Important Notes • Economics courses tend to be very heterogeneous in coverage • This review session is targeted at all ECON 102 students • Be cognizant of the chapters you need to know and the ones you don’t • For Vaughan: 1,2,5,6 • For Tucker: 1-3, 5, 7
Agenda • Chapters 1 – Ten Principles of Economics • Chapter 2 – Applying Economic Thinking • Chapter 3 – Why Trade Works! • Chapter 5 – Measuring a Nations Income • Chapter 6 – The Cost of Living • Chapter 7 - Production and Growth
Chapter 1 10 Principles of Economics
Chapter 1 Decision Making • Tradeoffs -choosing between marks vs. fun • Opportunity Cost -giving up the best alternative choice • Marginal changes -incremental effect of ‘one more’ • Incentives -decisions are driven by rewards/punishments
Chapter 1 Decision Making Timmy recently bought an iPhone for $300. However, he is now planning on selling the phone after it broke. He can either sell it for $100 in its current conditions, or spend $100 on repairs and sell it for $220. What should he do? • Don’t do anything • Sell it ‘as is’ • Repair it and sell it What would be the opportunity cost if he kept it for himself after repairing it?
Chapter 1 Interactions • Trades -specialization promotes efficiency • Market -buyers and sellers (households and firms) -what, how, who • Government Intervention -property rights -promotion of market efficiency and equity -can also be very bad
Chapter 1 The Economy • Standards of living -GDP and productivity • Inflation -increase in price level -long-run increase in money supply • Inflation vs. Unemployment -short-run tradeoff -inflation rises, unemployment falls
Chapter 2 ApplyingEconomic Thinking
Chapter 2Assumptions and models • The key to understanding economic models is knowing the assumptions being made • Simplifies complex problems • Focuses on the main issue
Chapter 2Circular Flow Diagram • The flow of money between households and firms within two different markets • The market for goods and services • The market for “factors of production” -land -labour -capital
Chapter 2Production Possibilities Frontier • Shows an economy’s ability to produce two goods given the available factors of production • Illustrates the concepts of tradeoffs and opportunity cost • Slope of the PPF is the opportunity cost of producing one good relative to another
The PPF (Realistic) • We suppose that an economy only makes Chips and Crackers • Plot the PDF to show the trade off between the 2
Chapter 2Production Possibilities Frontier A group of 4 students got together to do their math homework. In this scenario, they’re all equally good at doing Algebra and Calculus and each student is capable of doing 5 pages per hour.
Chapter 2Production Possibilities Frontier • Points on the PPF (A-E) • possible & efficient (all resources used) • production changes only possible through tradeoff • Points under the PPF (F) • possible but inefficient (unemployment, idle equip.) • production levels are capable of increasing • Points above the PPF (like G) • not possible • possible through economic growth which shifts the PPF outwards
Chapter 2Production Possibilities Frontier • The PPF could be a straight line, or bow-shaped • If the opportunity cost remains constant, the PPF is a straight line. • If opportunity cost of a good rises as the economy produces more of the good, which is more likely the case, then the PPF is bow-shaped. • Factors of production are specialized
Chapter 2Production Possibilities Frontier A group of 4 students got together to do their math homework. In this scenario, The students range in ability to do math homework. The best at doing Algebra happens to be the worst at doing Calculus, and vice versa. How would this be different than the previous scenario?
Chapter 2Positive vs. Normative • Positive statements: • Descriptive • Facts that can be labelled as true or false • Ex. Raising the minimum wage will increase unemployment. • Normative statements: • Opinions as to what should be • Ex. The government should raise the minimum wage. • Prescriptive
Chapter 3 Why Trade Works
Chapter 3 – Benefits from Trade • Today trade forms an integral part of our lives • Watches made in China • Software made in Seattle • Corn made in Sask • We use trade to satisfy our complex needs for food and products • Allows us to specialize and leverage comparative advantage!
Comparative vs Absolute Advantage • The comparison among producers of a good according to their productivity—absolute advantage • Describes the productivity of one person, firm, or nation compared to that of another. • The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. • The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
Why Trade Works • Consider a basic example with a farmer and a rancher • One day they suddenly discover that they live beside each other
It works! • Enables us to expand the PPF for both people
Chapter 5 Measuring a Nations Income
Chapter 5Gross Domestic Product • …the market value of all final goods & services produced within a country in a given period of time. • total income of everyone in the economy. • total expenditure on the economy’s output of goods & services.
Chapter 5Gross Domestic Product Things that are not included in GDP: • Things that do not have a market value • Underground economy • Intermediate goods • Goods produced in the past • Goods produced outside the country • Transfer payments
Chapter 5Gross Domestic Product • Recall: GDP is total spending. • Four components: • Consumption (C) • Investment (I) • Government Purchases (G) • Net Exports (NX) Exports - Imports • These components add up to GDP (denoted Y): Y = C + I + G + NX
Chapter 5Gross Domestic Product In each of the following cases, determine how much GDP and each of its components is affected (if at all). A. Charles spends $800 on a laptop to use for school. He got last year’s model on sale from a domestic company. B. RIM creates $300 million worth of phones, but only $200 million are purchased by consumers. C. Natalie spends $500 to buy her husband dinner at the finest restaurant in Toronto. D. Jenny spends $200 on a new pair of shoes for co-op. The shoes were made in China.
