Principles of Economics Professor Gulati Spring 2009 Chapter 1: Foundations and Models Outsourcing (off-shoring): the moving of the

e production of goods and services outside their home country Scarcity: the situation in which unlimited wants exceed the limited resources available to fulfill those wants Economics: the study of the choices people make to attain their goals, given their scarce resources Economic model: a simplified version of reality used to analyze real-world economic situations 1.1: The three key economic ideas A. market: a group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade 1. most of economics involves analyzing what happens in markets B. people are rational 1. Assumption DOES NOT mean that economists believe everyone knows everything or always makes the "best" decision 2. assumes that consumers/firms use all available information as they act to achieve their goals 3. weigh the benefits/costs of each action a. choose an action only if benefits > costs C. People respond to economic incentives 1. consumers/firms consistently respond to economic incentives a. increasing birthrates by paying families to have babies D. Optimal decisions are made at the margin 1. marginal: an extra or additional benefit or cost of a decision a. marginal benefit (MB) b. marginal cost (MC) 2. the optimal decision is to continue any activity up to the point where MB = MC 3. marginal analysis: analysis that involves comparing marginal benefits and marginal costs 1.2: The Economic Problem that Every Society Must Solve A. tradeoff: the idea that because of scarcity, producing more of one good or service means producing less of another good or service opportunity cost: highest-valued alternative that must be given up to engage in an activity B. What goods and services will be produced? 1. Determined by the choices made by consumers, firms, and the government 2. Each tradeoff made comes with an opportunity cost measured by the value of the best alternative given up C. How will the goods/services be produced? 1. in many cases, firms face a tradeoff between using more workers or using more machines D. Who will receive the goods/services? 1. depends largely on how income is distributed a. highest income can buy most goods/services 2. attempts by the government to make the distribution more equal in the form of higher taxing to those with greater income E. Centrally Planned Economics vs. Market Economics 1. Centrally planned economy: an economy in which the government decides how economic resources will be allocated

2. Market economy: an economy in which the decision s of households and firms interacting in markets allocate economic resources 3. Centrally planned economics have not been successful in producing low-cost, highquality goods and services a. Standard of living quite low b. All CPE's have also been political dictatorships c. Only a few small countries (Cuba, North Korea) have CPE's today 4. Market economics rely primarily on privately owned firms to produce goods and services and decide how to produce them a. Firms must produce goods/services that meet the wants of the consumer i. Ultimately consumer that decides what goods are produced b. Firms compete to offer highest quality at lowest price, so under pressure to use low-cost production methods c. Rewards hard work d. Income of an individual determined by the payments he receives for what he sells e. Market economies: US, Canada, Japan, Western Europe f. More extensive training + more hours worked = higher income g. Those most willing and able to buy them receive the goods and services produced F. The Modern "Mixed" Economy 1. mixed economy: an economy in which most economic decisions result from the interaction for buyers and sellers in markets but in which the government plays a significant role in the allocation of resources G. Efficiency and Equity 1. productive efficiency: the situation in which a good or service is produced at the lowest possible cost 2. Allocative efficiency: a state of the economy in which production is in accordance with consumer preferences; in particular, every good or service provides a marginal benefit to society equal to the marginal cost of producing it. a. Markets tend to be efficient because they promote competition and facilitate voluntary exchange 3. voluntary exchange: the situation that occurs when both the buyer and the seller of a product are made better off by the transaction 4. competition will force firms to continue selling goods and services as long as the additional benefit to consumers is greater than the additional cost of production 5. Inefficiency can arise from various sources a. May take some time to achieve an efficient outcome b. Limiting imported goods 6. many people prefer economic outcomes that they consider fair or equitable, even if those outcomes are less efficient a. equity: the fair distribution of economic benefits b. there is often a tradeoff between efficiency and equity 1.3: Economic Models A. economists rely on theories/models to analyze real-world issues 1. simplified versions of reality B. to develop a model: 1. decide on the assumptions to be used in developing the model 2. formulate a testable hypothesis 3. use economic data to test the hypothesis 4. revise the model if it fails to explain the economic data well 5. retain the revised model to help answer similar economic questions in the future C. the role of assumptions in economic models 1. any model is based on making assumptions 2. make behavioral assumptions about the motives of consumers/firms

a. consumers will buy goods that maximize their well-being, firms will maximize profits D. forming and testing hypotheses in economic models 1. hypothesis: a statement that may be either correct or incorrect 2. economic variable: something measurable that can have different values 3. hypothesis is usually about a casual relationship 4. must analyze statistics on the relevant variables 5. correlated: happen at the same time, not necessarily related E. normative and positive analysis 1. positive analysis: analysis concerned with what is 2. normative analysis: analysis concerned with what ought to be 3. econ is about positive analysis, which measures the costs and benefits of different courses of action F. economics as a social science 1. based on studying the actions of individuals 2. economists have studied issues such as how families decide the number of children to have, why people have difficulty losing weight or attaining other goals, and why people often ignore relevant information when making decisions 1.4: Microeconomics and Macroeconomics A. Microeconomics: the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices; policy issues B. Macroeconomics: the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth; recession and growth, etc. C. Many economic situations have both aspects 1.5: A preview of Important Economic Terms A. Entrepreneur: someone who operates a business. Decides what goods/services to produce and how B. Innovation: the practical application of an invention or any significant improvement in a good or in the means of producing a good C. Technology: processes a firm uses to produce goods and services D. Firm, company or business: an organization that produces a good or service E. Goods: tangible merchandise F. Services: activities done for others G. Revenue: total amount received for selling a good or service H. Profit: difference between its revenue and its costs 1. accounting profit: excludes the cost of some economic resources that the firm doesn't pay for explicitly 2. economic profit: include the opportunity cost of resources used by the firm I. household: all persons occupying a home J. Factors of production or economic resources: used to produce goods/services. Main factors: labor, capital, human capital, natural resources, entrepreneurial ability K. capital: financial or physical 1. financial capital: includes stocks, bonds issued by firms, bank accounts, and holdings of money 2. physical capital: includes manufactured goods that are used to produce other goods and services 3. capital stock: amount of physical capital available in a country L. human capital: accumulated training and skills that workers possess In-Class Notes: Patents let companies do research and development. Without it, everyone would wait for everyone else to develop new goods, services, etc. Chapter 2: Tradeoffs, Comparative Advantage, and the Market System Scarcity requires tradeoffs 2.1: Production possibilities frontiers and opportunity costs

