frontier?
Information gigabytes/yr
Textilescu m/yr
750,000
1 m
500,000
5m 6.5 m16 m
*
*
Module TwoPart One: Supply and Demand
Determinants of Demand Tastes Price Price of related goods Expectations Income
Demand Curve
D
Quantity
Price Downward sloping (law of demand)
Change in price leads to a change in quantity demanded (movement along the curve)
What causes an Increase/Decrease in Demand?
Price
QuantityQ1
D1
Q2
D2
P
Q0
D0
Change in tastes, expectations or the price of related goods move the curve
Determinants of Supply Price Input prices Technology Expectations
Supply Curve
Price
Q
SUpward sloping (law of supply)
Change in price leads to a movement along the supply curve (change in quantity supplied)
What Causes an Increase/Decrease in Supply?
Price
Quantity
S0
P
Q1 Q2Q0
S2
S1
Changes in input prices, expectations or technology shift the curve
Equilibrium
P
Q
Pe
Qe
D
S
What Happens to Equilibrium Price and Quantity When Supply and/or Demand Changes?
Price
Quantity
S0
P0
Q0
D0
P1
Q1
S1
D1
Module TwoPart Two: Elasticity
Revenue
Price
Quantity
S0
P0
Q0
D0
Q1
P1
D1
Elasticity A measurement of the responsiveness of
quantity demanded to a change in price, income, or the price of a substitute.
Calculated simply by:
%change in Qd
%change in price, income etc.
Remember: Actual elasticity can indicate
whether elastic or inelastic whether inferior or normal (if income elasticity) whether goods are substitutes or complements
(if cross price elasticity) Eg income elasticity = 2
Income elastic Normal good
Elasticity Depicted Geometrically
Inelastic Demand Curve
Elastic Demand Curve
Price
Quantity
Elasticity and Revenue
When demand is inelastic, an increase in price can increase revenue
Module TwoPart Three: Government Intervention
Government intervention Why would governments intervene in
markets? What are the forms of intervention? What happens to price and quantity? What happens to a market if government
intervention ceases? Assume it returns to equilibrium
Price floor (minimum price)Why will there be a surplus?
Price
Quantity
S0
P0
Q0
D0
P1
Q1
Price Ceiling (maximum price)Why will there be a ‘shortage’?
Price
Quantity
S0
P0
Q0
D0
P1
Q1
What Happens to Price and Quantity When Markets are Deregulated?
Price
Quantity
S0
P0
Q0
D0
P1
Q1
Who ‘Pays’ For a Tax on Goods and How Much Do They Pay?
Price
Quantity
S0
P0
Q0
D0
Pt
Qt
Consumer share of tax
P2
Producer share of tax
How Does the Imposition of a Tax Affect Consumer Price/Demand and Producer Revenue?
Price
Quantity
S0
P0
Q0
D0
Pt
Qt
P2
Initial producer revenue
Producer revenue with tax
Microeconomics: Summary Production Possibilities and Opportunity
Cost Supply and Demand Elasticity Government Regulation (price ceilings,
floors and taxes)
Macroeconomics
Module ThreeData for Macroeconomics
GDP What is GDP?
A measurement of the size of the economy or circular flow
Components of GDP (expenditure method): Consumption Investment Government Spending Net Exports
GDP = Y = C + I + G + NX
Inflation Inflation may be calculated using CPI or the
GDP deflator. Each calculation involves addition,
multiplication and percentage change.
Real and Nominal GDPYear Price of
ApplesQuantity of Apples
Price of Pears
Quantity of Pears
2000 $1 100 $2 50
2001 $2 150 $3 100
2002 $3 200 $4 150
Calculating Nominal GDPYear Apples Pears Nominal
GDP
2000 $1 X 100 $2 X 50 $200
2001 $2 X 150 $3 X 100 $600
2002 $3 X 200 $4 X 150 $1200
Calculating Real GDPYear Apples Pears Real GDP
2000 $1 X 100 $2 X 50 $200
2001 $1 X 150 $2 X 100 $350
2002 $1 X 200 $2 X 150 $500
Use price in base year
GDP Deflator (a measure of the price level or rise in nominal GDP caused by rising prices)
Year Deflator (Nominal/Real)
2000 $200/$200 X 100 = 100
2001 $600/$350 X 100 = 171
2002 $1200/$500 X 100 = 240
CPI (a measure of the cost of goods and services bought by the average consumer)
Find the basket of goods and services (ABS does this by survey)
Find the price of each good or service in each year
Calculate the cost of the basket in each year
Computing CPIYear Cost of
DVDsCost of Car Washes
Cost of Basket
2000 $1 X 500 $2 X 12 $524
2001 $2 X 500 $3 X 12 $1036
2002 $3 X 500 $4 X 12 $1548
Fix the basket (amounts remain the same as in base year)
Computing CPI (cont) Choose base year then compute CPI:
Year Calculate CPI
2000 $524/524 X 100 100
2001 $1036/524 X100 197
2002 $1548/524 X 100 295
Use CPI to Calculate Inflation RateYear Calculate Inflation Rate
2001 (197 – 100)/100 X 100
97%
2002 (295 – 197)/197 X 100
49%
Module FourThe Real Economy in the Long Run
Growth Productivity is a key determinant of growth. Getting more output from a given amount of factors of
production means that productivity has risen The factors of production enter into a production
function Y= A F(L, K, H, N)
Government policies (eg. education, population growth, savings and investment) can influence each factor to encourage growth
The Financial System Financial system matches savers with
borrowers. Private saving = Y – T – C Public Saving = T – G Total Saving = S In an economy, S = I
Loanable Funds Market
Interest rate
Quantity of Funds
D (from investors)
S (from savers)
Unemployment Cyclical and natural Cyclical unemployment is caused by:
Minimum Wages Unions Efficiency Wages Job Searching
Module FiveMoney and Prices
Money What is it? What are its functions? How is it created?
