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ECONOMICS why study it?. Social Science Efficiency Scarcity. Economics and Policy. Positive economics (what is going on?) Normative economics (what should be going on?). efficiency. Economic systems and fundamentals of economic efficiency

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ECONOMICSwhy study it?

Social Science



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Economics and Policy

  • Positive economics (what is going on?)

  • Normative economics (what should be going on?)

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  • Economic systems and fundamentals of economic efficiency

    • What? How? And For Whom? (productive and allocative efficiency)

    • Capitalism, Socialism, and Communism

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Frameworks of analysis within economics

  • MACRO-

    • Unit of analysis: economy as a whole

    • Variables of interest include inflation, unemployment, output…

  • MICRO-

    • Unit of analysis: individual economic agents: consumers, firms…

    • Variables of interest include costs of production, individual demands, prices…

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Economic cost

  • Opportunity cost (just how costly is this class to you or to me?)

  • Does the benefit of taking this class outweigh the cost?

  • Marginal analysis

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Specialization and gains from trade

  • Specialization and division of labor

  • Resource composition

    • Capital

    • Labor

    • Human capital

    • Land (inclusive of natural resources)

  • Production process (state of technology)

  • Absolute and comparative advantage principles

    • Relative cost

  • Why no complete specialization?

    [US trade example: BEA (]

    • Consumer preferences

    • Increasing opportunity cost (marginal cost)

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Principles of Trade

  • Absolute Advantage: total cost

  • Comparative Advantage: relative (opportunity) cost

    Consider two economies (A, B), each endowed with 200 worker-hours. Consider that there are only two goods being produced (X, Y). Consider that in country A the hourly wage is $A10, while in country B it is $B20, for simplicity assume that $A=$B. Table below shows costs in each country:

What can be said about the absolute and comparative advantage principles

in this case?

Productivity and trade (education, physical capital…)

Currency and Trade

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Should government influence our comparative advantage? Can it do so?

  • Can frequent changes in terms of trade reduce incentives to accumulate human capital (Can some of this be seen in the US economy today?)

  • Asian economies of the 70’s, 80’s and early 90’s

  • Recent aid from German government to AMD

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Markets it do so?

  • Defining a market

    • Product definition (and competition)

    • Geographical boundaries (internet, shipping cost reduction – globalization and outsourcing)

  • Market forces: Buyers (demand) versus Sellers (supply)

    • Price and quantity as the outcome

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demand it do so?

  • Quantity = f (price, other factors)

  • Price and the Law of Demand

  • Other factors

    • Income (normal versus inferior)

    • Related in consumption goods

      • Substitutes

      • Complements

    • Expectations about the future


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supply it do so?

  • Quantity = f ( price, other factors)

  • Price and the Law of Supply

  • Other factors

    • Costs of Production (MC, and price as MB)

    • Goods related in production

      • Substitutes: (agricultural products)

        • Note, identical to costs of production since is based on opportunity cost concept

      • Complements: (like gold and silver)

    • Producer expectations of future prices

  • Other factors…

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Market equilibrium it do so?

  • Qs = Qd

  • Shortage and surplus as unstable states and the stability property of the equilibrium

  • Market efficiency

  • Shifts in demand and supply

  • Roles of Prices

  • Is the equilibrium really efficient?

    • Productive and allocative efficiency

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Market example: ForEx it do so?

  • How can the US run a trade deficit consistently? Or, differently put, can one live on credit forever?

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  • Demand for the dollar it do so?

  • different economic agents that purchase the dollar:

    • Foreigners who wish to purchase US goods or services, foreign

  • tourists who wish to travel to the US (US exports)

    • Foreigners who wish to invest in the US (higher US interest rate, attractive US stock market returns)

  • Supply of the dollar

  • different economic agents that sell the dollar:

    • US consumers/firms that want to purchase foreign goods or services, US tourists who wish to travel abroad (US imports)

    • US residents who wish to invest abroad (higher interest rates abroad, etc.)