A. production possibilities frontiers (PPF): a curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology B. graphing the production possibilities frontier

C. Increasing Marginal Opportunity Costs 1. when the PPF is bowed rather than straight, the opportunity cost depends on where the economy currently is on the production possibilities frontier a. increasing marginal opportunity costs b. most situations will be bowed outward 2. the more resources already devoted to any activity, the smaller the payoff to devoting additional resources to that activity D. Economic Growth 1. at any time, the total resources available to any economy are fixed a. resources available may increase or decrease over time b. technological advance makes it possible to produce more goods with the same amount of workers and machinery 2. economic growth: the ability of the economy to produce increasing quantities of goods and services a. ultimately raises the standard of living 2.2: Comparative Advantage and Trade A. Trade: the act of buying or selling 1. Makes it possible for people to become better off by increasing both their production and consumption B. Specialization and Gains from Trade 1. trading can benefit both parties even if one party's initial PPF is greater than the other's C. Absolute Advantage versus Comparative Advantage

1. Absolute Advantage: the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources 2. Comparative Advantage: the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors D. Comparative Advantage and the Gains from Trade 1. the basis for trade is comparative advantage, not absolute advantage 2.3: The Market System A. product markets: markets for goodssuch as computersand servicessuch as medical treatment B. factor markets: markets for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability C. factors of production: the inputs used to make goods and services 1. labor: includes all types of work from part-time workers to CEOs 2. capital: refers to physical capital, such as computers and machine tools, that is used to produce other goods 3. natural resources: includes land, water, oil, iron ore, and other raw materials that are used in producing goods 4. entrepreneur: someone who operates a business 5. entrepreneurial ability: ability to bring together the other factors of production to successfully produce and sell goods and services D. The Circular Flow of Income 1. two key groups participate in markets: a. household: suppliers of factors of production, particularly labor used by firms to make goods and services i. households own firms (stock market) b. firms: use the funds received from selling goods and services to buy the factors of production needed to make the goods and services

2. circular-flow diagram: a model that illustrates how participants in markets are linked

E.

F. G.

H.

3. one of the great mysteries of market system is that it manages to successfully coordinate the independent activities of so many households and firms The Gains from Free Markets 1. countries that come closest to the free-market benchmark have been more successful than countries with centrally planned economics in providing their people with rising living standards 2. guild system: government gave guilds the authority to control the production of a good The Market Mechanism 1. individuals usually act in a rational, self-interested way The Role of the Entrepreneur 1. must determine what goods/services they believe consumers want, and then decide how to produce those goods and services most profitably 2. bring together the factors of production (labor, capital, natural resources) to produce goods and services 3. put their own funds at risk when they start a business The Legal Basis of a Successful Market System 1. Property rights: rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Property can be tangible property or intangible 2. intellectual property rights: includes books, films, software, and ideas for new products a. patent: gives exclusive rights to inventor or firm to produce and sell a new product for 20 years b. copyright: creator has exclusive rights during lifetime + 50 years

3. enforcement of contracts and property rights a. If not enforced, fewer goods and services will be produced, which reduces economic efficiency, leaving economy inside its PPF. Chapter 3: Where Prices Come From: The Interaction of Demand and Supply Perfectly competitive market: a market that meets the conditions of 1. many buyers and sellers, 2. all firms selling identical products, and 3. no barriers to new firms entering the market 1. assumptions are very restrictive and apply only to a few markets 2. useful when analyzing markets where competition among sellers is intense, even if there are relatively few sellers and products are not identical 3.1: The Demand Side of the Market demand considers what a consumer is both willing and able to buy A. Demand schedules and demand curves 1. demand schedule: a table showing the relationship between the price of a product and the quantity of the product demanded 2. quantity demanded: the amount of a good or service that a consumer is willing and able to purchase at a given price 3. demand curve: a curve that shows the relationship between the price of a product and the quantity of the product demanded 4. market demand: the demand by all the consumers of a given good or service B. The Law of Demand: the rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease C. What Explains the Law of Demand? 1. substitution effect: the change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes 2. income effect: the change in the quantity demanded of a good that results from the effect of a change in the good's price on consumers' purchasing power a. purchasing power: the quantity of goods a consumer can buy with a fixed amount of income 3. substitution and income effect happen simultaneously whenever a price changes D. Holding Everything Else Constant: The Ceteris Paribus Condition 1. ceteris paribus ("all else equal"): the requirement that when analyzing the relationship between two variablessuch as price and quantity demandother variables must be held constant 2. a shift of a demand curve is an increase/decrease in demand 3. movement along a demand curve is an increase/decrease in quantity demanded E. Variables that Shift Market Demand 1. income, prices or related goods, tastes, population and demographics, expected future prices 2. income: income consumers have available affects their willingness and ability to buy a good a. normal good: a good for which the demand increases as income rises and decreases as income falls b. inferior good: a good for which the demand increases as income falls and vice versa 3. prices of related goods a. substitutes: goods and services that can be used for the same purpose b. complements: goods and services that are used together 4. tastes: consumers can be influenced by ad campaigns for a product 5. population and demographics: population increase, demand increases a. demographics: the characteristics of a population with respect to age, race, and gender 6. expected future price: consumers might wait for lower prices or expect higher prices and buy more

