Module The Study of Economics

•KRUGMAN'S•MACROECONOMICS for AP*

ModuleThe Study ofEconomics

1

Margaret Ray and David Anderson

What you will learnin this Module:• How scarcity and choice are central to

the study of economics

• The importance of opportunity cost in individual choice and decision making

• The difference between positive economics and normative economics

• When economists agree and why sometimes disagree

• What makes macroeconomics different from microeconomics

Individual Choice: The Core of Economics

• Economics• Individual choice• Economy• Market economy• Property rights• Marginal analysis

I. Individual Choice

A. Economics is the study of scarcity and choiceB. Market and Command Economies

1. Market Economies- production and consumption are the result of decentralized decisions by many firms and individuals

2. Command Economies- Industry is publicly owned and there is a central authority making production and consumption decisions

3. Why have most Command Economies Failed and Market Economies succeed?a. Incentives- Price is a powerful incentiveb. Property Rights- Who owns the land mattersc. When markets fail- government is there to intervene

II. Resources are Scarce

A. Resources are:1. Land- resources that come from nature2. Labor- effort of workers3. Capital- machinery, buildings, tools4. Entrepreneurship- risk takers

B. Needs vs. WantsC. Scarcity requires that choices be madeD. Choices require that things are given up

III. Opportunity Costs

A. The real cost of something is what you must give up to get it.

B. Marginal Analysis1. Many of our decisions are based on an

incremental basis (example: one hour of time)• Utility and Diminishing Marginal Utility

2. Additional benefits are called marginal benefits3. Additional costs are called marginal costs4. If MB>MC, do it. If MB<MC, don’t do it.

IV. Micro vs. Macro

A. Microeconomics focuses on the individual and how they make decisions and how those decisions interact.

B. Macroeconomics is concerned with the overall ups and downs in the economy.

1. Aggregates- measures that summarize data2. Examples- Unemployment, inflation rate, GDP

V. Positive vs. Normative

A. Positive economics is analysis of how the economy actually works (facts)

B. Normative economics is how the economy should work (what if)

C. The overall economy is so complex that economists often disagree on what to measure and how to use those measurements.

1. Politicians often use whatever economist’s data fits their beliefs

2. Ex. Taxes

VI. When and Why Economists Disagree

• Economists may disagree because they have different values or opinions

• Economists may disagree because they use different models or methods to conduct their analysis

• Over time, disputes in economics are resolved by the accumulation of evidence (but this can sometimes take a long time!)

ModuleIntroduction toMacroeconomics


2


What you will learnin this Module:• What a business cycle is and why policy makers

seek to diminish the severity of business cycles

• How employment and unemployment are measured and how they change over the business cycle

• The definition of aggregate output and how it changes over the business cycle

• The meaning of inflation and deflation and why price stability is preferred

• How economic growth determines a country's standard of living

• Why models - simplified representations of reality- play a crucial role in economics

The Business Cycle• Business Cycle• Depression• Recession• Expansion

Employment, Unemployment, and the Business Cycles

•Employment

•Unemployment

•Labor force

•Unemployment rate

Aggregate Output and the Business Cycle

•Output

•Aggregate Output

Inflation, Deflation, and Price Stability

•Nominal income v. Real income

•Inflation

•Deflation

•Price Stability

Economic Growth• Standards of living• Economic growth

The Use of Models in Economics

•Models

•Other things equal assumption

•Ceteris Paribus

ModuleThe ProductionPossibilities Curve Model


3


What you will learnin this Module:• The importance of trade-offs in

economic analysis• What the production possibilities

curve model tells us about efficiency opportunity cost, and economic growth

• The two sources of economic growth - increases in the availability of resources and improvements in technology

I. The Production Possibilities Curve

II. Opportunity Cost - Constant

III. Opportunity Cost - Increasing

IV. Efficient Allocation

• Productive Efficiency- the production of any particular good in the least costly way.– Society produces at the lowest achievable per unit

cost– It is expending the least-valued combination of

resources to produce that product– Lowest ATC

• Allocative Efficiency- Producing the particular mix of goods and services most valued by soceity.– MB=MC, no DWL

V. Economic Growth• Economic growth• Expansion of the economy’s

production possibilities• Availability of resources (land, labor,

capital, entrepreneurship)• Technology

Economic Growth

ModuleComparativeAdvantage and Trade


4


What you will learnin this Module:• How trade leads to gains for an

individual or an economy

• The difference between absolute advantage and comparative advantage

• How comparative advantage leads to gains from trade in the global marketplace

Gains from Trade

• Trade• Gains from trade• Specialization• The importance of

markets

Module 4

Absolute and Comparative Advantage

I. Absolute Advantage

A. When a worker in a country can produce more than a worker in another country, the worker in the first country has an Absolute Advantage in producing that good.

Globalization

• Globalization is the manner in which human activities, such as communication, international trade, and cultural awareness, are increasingly integrated on a multinational basis.

• Students at DPHS are competing with human resources globally for thoughtful ideas and productivity

Should we do it all?

• As the US, we have absolute advantages in many industries. Does that mean we should produce everything ourselves?–Not if we are looking at it from global

perspective.–Think about Student A and B as

countries. What should they do?

II. Comparative Advantage

A. When companies specialize in the production of a good or service for which they have a lower opportunity cost.

B. For students A and B, who should specialize in what for the best overall score?

Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts?

To find out:

1. Calculate the opportunity costs of production for each country2. Determine the comparative advantage for each country3. Determine if the terms of trade are mutually beneficial

Production Possibilities for Two Countries

Bangladesh United States

Cotton Shirts (C)

750C = 250M1C = 1/3M

1000C =1000M1C = 1M

Malaria Medicine (M)

250M = 750C1M = 3C

1000M =1000C1M = 1C



Cotton Shirts (C)

750C = 250M1C = 1/3M

1000C =1000M1C = 1M


250M = 750C1M = 3C

1000M =1000C1M = 1C

The United States has a comparative advantage in Malaria Medicine (M) because they only give up 1 cotton shirt while Bangladesh must give up 3 cotton shirts to gain 1 unit of medicine.

Bangladesh has a comparative advantage in Cotton Shirts (C) because they only give up 1/3 unit of medicine while The United States must give up 1 unit of medicine to gain 1 cotton shirt.



Cotton Shirts (C)

750C = 250M1C = 1/3M

1000C =1000M1C = 1M


250M = 750C1M = 3C

1000M =1000C1M = 1C

The terms of trade are mutually beneficial as long as they are between the two countries’ opportunity costs.

For example, any amount of medicine greater than 1/3 and less than 1 traded for 1 cotton shirt would represent mutually beneficial terms of trade.

Likewise, any number of cotton shirts greater than 1 and less than 3 traded for 1 unit of medicine would represent mutually beneficial terms of trade.


Module The Study of Economics

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