  • The dollar will appreciate if demand exceeds supply at the current exchange rate.

  • Note that when you purchase a foreign made product, the cost of the production of that product is paid in foreign currency, hence somewhere between the production process and your purchase someone would have to convert your currency into that foreign currency in order to pay for the production.

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Demand and supply: the USD it do so?

  • US trade deficit -> sale of USD ->dollar depreciation

  • US borrowing from abroad -> purchases of USD -> appreciation of the USD

  • 1990’s and the post 9/11framework

  • US balance of payments: BEA

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Who is more flexible? Elasticity of demand it do so?

  • Elasticity of demand =

    %D(Quantity demanded)/%D(Price)

  • Elasticity as a measure of responsiveness of demand

  • Inelastic and elastic ranges; marginal revenue

  • Elasticity and revenue maximization

  • Comparing demands in terms of their relative elasticities

  • What makes demand relatively less elastic?

    • Gasoline here

    • Health care

    • Health care insurance and elasticity of demand (moral hazard)

  • Sales Tax and elasticity of demand?

    • Who really pays sales tax and why?

    • Excise tax

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Elasticity long and short run it do so?

  • Are our demands more flexible from the long-run perspective?

    • Defining short and long run in economics

    • Demand for gasoline

    • Demand for cars (capital goods in general, like PCs at GSU)

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Other types of elasticity of demand it do so?

  • Income elasticity of demand

  • Cross price elasticities

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When Markets Fail it do so?

  • Externalities (bad and good)

    • Internalizing external costs through taxation

  • Public goods

    • Non-excludability

    • Non-rivalry

  • Lack of certain institutions or mechanisms

    • Asymmetry of information

      • Used car market

      • eBay and emergence of a correcting mechanism (a local public good)

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Role of government in a market based economy it do so?


    • Just think of how many different institutions set up and maintained by various government levels make this very class possible…

    • Institutions at the micro and macro levels

      • Property rights and well functional legal system

      • Contract enforcement

      • Business culture

    • Negative institutions can also emerge (corruption is a good example)

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Consumer Behavior it do so?

  • Utility function

    • Assumption of rationality

    • Total utility versus marginal utility

    • Diminishing marginal utility

      • DMU and consumption choice

        • MU per dollar spent

      • DMU and progressive income taxation

      • What if the Law of DMU is violated?

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Production it do so?firms

  • Assumption of profit maximization

  • Do firms really maximize profits?

    • Principal-agent problem and the size of the firm

      • Conflict of interests and correcting mechanisms

        • Stocks and options as reward to workers/executives

        • External debt

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Production it do so?

  • Production function or Total Product

    Output = f (inputs, technology) = TP

  • Marginal Product – change in output resulting from a change in an input

    • MPL, MPK

  • Diminishing Marginal Product

    • Choice of the combination of inputs

      • MP of input per dollar (long-run production)

  • Long-run versus Short-run (assumption about capital, why not labor?)

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Production and costs in the short-run it do so?

  • Cost of labor – Wage (w)

  • Cost of capital - ?

    • Defining user cost of capital (r)

  • Total cost of production

    TC (Q) = w L + r K

    Other inputs can be included (oil, land… furthermore we assume homogeneous labor and capital)

  • Fixed cost versus variable cost

  • Sunk cost (stock price at the time of purchase)

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Costs of production in short-run it do so?

  • Average costs

    ATC = AVC + AFC

  • Marginal cost

    Change in total cost of change in output

    Marginal cost as a function of Marginal product of labor (in our simple case)

    • diminishing marginal product and rising marginal cost

  • AVC = wage / APL

  • Relationship between MC and ATC, AVC

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Profit maximization it do so?

In equilibrium, a profit maximizing firm will select to produce the level of output at which the wage rate is equal to the value of the marginal product of labor, in other words the marginal cost of a unit of labor (wage) is equal to the marginal benefit of that unit of labor expressed as the change in total revenues.