F. a change in demand versus a change in quantity demanded 1. shift: change in demand 2. movement: change in quantity demanded 3.2: The Supply Side of the Market many variables influence the willingness and ability of firms to sell a good or service (most important is price) A. quantity supplied: the amount of a good/service that firm is willing and able to supply at a given price 1. with higher marginal costs, firms will supply a larger quantity only if the price is higher B. Supply schedules and supply curves 1. supply schedule: a table that shows the relationship between the price of a product and the quantity of the product supplied 2. supply curve: a curve that shows the relationship between the price of a product and the quantity of the product supplied 3. both show that as prices rise, firms will increase the quantity they supply C. the law of supply: the rule that, holding everything else constant, increases in price cause increases in the quantity supplied and decreases in price cause decreases in the quantity supplied D. variables that shift supply 1. prices of inputs: input is anything used in the production of a good or service 2. technological change: a positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs. Happens when productivity of workers or machines increases 3. prices of substitutes in production: alternative products that a firm could produce are substitutes in production and if one item gained profitability, the firm would make more 4. number of firms in the market: change in number of firms in the market will change supply. Additional firms result in a greater quantity supplied at every price 5. expected future prices: if a firm expects the price of its profit will be higher in the future, it has an incentive to decrease supply now and increase later E. a change in supply versus a change in quantity supplied 1. shift: change in supply 2. movement: change in quantity supplied 3.3: Market Equilibrium: putting demand and supply together A. market equilibrium: a situation in which quantity demanded equals quantity supplied B. competitive market equilibrium: a market equilibrium with many buyers and many sellers C. How markets eliminate surpluses and shortages 1. a market that is not in equilibrium moves towards equilibrium and one that is, and then stays in equilibrium 2. surplus: a situation in which the quantity supplied is greater than the quantity demanded 3. shortage: a situation in which the quantity demanded is greater than the quantity supplied D. demand and supply both count 1. the interaction of demand and supply determines equilibrium price 3.4: The Effect of Demand and Supply Shifts on Equilibrium A. The effects of shifts in supply on equilibrium 1. when firms enter the market, supply shifts to right and there is a surplus at original equilibrium price, and vice versa when firms exit market B. The effects of shifts in demand on equilibrium 1. shift to right causes a shortage, and vice versa C. The effects of shifts in demand and supply over time 1. whether the equilibrium price in a market rises or falls over time demands on whether demand shifts to the right more than supply D. Shifts in a Curve versus movements along a curve 1. when a shift in a demand or supply curve causes a change in equilibrium price, the change in price does not cause a further shift in demand or supply

In-Class Notes:

Chapter 4: Economic Efficiency, Government Price Setting, and Taxes price ceiling: a legally determined maximum price that sellers may charge price floor: a legally determined minimum price that sellers may receive governments also impose taxes to intervene in markets whenever government imposes a price ceiling, price floor, or tax, there are predictable negative economic consequences (consumer surplus, producer surplus, economic surplus) 4.1: Consumer Surplus and Producer Surplus A. consumer surplus: the difference between the highest price a consumer is wiling to pay and the price the consumer actually pays economic surplus: the sum of consumer surplus plus producer surplus 1. when the government imposes a price ceiling or a price floor, the amount of economic surplus in a market is reduced B. marginal benefit: the additional benefit to a consumer from consuming one more unit of a good or service C. the total amount of consumer surplus in a market is equal to the area below the demand curve and above the market price D. producer surplus: the difference between the lowest price a firm would be willing to accept and the price it actually receives 1. willingness to supply a product depends on the cost of producing it 2. marginal cost: the additional cost to a firm of producing one more unit of a good or service a. often the marginal cost of producing a good increases as more of the good is produced during a given period of time 3. the total amount of producer surplus in a market is equal to the area above the market supply curve and below the market price E. What consumer surplus and producer surplus measure 1. consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit 2. producer surplus measures the net benefit received by producers from participating in a market 4.2: The Efficiency of Competitive Markets A. marginal benefit equals marginal cost in competitive equilibrium 1. to achieve economic efficiency, the marginal benefit from the last unit sold should equal the marginal cost of production 2. equilibrium in a competitive market results in the economically efficient level of output, where marginal benefit equals marginal cost B. Economic Surplus: the sum of consumer surplus and producer surplus 1. with no government restriction, economic surplus is at a max when the market is in equilibrium C. Deadweight loss: the reduction in economic surplus resulting from a market not being in competitive equilibrium 1. occurs when market is not in equilibrium

D. Economic Surplus and Economic Efficiency 1. consumer surplus measures the benefit to consumers from buying a particular product. Producer surplus measures the benefit to firms from selling a particular product 2. equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service 3. economic efficiency: a market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum 4.3: Government Intervention in the Market: Price Floors and Price Ceilings producers/consumers can lobby government to legally require that a different price be charged A. Price Floors: Government Policy in Agricultural Markets 1. after great depression, many farmers were unable to sell their products or could only sell them at very low prices 2. government farm programs have often resulted in large surpluses of wheat and other agricultural products B. Earned income tax credit reduces the amount of tax that low-income wage earners would otherwise pay to the federal government C. Price Ceilings: Government rent control policy in housing markets 1. support for floors comes from sellers and ceilings come from buyers D. Black Markets: a market in which buying and selling take place at prices that violate government price regulations E. The results of government price controls: winners, losers, and inefficiency 1. some people win 2. some people lose 3. there is a loss of economic inefficiency F. Positive and Normative Analysis of Price Ceilings and Price Floors 4.4: The Economic Impact of Taxes A. The effect of taxes on economic efficiency 1. whenever a government taxes a good/service, less of that good/service will be produced and consumed 2. a tax is efficient if it imposes a small excess burden relative to the tax revenue it raises B. Tax Incidence: Who actually pays a tax? 1. tax incidence: the actual division of the burden of a tax between buyers and sellers in a market 2. incidence of tax does not depend on whether a tax is collected from the buyers of a good or from the sellers Chapter 6: Elasticity: The Responsiveness of Demand and Supply elasticity: a measure of how much one economic variable responds to changes in another economic variable 6.1: The Price Elasticity of Demand and its Measurement A. Measuring the Price Elasticity of Demand 1. price elasticity of demand: the responsiveness of the quantity demanded of a good to changes in its price Price Elasticity of Demand = Percentage Change in Quantity Percentage Change in Price 2. Price elasticity of demand is not the same as the slope of the demand curve 3. always negative, but usually compare absolute values B. Elastic Demand and Inelastic Demand 1. elastic demand: demand is elastic when the percentage change in quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value 2. inelastic demand: demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value

3. unit-elastic demand: demand is unit-elastic when the percentage change in quantity demand is equal to the percentage change in price, so the price elasticity is equal to 1 in absolute value C. the midpoint formula 1. ensures that we have only 1 value of the price elasticity of demand between the same two points on a demand curve