Commercial banks Reserve Bank
Money Supply & Demand
Quantity of money
Value ofMoney
Price Level
A
Moneydemand
0
1
(Low)
(High)
(High)
(Low)
1/2
1/4
3/4
1
1.33
2
4
M1
MS1
The Effects of Monetary Injection
Suppose the RBA injects money into the economy by lowering the cash rate: The supply of money curve shifts to the right. The equilibrium value of money decreases. The equilibrium price level increases.
The Effects of Monetary Injection
Quantity of money
Value ofMoney
Price Level
A
B
Moneydemand
0
1
(Low)
(High)
(High)
(Low)
1/2
1/4
3/4
1
1.33
2
4
M1
MS1
M1
MS2
2....decreases the value of money ... 3. and
increasesthe pricelevel.
1. An increase in the money supply...
The Quantity Theory of Money
How the price level is determined and why it might change over time may be explained by the quantity theory of money. This theory has two main arguments: The quantity of money available in the economy
determines the value of money. The primary cause of inflation is the growth in the
quantity of money.
Inflation Causes of inflation
Quantity theory
Problems with having high inflation Menu costs Shoeleather costs etc.
Module SixThe Open Economy
An Open Economy… Exchanges goods and assets with the rest
of the world. Flow of goods (NX) Flow of money (NFI) Equilibrium: NX = NFI and S = I + NFI All this can be depicted using a single
three-part diagram.
(a) The Market for Loanable Funds (b) Net Foreign Investment
(c) The Market for Foreign-Currency Exchange
Net foreigninvestment,NFI
RealInterest
Rate
Net ForeignInvestment
r 1
RealInterest
Rate
Quantity ofLoanable Funds
r1
Supply
Demand
Quantity ofDollars
RealExchange
Rate
E1
Supply
Demand
Module SevenAggregate Demand and Aggregate
Supply
The AD/AS Model
AS
AD
Output
Price Level
Why the Curves Slope the Way They Do
AD: Pigou’s wealth effect Keynes’ interest rate effect Mundell-Fleming exchange rate effect
AS: Neoclassical misperceptions Keynesian sticky wages New Keynesian sticky prices
What Shifts the Curves? AD:
C, I, G, NX
AS: Input prices Productivity Expectations of a higher or lower price level.
Long Run EquilibriumLRAS
SRAS
AD
Output
Price level
Natural rate
Module EightPolicy
Monetary Policy
AD1AD0
MS1MS0
MDMoney Market
Interest rate
Price Level
Increase MS, Increase AD (and vice versa)
Fiscal Policy
Increase government spending, increase AD and vice versa
AD0
AD1
Fiscal Policy and the Multiplier Effect
AD0
AD1AD2
Multiplier Formula Simple: Multiplier = 1/(1 – MPC) Where MPC is the marginal propensity to
consume. When MPC = 0.5, Multiplier = 2.
Fiscal Policy and Crowding Out
AD0AD1
AD2
Increase in government spending eventually increases interest rates through increased money demand which then decreases investment and consumption
Unemployment/Inflation Trade-Off
There is a trade-off that policy makers face. Increase output (decrease unemployment) and you increase prices. Decrease prices and you decrease output (increase unemployment). Try it on the ADAS model.
The trade-off is depicted geometrically by the Phillips curve.
Phillips Curve
Unemployment rate
Inflation Rate
Policy Debates The pros and cons of active stabilisation The pros and cons of using discretionary
monetary policy How much should inflation be? The pros and cons of balance budgets
What You Should Know About Now
PPF’s Supply and Demand + Elasticity +
Government Policies GDP and Growth Open Economy Macroeconomics ADAS Monetary and Fiscal Policy
What ECO1000 Should Have Taught You
How to think logically in a step-by-step fashion
The importance of defining your terms and constructing your arguments carefully
The value of objective analysis And, of course, the content that constitutes
elementary economics.
Tips for Success in the Future Never make the same mistake twice. Enrol in an economics major. Study hard.
Golden Rules for Success in Business
Rule Number One:Never Lose Money
Rule Number Two:Never Forget Rule Number One
THE END Exam is very soon. Attend the revision sessions next week. The course leader and tutors are available
for consultation over the next few weeks (including during the first exam week)
Seek help if you need it.