Economics Review

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Economics Review

• Capstone Course

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Why you need to know

• Every decision that you make is based on an
  analysis of the costs and benefits.
• This applies to personal decisions as well as
  business decisions.
• Economics is the study of choice. Before you
  make a decision, you must have a clear
  understanding of what the costs and benefits are.
• You must also know the impact of that decision.

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Format

• I am going to work on 2 problems
• What happens to GDP when the Japanese national
  bank (Bank of Japan) sells US dollars?
• What happens to GDP when the US government lowers
  taxes?
• Why am I asking about GDP?

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Why GDP is important

• Why do you work? To get stuff.
• Why are you in school? To get more stuff.
• The variable that most closely measures our
  ability to get stuff is GDP.
• NOTE We are not so much interested in the
  actual level of GDP as in how much it changes and
  in which direction.

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Reminders

• GDP C I G X M
• The Bank of Japan and all national banks hold
  onto currency from other countries (particularly
  ours) to help manage exchange rates.

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What happens?

• Focus on the demand and supply of in Japan.
• Supply of dollars increases.
• Causes the price of dollars with respect to yen
  to fall, and conversely the price of yen to rise.
• Japanese goods are now more expensive to people
  outside Japan.

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So

• Exports from Japan fall and Imports to Japan
  rise.
• What??? Why would they do that?
• They want a strong yen. Why?
• Reduces domestic inflation.
• Increases the incomes of their trading partners
  (the rest of the Pacific Rim) which will cause
  exports from Japan to go back up.

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What does this have to do with us?

• If Japanese goods are more expensive (compared to
  ours) we buy fewer of them. So Imports to the US
  go down.
• If Japanese goods are more expensive compared to
  ours, then they will buy more of our stuff. So X
  goes up.
• Both X up and M down causes GDP to go up.
  (Assuming our Federal Reserve doesnt do anything
  to shore the dollar back up.)

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But

• When this occurs, we see prices also rising in
  our country.
• Ideally we would like to see GDP going up at the
  same time prices are going down or staying the
  same.
• How can we do this? What if we shifted AS out
  instead of AD? How can we do that? What if we
  lowered taxes?

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Lets suppose

• Just to be weird, lets suppose that the
  government lowered excise taxes on gasoline.
• Recall that a perfectly competitive firm produces
  at the point where MC MR (which is equal to the
  price) because this is where TR TC is
  maximized.
• The break-even point is where MR ATC.

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Reminders

• There are four different types of firms
• Perfectly Competitive Firms many firms, there
  is no differentiation among products
• Monopolistically Competitive Firms many firms,
  may have some product differentiation or an
  advantage with respect to location
• Monopolies firm is the entire industry
• Oligopolies a few firms in the industry

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Marginal Revenue and Price

• For a firm under perfect competition, the price
  comes from the market price.
• They can sell all they want at the going price.
• The Marginal Revenue is the amount of revenue
  that get from selling one more unit the price.

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Cost Curves

• Total Cost is all of your costs, fixed and
  variable.
• Average Total Cost is TC / q which decreases then
  increases.
• MC is the change in TC that occurs when you
  produce one more unit. It also increases after a
  certain amount of production.
• (The increase in MC is what eventually causes ATC
  to rise.)

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What happens?

• When excise taxes are decreased, marginal cost
  and average total cost decreases.
• Assume initially that the firm didnt pass on the
  savings to its consumers.
• Now profits have increased because revenue hasnt
  changed but costs have gone down.
• Other firms will enter the industry which shifts
  the market supply curve out.
• As a result prices fall and quantities increase.

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Extrapolating to the Macro Environment

• Can we take this argument to the macro level?
• Not directly. But, if we reduce costs to the
  firm, then we can use those resources that we
  previously used to pay taxes to produce other
  goods and services. This is how the AS curve
  gets shifted out.