2. where P1 = initial price P2 = final price Q1 = initial quantity Q2 = final quantity D. when demand curves intersect, the flatter curve is more elastic E. Polar cases of perfectly elastic and perfectly inelastic demand 1. perfectly inelastic demand: the case where quantity demanded is completely unresponsive to price and the price elasticity of demand equals 0. (vertical line demand curve) 2. perfectly elastic demand: the case where quantity demanded is infinitely responsive to price, and the price elasticity of demand equals infinity (horizontal line demand curve) 6.2: The Determinants of the Price Elasticity of Demand A. Availability of Close Substitutes 1. If a product has more substitutes available, it will have more elastic demand. If it has fewer substitutes available, it will have less elastic demand B. Passage of Time 1. the more time that passes, the more elastic the demand for a product becomes C. Luxuries versus Necessities 1. the demand curve for a luxury is more elastic than the demand curve for a necessity D. Definition of the Market 1. the more narrowly we define a market, the more elastic demand will be E. Share of a Good in a Consumer's Budget 1. the demand for a good will be more elastic the larger the share of the good in the average consumer's budget 6.3: The Relationship Between Price Elasticity of Demand and Total Revenue A. total revenue: the total amount of funds received by a seller of a good or service, calculated by multiplying price per unit by the number of units sold 1. when demand is inelastic, price and total revenue move in the same direction 2. when demand is elastic, price and total revenue move inversely 3. when a demand is unit elastic, neither a decrease in price nor an increase affects revenue If Demand Is Then Because Elastic An increase in price reduces The decrease in quantity revenue demanded is proportionally greater than the increase in price Elastic A decrease in price The increase in quantity increases revenue demanded is proportionally greater than the decrease in price Inelastic An increase in price The decrease in quantity increases revenue demanded is proportionally smaller than the increase in price Inelastic A decrease in price reduces The increase in quantity

revenue Unit elastic An increase in price does not affect revenue A decrease in price does not affect revenue

Unit elastic

demanded is proportionally smaller than the decrease in price The decrease in quantity demanded is proportionally the same as the increase in price The increase in quantity demanded is proportionally the same as the decrease in price

B. Elasticity and Revenue with a Linear Demand Curve 6.4: Other Demand Elasticities A. Cross-price elasticity of demand: the percentage change in quantity demanded of one good divided by the percentage change in the price of another good 1. if products are substitutes, then CPED > 0 2. if products are complements, then CPED < 0 3. if products are unrelated, then CPED = 0 B. Income Elasticity of Demand: a measure of the responsiveness of quantity demanded to changes in income

1. If IED is positive but less than 1, then the good is normal and a necessity 2. If IED is positive and greater than 1, then the good is normal and a luxury 3. If IED is negative, then good is inferior a. Good is inferior if the quantity demanded falls when income increases; dependent on individual tastes and preferences 6.5: Using Elasticity to Analyze the Disappearing Family Farm 6.6: The Price Elasticity of Supply and Its Measurement A. Price elasticity of supply: the responsiveness of the quantity supplied to a change in price

B. Determinants of the Price Elasticity of Supply 1. depends on ability and willingness of firms to alter the quantity they produce as price increases C. polar cases of perfectly elastic and perfectly inelastic supply 1. very rare 2. perfectly inelastic: quantity supplied is completely unresponsive to price. Vertical supply curve 3. perfectly elastic: quantity supplied is infinitely responsive to price. Horizontal supply curve See Table 6-6 (Page 197) for a Summary of Elasticities

In-Class Notes:

Elasticity declines as you move down a demand curve Total Expenditure (TE) = Total Revenue (TR) Chapter 9: Consumer Choice and Behavioral Economics 9.1: Utility and Consumer Decision Making A. The Economic Model of Consumer Behavior in a Nutshell 1. economists assume that consumers act so as to make themselves as well off as possible B. Utility: the enjoyment or satisfaction people receive from consuming goods and services C. The principle of Diminishing Marginal Utility 1. marginal utility (MU): the change in total utility a person receives from consuming one additional unit of a good or service 2. law of diminishing marginal utility: the principle that consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time D. The Rule of Equal Marginal Utility per Dollar Spent 1. budget constraint: the limited amount of income available to consumers to spend on goods and services 2. optimal decisions are made at the margin 3. must equalize your marginal utility per dollar spent

and spending on item 1 + spending on item 2 = amount available to be spent E. The Income Effect and Substitution Effect of a Price Change 1. income effect: the charge in the quantity demanded of a good that results from the effect of a change in price on consumer purchasing power, holding all other factors constant 2. substitution effect: the change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods, holding constant the effect of the price change on consumer purchasing power

Table 9-4 (Page 294) Price Decrease

Income Effect Increases the consumer's purchasing power, which if a normal good, causes the quantity demanded to increase if an inferior good, causes the quantity demanded to decrease

Price Increase

Decreases the consumer's purchasing power, which

if a normal good, causes the quantity demanded to decrease.

if an inferior good, causes the quantity demanded to increase.

Substitution Effect Lowers the opportunity cost of consuming the good, which causes the quantity of the good demanded to increase Raises the opportunity cost of consuming the good, which causes the quantity of the good demanded to decrease

9.2: Where Demand Curves Come From A. Giffen Goods: goods that are inferior and the income effect is larger than the substitution effect (that which people consume more of as price rises, violating the law of demand) 9.3: Where Demand Curves Come From A. The Effects of Celebrity Endorsements 1. many consumers feel more fashionable and closer to famous people if they use the same products B. Network Externalities: the situation where the usefulness of a product increases with the number of consumers who use it (i.e., cell phones) 1. switching costs: when a product becomes established, consumers may find it too costly to switch to a new product that contains new technology 2. path dependent: because of switching costs, the technology that was first available may have advantages over better technologies that were developed later 3. market failure: a situation in which the market fails to produce the efficient level of output C. Does fairness matter? 1. a test of fairness in the economic laboratory: the Ultimatum Game Experiment