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Production and costs in the long-run it do so?

  • Full flexibility

  • LRAC (to LRAC from S-R AC)

    • Deriving LRAC from SR AC

    • Economies of scale

      • Increased specialization

      • Use of indivisible inputs (trade mark…)

    • Constant returns to scale

    • Diseconomies of scale

      • Principal-agent problem and size of business

      • Possible increase in input costs due to increased demand

  • Long term cost improvements

    • Technological progress

    • Learning by doing

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market structure it do so?






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Perfect competition it do so?and the internet


  • number of firms

  • Ease of entry and exit

  • Perfect information

  • Identical transaction costs

  • Homogeneous good

    Consequences of these assumptions:

    - Competition along one dimension – the price

    - Lack of collusion

    - Horizontal demand and MR – price taking behavior

    - MC as the supply curve

    Shut down and break even price levels – cost diagram in the short-run

    • K-Mart example

      Long-run and cost structure of the industry

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Market Supply Curve it do so?

  • Individual firm’s supply curve – MC

    • Recall that P=MR, and profit maximization requires MR=MC

  • Market supply curve is the horizontal summation of individual curves

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Adjustment to a change in demand it do so?

Industry Demand Increases


  • Each firm expands output

  • The number of firms remains the same

    • Recall that changing the number of firms requires changes in capital stock


  • Positive economic profits attract entry: number of firms increases

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  • Entry of new firms and the impact on costs of production it do so?

    • Does building more fast food restaurants around the campus change the cost of low-skilled labor?

    • Does an increased demand for computer programmers change the cost of training a software engineer?

      Note that MC, ATC, AVC are all functions of input costs (if labor is the only variable input then: MC = wage/MPL, and AVC = wage/APL)

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Increasing Cost Industry it do so?

  • Industry expansion rises the demand for inputs, and as a result the cost of those inputs increases, and thus the price (equilibrium) at which the firms earn zero economic profits also increases

    • Diseconomies of scale in the production of inputs

    • Inelastic supply of inputs

    • Lack of substitutability of inputs

      Decreasing Cost Industry

  • Industry expansion rises the demand for inputs, and as a result the cost of those inputs declines, and thus the price at which the firms earn zero economic profits decreases

    • Economies of scale in the production of inputs (adjustments in the educational system in the 1990 as a result of increased demand for software engineers)

      Constant Cost Industry

  • Industry expansion does not affect input costs

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MONOPOLY it do so?

  • Monopoly diagram and profit maximization

  • Social costs of monopoly

  • Price discrimination

  • Natural monopoly

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Monopolistic Competition it do so?

  • Product differentiation

  • Large number of firms differentiated products

  • Entry/Exit

  • Diagram and equilibrium outcome

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OLIGOPOLY it do so?

  • Barriers to entry and formation of oligopolies

  • Strategic interdependence

  • Understanding an Oligopoly

    • Kinked Demand Model

    • Cournot Duopoly Model

    • Game Theoretical Approach

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Game Theory it do so?

  • Modeling decisions as strategies in an interactive game

  • Simultaneous move games and matrix form

    • Nash Equilibrium and Best Response Strategies

    • Dominant Strategies

  • Sequential move games and tree form approach

    • Entry deterrence game

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Monopoly, Oligopoly and Anti-trust it do so?

  • Sherman Act

  • Clayton Act


  • Price discrimination

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Public Sector it do so?

Government role in the economy:

  • Institutional support

  • Provision of public goods and services

  • Correction of externalities

  • Economic policies (stabilization and development)

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How do we pay for the government? it do so?

  • Taxes and user fees

    • Income tax

    • Sales tax

      • Excise tax

    • Property tax

    • Value added tax

  • Fiscal Federalism: US example

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Taxes and Incentives it do so?

  • Income tax

    • Marriage neutrality

    • Labor force participation

    • Impact on revenues of government

    • Impact on population growth

    • Savings and investment (capital gains taxation and IRAs)