Chapter 5Gross Domestic Product A. Charles spends $800 on a laptop to use for school. He got last year’s model on sale from a domestic company. Current GDP does not change, because the laptop was made last year. B. RIM creates $300 million worth of phones, but only $200 million are purchased by consumers. Consumption rises by $200 million, inventory investment rises by $100 million, and GDP rises by $300 million.
Chapter 5Gross Domestic Product C. Natalie spends $500 to buy her husband dinner at the finest restaurant in Toronto. Consumption and GDP rise by $500. D. Jenny spends $200 on a new pair of shoes for co-op. The shoes were made in China. Consumption rises by $200, net exports fall by $200, GDP is unchanged.
Chapter 5Real vs. Nominal GDP • Nominal GDP • output valued at current prices • not corrected for inflation • Real GDP • output valued at constant prices of a base year • corrected for inflation • allows us isolate the change in output levels
Chapter 5GDP Deflator GDP deflator = 100 x nominal GDP real GDP • GDP deflator is a price index • is used to “deflate” (i.e., take the inflation out of) nominal GDP to get real GDP.
Chapter 5GDP Deflator By using the given data, find the GDP deflator for 2011.
Chapter 5GDP Deflator Nominal GDP = $12 x 4440 + $525 x 30 = $69,030 Real GDP = $10 x 4440 + $500 x 30 = $59,400 GDP deflator = 100 x (Nominal GDP)/(Real GDP) = 100 x ($69,030)/($59,400) = 116.2 What does this number mean?
Chapter 6 The Cost of Living
Chapter 6Consumer Price Index • A measure of the overall cost of living for a typical consumer • Based on a fixed basket of products and services from all around the world • GDP deflator only includes domestic production • The inflation rate can be calculated by comparing CPI from one year to a past year • Big 3 = Shelter, Transportation, Food
Chapter 6Consumer Price Index CPI this year – CPI last year CPI last year 100 x cost of basket in current year inflationrate cost of basket in base year x 100% = CPI =
Chapter 6Consumer Price Index The basket contains 1000 donuts and 400 cups of coffee. The table shows their prices for 2009-2011. The base year is 2009. A. How much did the basket cost in 2009? B. What is the CPI in 2010? C. What is the inflation rate from 2010-2011?
Chapter 6Consumer Price Index The basket contains 1000 donuts and 400 cups of coffee. The table shows their prices for 2009-2011. The base year is 2009. A. How much did the basket cost in 2009? ($2 x 1000) + ($4 x 400) = $3,600
Chapter 6Consumer Price Index The basket contains 1000 donuts and 400 cups of coffee. The table shows their prices for 2009-2011. The base year is 2009. B. What is the CPI in 2010? cost of basket in 2010= ($3 x 1000) + ($4 x 400) = $4600 CPI in 2010 = 100 x ($4600/$3600) = 127.7
Chapter 6Consumer Price Index The basket contains 1000 donuts and 400 cups of coffee. The table shows their prices for 2009-2011. The base year is 2009. C. What is the inflation rate from 2010-2011? cost of basket in 2011= ($3 x 1000) + ($5 x 400) = $5000 CPI in 2011 = 100 x ($5000/$3600) = 138.8 Inflation rate = (138.8 – 127.7)/127.7 = 8.6%
Chapter 6CPI vs. GDP Deflator • CPI • Includes import purchases • Fixed basket every year • GDP Deflator • Includes capital goods • Uses current production levels
Chapter 6CPI vs. GDP Deflator In each scenario, determine the effects on the CPI and the GDP deflator. A. American Apparel raises the price of its cardigans. The CPI increases, but the GDP deflator does not change. B. A Canadian manufacturing company raises the price for the machinery it produces. The GDP deflator increases, the CPI does not. C. Tim Hortons raises the price of Iced Cappuccinos. The CPI and GDP deflator both increase.
Chapter 6Consumer Price Index CPI overstates increases in the cost of living • Substitution Bias -consumers switch to relatively cheaper goods • Introduction of New Goods -more selection increases value of the dollar • Unmeasured Quality Change -quality improvements increase value of the dollar
Chapter 6Indexation Current CPI Past CPI Past CPI Current CPI Current year value Past year value x Past year value = = x Current year value • To inflate past prices to today’s prices: • To deflate today’s prices into past year prices:
Chapter 6Indexation Are fortune cookie writers better off today or in 1969? $5,000 x (143/24) = $29791.67 OR $30,000 x (24/143) = $5034.97 Fortune cookie writers are better off today.