2. Business Implications of Fairness 9.4: Behavioral Economics: Do People Make Their Choices Rationally? A. Behavioral economics: the study of situations in which people make choices that do not appear to be economically rational B. Ignoring nonmonetary opportunity costs 1. opportunity cost: the highest-valued alternative that must be given up to engage in an activity 2. endowment effect: the tendency of people to sell a good they already own even if they are offered a price that is greater than the price they would be willing to pay to buy the good if they didn't already own it. 3. nonmonetary opportunity costs are just as real as monetary costs and should be taken into account when making decisions C. Business implications of consumers ignoring nonmonetary opportunity costs D. Failing to Ignore Sunk Costs 1. sunk cost: a cost that has already been paid and cannot be recovered E. Being Unrealistic about Future Behavior Chapter 9 Appendix: Using Indifference Curves and Budget Lines I. Consumer Preferences A. We assume the consumer will always be able to decide between the following 1. consumer prefers bundle A to bundle B 2. consumer prefers bundle B to bundle A 3. consumer is indifferent between the two bundles B. indifference curves: shows combinations of consumption bundles that give the consumer the same utility. They are parallel to each other C. The slope of an indifference curve 1. slope tells us the rate at which the consumer is willing to trade off one product for another while keeping the consumer's utility constant a. marginal rate of substitution: slope of indifference curve D. Can Indifference Curves ever Cross? 1. No, it would violate transitivity II. The Budget Constraint A. Budget constraint: the amount of income a consumer has available to spend on goods and services B. Slope of line is constant because the budget constraint is a straight line. Slope of line equals change in number of 1 product over change in number of another product C. The slope of the budget constraint is equal to the ratio of the price of the good on the horizontal axis divided by the price of the good on the vertical axis, multiplied by -1 III. Choosing the Optimal Consumption of Pizza and Coke A. To maximize utility, a consumer needs to be on the highest indifference curve given his budget constraint B. How a price Change Affects Optimal Consumption C. The Income Effect and the Substitution Effect of a Price Change 1. to isolate substitution effect, we change the price of pizza relative to Coke but at the same time holding his utility constant by keeping Dave on the same indifference curve IV. The Slope of the Indifference Curve, the Slope of the Budget Line and the Rule of equal Marginal Utility per Dollar Spent A. At the point of optimal consumption, the marginal rate of substitution (MRS) is equal to the ratio of the price of the product on the horizontal axis to the price of the product on the vertical axis B. At the point of optimal consumption, MU pizza/Ppizza = MUCoke/PCoke Chapter 10: Technology, Production, and Costs 10.1: Technology: An Economic Definition A. Technology: the processes a firm uses to turn inputs into outputs of goods and services 1. depends on skill of its managers, the training of its workers, and the speed and efficiency of its machinery and equipment

B. Technological change: a change in the ability of a firm to produce a given level of output with a given quantity of inputs 10.2: The Short Run and the Long Run in Economics A. Short run: the period of time during which at least one of a firm's inputs is fixed. B. Long run: the period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant C. The difference between fixed costs and variable costs 1. total cost: the cost of all the inputs a firm uses in production 2. variable costs: costs that change as output changes 3. fixed cost: costs that remain constant as output changes 4. total cost = fixed cost + variable cost D. Implicit Costs versus Explicit Costs 1. opportunity cost: the highest-valued alternative that must be given up to engage in an activity 2. explicit cost: a cost that involves spending money 3. implicit cost: a nonmonetary opportunity cost 4. explicit costs sometimes called accounting costs E. the production function: the relationship between the inputs employed by a firm and the maximum output it can produce with those inputs F. A first look at the relationship between production and cost 1. average total cost: total cost divided by the quantity of output produced 10.3: The Marginal Product of Labor and the Average Product of Labor A. marginal product of labor: the additional output a firm produces as a result of hiring one more worker B. the law of diminishing returns: the principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline C. Graphing Production 1. because of specialization and the division of labor, out put at first increases at an increasing rate, with each additional worker hired causing production to increase by a greater amount than did the hiring of the previous worker. When the point of diminishing return is reached, production increases at a decreasing rate D. The relationship between marginal and average product 1. average product of labor: the total output produced by a firm divided by the quantity of workers 2. the average product of labor is the average of the marginal products of labor 10.4: the relationship between short-run production and short-run cost A. marginal cost: the change in a firm's total cost from producing one more unit of a good or service MC = TC Q B. Why are marginal and average cost curves U-shaped? 1. when the marginal product of labor is rising, the marginal cost of output is falling; when the marginal product of labor is falling, the marginal cost of production is rising 2. marginal cost of production falls and risesforming a U-shapebecause the marginal product of labor rises and then falls 10.5: Graphing Cost Curves A. average fixed cost: fixed cost divided by the quantity of output produced B. average variable cost: variable cost divided by the quantity of output produced 10.6: Costs in the Long Run A. In the long run, all costs are variable. There are no fixed costs on the long run 1. total cost = variable cost; average total cost = average variable cost B. Economics of scale 1. long-run average cost curve: a curve showing the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed 2. economies of scale: the situation when a firm's long-run average costs fall as it increases output

C. Long-Run Average Total Cost Curves for Bookstores 1. constant returns to scale: the situation when a firm's long-run average costs remain unchanged as it increases output 2. minimum efficient scale: the level of output at which all economies of scale are exhausted 3. diseconomies of scale: the situation when a firm's long-run average costs rises as the firm increases output Chapter 11: Firms in Perfectly Competitive Markets 11.1: Perfectly Competitive Markets: a market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products (3) no barriers to new firms entering the market A. market for most goods do no meet the requirements for perfectly competitive market B. a perfectly competitive firm cannot affect the market price 1. price taker: a buyer or seller that is unable to affect the market price 2. the market supply curve for wheat (a perfectly competitive market) will not shift by enough to change the equilibrium price by even 1 cent. C. The demand curve for the output of a perfectly competitive firm 11.2: How a firm maximizes profit in a perfectly competitive market A. Profit: total revenue minus total cost B. Revenue for a firm in a perfectly competitive market 1. average revenue: total revenue divided by the quantity of the product sold 2. marginal revenue: change in total revenue from selling one more unit of a product MR = TR Q 3. for a firm in a perfectly competitive market, price is equal to both average revenue and marginal revenue C. Determining the profit-maximizing level of output 1. the marginal revenue curve for a perfectly competitive firm is the same as its demand curve 2. the profit-maximizing level of output is where the difference between total revenue and total cost is the greatest 3. the profit-maximizing level of output is also where marginal revenue equals marginal cost, or MR = MC 11.3: Illustrating Profit or Loss on the Cost Curve Graph A. Profit = (Price Average Total Cost) x Quantity B. Showing a Profit on the Graph 1. Firms want to maximize total profit, not profits per unit C. Illustrating when a firm is breaking even of operating at a loss 1. P > ATC : profit 2. P = ATC : breaking even 3. P < ATC : experiencing a loss 11.4: Deciding whether to Produce or to Shut down in the Short Run A. Sunk cost: a cost that has already been paid and that cannot be recovered B. The supply curve of a firm in the short run 1. a perfectly competitive firm's marginal cost curve is also its supply curve a. only for prices at or above average variable cost 2. shutdown point: the minimum point on a firm's average variable cost curve, if the price falls below this point, the firm shuts down production in the short run C. the market supply curve in a perfectly competitive industry 11.5: "If everyone can do it, you can't make money at it:" the entry and exit of firms in the long run A. Economic profit and the entry or exit decision 1. economic profit: a firm's revenues minus all its costs, implicit and explicit 2. economic profit leads to entry of new firms 3. economic losses lead to exit of firms 4. economic loss: the situation in which a firm's total revenue is less than its total cost, including all implicit costs

B. Long-Run Equilibrium in a Perfectly Competitive Market 1. long-run competitive equilibrium: the situation in which the entry and exit of firms has resulted in the typical firm breaking even. a. Long run equilibrium market price is at a level equal to the minimum point on the typical firm's average total cost curve C. The Long-run supply curve in a perfectly competitive market 1. long-run supply curve: a curve that shows the relationship in the long run between market price and the quantity supplied 2. in the long run, a perfectly competitive market will supply whatever amount of a good consumer's demand at a price determined by the minimum point on the typical firm's average total cost curve D. increasing-cost and decreasing-cost industries 1. constant-cost industries: any industry in which the typical firm's average costs do not change as the industry expands production (horizontal long-run supply curve) 2. increasing-cost industries: industries with upward-sloping long-run supply curves 3. decreasing-cost industries: industries with downward-sloping long-run supply curves 11.6: Perfect Competition and Efficiency A. productive efficiency: the situation in which a good or service is produced at the lowest possible cost B. allocative efficiency: a state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. In-Class Notes: Profit = Marginal Revenue = Marginal Cost = Minimum Average Cost Chapter 14: Monopoly and Antitrust Policy 14.1: Is any firm ever really a monopoly? A. Monopoly: a firm that is the only seller of a good 1. so yes, as long as the substitutes are not close (i.e., electric light bulbs and candles) 14.2: Where do monopolies come from? A. Entry blocked by Government action 1. granting a patent/copyright to an individual or firm, giving it the exclusive right to produce a product 2. granting a firm a public franchise, making it the exclusive legal provider of a good or service 3. patents and copyrights a. patent: the exclusive right to a product for a period of 20 years from the date the product is invented b. copyright: a government-granted exclusive right to produce and sell a creation 4. public franchise: a designation by the government that a firm is the only legal provider of a good or service a. public enterprise: when the government provides certain services directly to consumers (i.e., water/sewage, railroads, etc.) B. Control of a Key Resource 1. Alcoa (aluminum) C. Network Externalities: the situation where the usefulness of a product increases with the number of consumers who use it (cell phones) D. Natural Monopoly: a situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms 14.3: How does a monopoly choose price and output? A. A monopoly's demand curve is the same as the demand curve for the product B. Marginal revenue once again 1. when a firm cuts the price of a product it sells more of a product by less revenue from each unit C. profit maximization for a monopolist

14.4: Does monopoly reduce economic efficiency? A. Equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service B. Comparing monopoly and perfect competition 1. a monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good C. measuring the efficiency losses from monopoly 1. monopoly causes a reduction in consumer surplus 2. monopoly causes an increase in producer surplus 3. monopoly causes a deadweight loss, which represents a reduction in economic efficiency D. how large are the efficiency losses due to monopoly? 1. market power: the ability of a firm to charge a price greater than the marginal cost 2. because few markets are perfectly competitive, some loss of economic efficiency occurs in the market for nearly every good or service 3. loss of economic efficiency is small because true monopolies are very rare E. market power and technological change 1. Joseph Schumpeter argued economic progress is depended on technological change in the form of new products 14.4: Government Policy toward monopoly A. Collusion: an agreement among firms to charge the same price or otherwise not to compete B. Antitrust laws and antitrust enforcement 1. antitrust laws: laws aimed at eliminating collusion and promoting competition among firms 2. Sherman Act (1890): outlaws every contract, combination in the form of trust or otherwise, or conspiracy in restraint of trade. Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce shall be deemed guilty of a felony C. Mergers: The tradeoff between market power and efficiency 1. Horizontal merger: a merger between firms in the same industry 2. vertical merger: a merger between firms at different stages of production of a good 3. although the newly merged firm has a great deal of market power, because it is more efficient, consumers are better off and economic efficiency is improved D. The Department of Justice and Federal Trade Commission Merger Guidelines 1. market definition: a market consists of all firms making products that consumers view as close substitutes 2. measure of concentration: market is concentrated if a relatively small number of firms have a large share of total sales in the market a. Herfindahl-Hirschman Index (HHI): squares the market shares of each firm in the industry and adds up the values ex: 10 firms, each with market shares of 10%: HHI = 10(102) = 1000 3. merger standards: (post-merger) a. HHI below 1000: not concentrated market, so mergers in them are not challenged b. HHI between 1000 and 1800: moderately concentrated. Mergers that are raised by less than 100 probably not challenged. Raise by more than 100 may be challenged c. HHI above 1800: highly concentrated. Increase by less than 50 not challenged. 50-100 maybe challenged. >100 will be challenged E. Regulating Natural Monopolies 1. local or state regulatory commissions usually set prices for natural monopolies Chapter 12: Monopolistic Competition: the Competitive Model in a More Realistic Setting monopolistic competition: a market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products 12.1: Demand and Marginal Revenue for a firm in a monopolistically competitive market

A. the demand curve for a monopolistically competitive firm B. marginal revenue for a firm with a downward-sloping demand curve 1. cut price: a. good thing: sells more. Called output effect. b. bad thing: receives less revenue per unit sold. Called price effect. 2. every firm that has the ability to affect the price of the good or service it sells will have a marginal revenue curve that is below its demand curve 12.2: How a monopolistically competitive firm maximizes profits in the short run A. profit = (P ATC) x Q P > MC to maximize profits 12.3: what happens to profits in the long run? A. How does the entry of new firms affect the profits of existing firms? 1. demand curve will shift to left 2. demand curve more elastic B. Is zero economic profit inevitable in the long run? 1. if a firm introduces a new technology that allows it to sell a good/service at a lower cost, competing firms will eventually be able to duplicate that technology and eliminate the firm's profits but only if the firm stands still and fails to find new ways of differentiating its product or fails to find new ways of lowering the cost of producing its product 12.4: Comparing perfect competition and monopolistic competition A. monopolistically competitive firms charge a price greater than marginal cost B. monopolistically competitive firms do not produce at minimum average total cost C. Excess Capacity under Monopolistic Competition 1. a monopolistically competitive firm has excess capacity if when it increased its output, it could produce at a lower average cost D. Is monopolistic competition inefficient? 1. neither productive efficiency nor allocative efficiency is achieved, but unknown as to whether this results in a significant loss of well-being to society E. how consumers benefit from monopolistic competition 1. firms differentiate their products to appeal to consumers 2. consumers face a tradeoff because the price they pay is greater than marginal cost, but benefit in being able to purchase a product that is differentiated and more closely suited to taste 12.5: How market differentiates products A. marketing: all the activities necessary for a firm to sell a product to a consumer B. brand management: the actions of a firm intended to maintain the differentiation of a product over time C. advertising 12.6: What makes a firm successful A. differentiation from competing products, average cost of production relative to competing firms, value created relative to competitors, factors affecting the firm's market, chance events Chapter 13: Oligopoly: Firms in Less Competitive Markets oligopoly: a market structure in which a small number of interdependent firms compete 13.1: Oligopoly and Barriers to entry A. concentration ratio states the fraction of each industry's sales accounted for by its four largest firms. If it's greater than 40$ then it's an oligopoly B. Herfindahl-Hirschman Index C. Barriers to entry: anything that keeps new firms from enter an industry in which firms are earning economic profits 1. economics of scale: the situation when a firm's long-run average costs fall as it increases output 2. ownership of a key input 3. government-imposed barriers a. patent: the exclusive right to a product for a period of 20 years from the date the product is invented 13.2: Using Game Theory to analyze Oligopoly

A. game theory: the study of how people make decisions in situations in which attaining their goals depends on their interactions with others; in economics, the study of the decision of firms in industries where the profits of each firm depend on its interaction with other firms B. games share 3 key characteristics 1. rules that determine what actions are allowable 2. strategies that players employ to attain their objectives in the game 3. payoffs that are the results of the interaction among the players' strategies C. business strategy: actions taken by a firm to achieve a goal, such as maximizing profits D. a duopoly game: price competition between two firms 1. payoff matrix: a table that shows the payoff that each firm earns from every combination of strategies by the firms 2. collusion: an agreement among firms to charge the same price or otherwise not to compete 3. dominant strategy: a strategy that is the best for a firm, no matter what strategies other firms use 4. Nash equilibrium: a situation in which each firm chooses the best strategy, given the strategies chosen by other firms E. Firm behavior and the prisoners' dilemma 1. cooperative equilibrium: an equilibrium in a game in which players cooperate to increase their mutual payoff 2. non-cooperative equilibrium: an equilibrium in a game in which players do not cooperate but pursue their own self-interest 3. prisoners' dilemma: a game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off. F. Can firms escape the prisoners' dilemma? 1. price leadership: a form of implicit collusion where one firm in an oligopoly announces a price change, which is matched by the other firms in the industry. G. Cartels: the case of OPEC 1. cartel: a group of firms that collude by agreeing to restrict output to increase prices and profits 13.3: sequential games and business strategy A. deterring entry B. bargaining 13.4: the five competitive forces model A. competition from existing firms B. the threat from potential entrants C. competition from substitute goods or services D. the bargaining power of buyers Chapter 5: Externalities, Environmental Policy, and Public Goods externality: a benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service Private marginal benefit Society marginal benefit Private marginal cost Society marginal cost 5.1: Externalities and Economic Efficiency A. the effect of externalities 1. private cost: the cost borne by the producer of a good or service 2. social cost: the total cost of producing a good or service, including both the private cost and any external cost 3. private benefit: the benefit received by the consumer of a good or service 4. social benefit: the total benefit from consuming a good or service, including both the private benefit and any external benefit 5. how a negative externality in production reduces economic efficiency a. when there is a negative externality in producing a good or service, too much of the good or service will be produced at market equilibrium 6. how a positive externality in consumption reduces economic efficiency

a. when there is a positive externality in consuming a good or service, too little of the good or service will be produced at market equilibrium B. externalities may result in market failure 1. market failure: a situation in which the market fails to produce the efficient level of output C. what causes externalities? 1. property rights: the rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it 2. externalities and market failures results from incompletely property rights or from the difficulty of enforcing property rights in certain situations 5.2: Private solutions to externalities: the Coase Theorem A. completely eliminating an externality usually is not economically efficient B. the economically efficient level of pollution reduction C. the basis for private solutions to externalities 1. it's the NET benefit that counts D. do property rights matter? E. The problem of transaction costs 1. transaction costs: the costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services F. The Coase Theorem: the argument of economist Ronald Coase that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities 5.3: Government policies to deal with externalities A. Pigovian taxes and subsidies: government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities B. Command and Control versus Tradable Emissions Allowances 1. command and control approach: an approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices C. Are tradable Emissions Allowances Licenses to Pollute? 5.4: Four Categories of Goods A. Rivalry: the situation that occurs when one person's consuming a unit of a good means no one else can consume it B. Excludability: the situation in which anyone who does not pay for a good cannot consume it C. Four categories 1. private good: a good that is both rival and excludable (food, clothing, etc.) 2. public good: a good that is both non rivalrous and non excludable (national defense) a. free riding: benefiting from a good without paying for it (provision of national defense) 3. quasi-public goods: some goods are excludable but not rival (cable television) 4. common resources: a good that is rival but not excludable (forest land, un-owned land) D. the demand for a public good E. the optimal quantity of a public good 1. cost-benefit analysis to determine what quantity of a public good should be supplied F. common resources 1. tragedy of the commons: the tendency for a common resource to be overused 2. Is there a way out of the tragedy of the commons? a. Must use government intervention In-Class Notes: In the absence of large bargaining costs, private parties will come to the optimal point as long as property rights are well-defined (Coase Theorem) Chapter 17: The Economics of Information 17.1: Asymmetric Information: a situation in which the party to an economic transaction has less information than the other party A. Adverse selection and the market for "lemons"

1. adverse selection: the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction B. reducing adverse selection in the car market: warranties and reputations 1. some states have "lemon laws" a. new cars that need several major repairs during the first year or two after the date of the original purchase may be returned to the manufacturer for a full refund b. car manufacturers must indicate whether a used car they are offering for sale was repurchased from the original owner as a lemon C. asymmetric information in the market for insurance D. reducing adverse selection in the insurance market E. moral hazard: the actions people take after they have entered into a transaction that make the other party to the transaction worse off 17.2: Adverse Selection and Moral Hazard in Financial Markets A. reducing adverse selection and moral hazard in financial markets 1. SEC: securities and exchange commission 17.3: adverse selection and moral hazards in labor A. principal-agent problem: a problem caused by agents pursuing their own interests rather than the interests of the principals who hired them. B. Ways firms make a job seem valuable 1. efficiency wages: there is a market for every kind of labor, just as there is a market for every good and service 2. seniority system: workers who've been with a firm longer receive higher pay and other benefits 3. profit sharing: employees receive a profit the harder they work 17.4: the winner's curve: when is it bad to win an auction? A. Winner's curse: The idea that the winner in certain auctions may have overestimated the value of the good, thus ending up worse off than the losers B. Two conclusions: 1. in competitive bidding, the winner tends to be the player who most overestimates true tract value 2. he who bids on a parcel what he thinks it is worth will, in the long run, be taken to the cleaners C. when does the winner's curse apply? 1. only to auctions of common-value assets (oil fields) D. Pacific Telesis uses the winner's curse to its own advantage Chapter 8: Comparative Advantage and Gains from International Trade 8.1: The United States in the International Economy Tariff: a tax imposed by a government on imports Imports: goods and services bought domestically but produced in other countries Exports: goods and services produced domestically but sold to other countries A. The importance of trade to the US economy 1. GDP: gross domestic product. The value of all the goods and services produced in a country during a year 2. US agricultural production is exported 3. US manufacturing jobs depend on exports either directly or indirectly (about 20%) B. US international trade in a world context 8.2: Comparative Advantage in International Trade A. A brief overview of comparative advantage 1. comparative advantage: the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors 2. opportunity cost: the highest-valued alternative that must be given up to engage in an activity B. Comparative advantage in international trade

1. absolute advantage: the ability to produce ore of a good or service than competitors when using the same amount of resources 8.3: how countries gain from international trade A. autarky: a situation in which a country does not trade with other countries B. increasing consumption through trade 1. terms of trade: the ratio of which a country can trade its exports for imports from other countries 2. countries gain from specializing in producing goods in which they have a comparative advantage and trading for goods in which other countries have a comparative advantage C. Why don't we see complete specialization? 1. not all goods/services are traded internationally 2. production of most goods involves increasing opportunity costs 3. tastes for products differ D. Does anyone lose as a result of international trade? 1. the CEOs/owners of firms whose products are being imported E. where does comparative advantage come from? 1. climate and natural resources 2. relative abundance of labor and capital 3. technology 4. external economies: reductions in a firm's costs that result from an increase in the size of an industry F. Comparative advantage over timethe rise and falland riseof the US consumer electronics industry 8.4: Government Policies that restrict international trade A. Free trade: trade between countries that is without government restrictions 1. makes consumers better off B. tariffs 1. increases the cost of selling a good 2. succeed in helping domestic producers but hurts consumers and efficiency of economy C. quotas and voluntary export restraints 1. quota: a numeric limit imposed by a government on the quantity of a good that can be imported into the country 2. voluntary export restraints (VER): an agreement negotiated between two countries that places a numeric limit on the quantity of a good that can be imported by one country from the other country. D. Measuring the economic effect of the sugar quota E. The high cost of preserving jobs with tariffs and quotas F. Gains from unilateral elimination of tariffs and quotas 1. the US economy would gain from the elimination of tariffs and quotas even if other countries do not reduce their tariffs and quotas G. Other barriers to trade 1. health and safety requirements 2. national security grounds (can't depend on imported war materials in a time of war) 8.5: The argument over trade policies and globalization A. world trade organization (WTO): an international organization that oversees international trade agreements B. why do some people oppose the WTO? 1. globalization: the process of countries becoming more open to foreign trade and investment 2. anti-globalization: many protestors believe globalization destroys distinctive cultures 3. "Old-Fashioned" protectionism a. Protectionism: the use of trade barriers to shield domestic firms from foreign competition b. Justified by: i. Saving jobs ii. Protecting high wages

iii. Protecting infant industries iv. Protecting national security C. Dumping: selling a product for a price below its cost of production D. Positive versus normative analysis (once again) 1. the costs tariffs and quotas impose on consumers are large in total but relatively small per person 2. the jobs lost to foreign competition are easy to identify, but the jobs created by foreign trade are less easy to identify Chapter 19: GDP: Measuring Total Production and Income microeconomics: the study of how households and firms make choices, how they interact in markets, and how the government attempts to influence their choices macroeconomics: the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth business cycle: alternating periods of economic expansion and economic recession expansion: the period of a business cycle during which total production and total employment are decreasing recession: the period of a business cycle during which total production and total employment are decreasing economic growth: the ability of an economy to produce increasing quantities of goods and services inflation rate: the percentage increase in the price level from one year to the next A. What macroeconomics analyzes/pertains to: 1. business cycle 2. economic growth 3. total level of employment in an economy 4. inflation rate 5. linkages among economics: international trade and international finance 19.1: Gross Domestic Product measures total production A. measuring total production: gross domestic product 1. gross domestic product (GDP): the market value of all final goods and services produced in a country during a period of time, typically 1 year a. Bureau of Economic Analysis (BEA) in the Department of Commerce compiles the data needed to calculate GDP 2. GDP is measured using market values, not quantities a. Dollar terms (value), not # sold (quantity) 3. GDP includes only the market value of final goods a. final good or service: a good or service purchased by a final user b. intermediate good or service: a good or service that is an input into another good or service, such as a tire on a truck. i. If tire were included in calculating GDP, that would be double counting 4. GDP includes only current production B. Production, Income, and the Circular Flow Diagram 1. every penny of a purchased good must end up as someone's income (except sales tax) 2. Page 637 3. factors of production: labor, capital, natural resources, and entrepreneurship 4. transfer payments: payments by the government to individuals for which the government does not receive a new good or service in return a. i.e., social security payments C. Components of GDP 1. personal consumption expenditures or "consumption" a. consumption: spending by households on goods and services, not including spending on new houses i. services (medical care ) ii. non-durable goods (foods, clothing)

iii. durable goods (cars, furniture) 2. Gross Private Domestic Investment, or "investment" a. Investment: spending by firms on new factories, office buildings, machinery, and additions to inventories, and spending by households on new houses i. Business fixed investment (factories, buildings) ii. Residential investment (new housing) iii. Changes in business inventories 3. Government Consumption and Gross Investment, or "Government Purchases" a. Government purchases: spending by federal, state, and local governments on goods and services (teachers' salaries, highways, aircraft carriers) 4. net exports of goods and services, or "net exports" a. net exports: exports minus imports D. An equation for GDP and Some Actual Values GDP (Y) = C + I + G + NX