Slides 1:

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Rose-Hulman Institute of Technology Department of
Humanities Social Sciences / K. Christ SL 151,
Principles of Economics
Slides 1 Introduction Foundational Principles
2
SL151, Principles of Economics
Winter 2006 2007
Monday
Tuesday
Thursday
Friday
Week 1 Nov. 27 Dec. 1
Market Demand Schiller, 3
Introductory Concepts Schiller, 1 2
Introductory Concepts Schiller, 1 2
Market Supply Schiller 3
Week 2 Dec. 4 8
Disequilibrium Schiller, 3
Demand Decisions Schiller, 4
Elasticity Schiller, 4
Exam 1
Week 3 Dec. 11 15
Economic Cost Theory Schiller, 5
Supply Decisions Schiller, 5
Economic C-B-A
Economic C-B-A
Week 4 Dec. 18 22
Competitive Markets Schiller, 6
Market Power Schiller, 7
Competitive Markets Schiller, 6
Exam 2
Week 5 Jan. 8 12
Macro GDP Schiller, 10
Macro Cycles Trends Schiller, 10
Market Failure Schiller, 9
Market Failure Schiller, 9
Week 6 Jan. 15 19
Economic Growth Schiller, 15
Economic Growth Schiller, 15
Macro Unemployment Schiller, 10
Macro Prices Schiller, 10
Week 7 Jan. 22 26
Explaining Fluctuations Schiller, 11
The Financial System Schiller, 13
Explaining Fluctuations Schiller, 11
Exam 3
Week 8 Jan. 29 Feb. 2
Fiscal Policy Schiller, 12
Fiscal Policy Schiller, 12
Monetary Policy Schiller, 14
Monetary Policy Schiller, 14
Week 9 Feb. 5 9
Economic Policy Schiller, 16
Economic Policy Schiller, 16
Economic Policy Schiller, 16
Exam 4
Week 10 Feb. 12 16
International Trade Schiller, 17
International Finance Schiller, 17
International Trade Schiller, 17
International Finance Schiller, 17
3
Foundational Principles
Over time, small differences in growth rates lead
to big differences in standards of living
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
U.S. Per Capita GDP, 1950 to Present, and Three
Forecasts
3 annual growth (Std. dev. 2)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
1950 2005 2.2 annual growth (Std. dev.
2.3)
Current U.S. Per capita output 38,000
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
1950 Per capita output 11,700
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
2 annual growth (Std. dev. 2)
1 annual growth (Std. dev. 2)
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
Forecasts for 2005 2054 based on stochastic
growth simulations.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
4
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
Some common definitions of Economics
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.

• The study of choice under conditions of scarcity.
• The study of how society manages its scarce
  resources.
• The study of the means by which a society
  allocates its scarce resources among competing
  uses.
• The science which studies human behavior as a
  relationship between ends and scarce means which
  have alternative uses.

4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
5
Model 1 Production Possibilities Curve
Opportunity Cost
y
70
60
50
40
30
20
10
x
0
70
80
90
100
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60
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Model 1 Production Possibilities Curve
Increasing Opportunity Cost
y
70
60
50
40
30
20
10
x
0
70
80
90
100
10
20
30
40
50
60
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Model 1 Production Possibilities Curve
Economic Growth
y
70
60
50
A
40
30
20
10
x
0
70
80
90
100
10
20
30
40
50
60
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Model 1 Production Possibilities Curve
Unemployed Resources
y
70
60
.
50
A
40
30
20
10
x
0
70
80
90
100
10
20
30
40
50
60
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Model 1 Production Possibilities Curve
Economic Growth and Choice
y
70
B
C
60
D
50
A
40
30
20
10
x
0
70
80
90
100
10
20
30
40
50
60
10
Case 1 Medicare Prescription Drug Benefits

Bush signs landmark Medicare bill into law
Monday, December 8, 2003 WASHINGTON (CNN) --
President Bush on Monday signed into law landmark
Medicare reform legislation that includes
prescription drug benefits and has sparked a
bitter fight between opponents and supporters.
Speaking at DAR Constitution Hall in
Washington, Bush characterized the measure as
"the greatest advance in health care coverage for
America's seniors since the founding of
Medicare."
Backers say the 400 billion Medicare
Prescription Drug Modernization Act will provide
much-needed help for the nation's 40 million
senior citizens to buy medications critics say
it is a giveaway to drug makers and insurance
companies and a prelude to the dismantling of the
program. "With this law, we're giving older
Americans better choices and more control over
their health care, so they can receive the modern
medical care they deserve," he said. It is the
largest expansion of Medicare since the program
was created in 1965, though most of its
provisions won't take effect for several years.

11
Foundational Principles
Model 2 Circular Flow of a Market Economy
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
Goods and Services
Output Markets
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
Payments
Business Sector
Household Sector
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
Factor Payments
Input (or Factor) Markets
Factors of Production (or Production inputs)
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
12
Maximizing Net Benefits requires selecting a
level of activity for which Marginal Benefits
Marginal Costs
SL151, Principles of Economics / K. Christ
13
Model 1 (Again!) Production Possibilities Curve
Evaluating Reallocations
y
Of all the points along the curve, how do we
decide which one is best?
70
60
50
A
40
30
20
10
x
0
0
70
10
20
30
40
50
60
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Model 1 (Again!) Production Possibilities Curve
Evaluating Reallocations
y
Of all the points along the curve, how do we
decide which one is best?
70
60
First, notice that as we choose to get more of
one thing, we must give up something
else. Economists call this process a
reallocation of resources. But how do we decide
whether to do it or not?
50
A
40
B
30
20
10
x
0
0
70
10
20
30
40
50
60
15
Model 1 (Again!) Production Possibilities Curve
Evaluating Reallocations
y
Of all the points along the curve, how do we
decide which one is best?
70
60
x 0 10 20 30 40 50 60 70
y 70 69 67 64 58 50 36 0
C(x) -- 1y 3y 6y 12y 20y 34y 70y
50
A
40
B
30
20
10
x
0
0
70
10
20
30
40
50
60
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Marginal analysis a simple example
17
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Scarcity of Resources
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.

• What to produce?
• How to produce?
• Who receives production?

4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.

• Tradition
• Authoritarian Planning
• Markets

6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
18
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Every individual . . . intends only his own
security and by directing that industry in such
a manner as its produce may be of the greatest
value, he intends only his own gain, and he is
in this, as in many other cases, led by an
invisible hand to promote an end which was no
part of his intention. Adam Smith The Wealth of
Nations (1776)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
19
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
The economic problem of society is thus not
merely a problem of how to allocate given
resources It is rather a problem of how to
secure the best use of resources known to any of
the members of society, for ends whose relative
importance only these individuals know. Or, to
put it briefly, it is a problem of the
utilization of knowledge which is not given to
anyone in its totality. Friedrich Hayek The
Use of Knowledge in Society (1945)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
20
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Today there is no respectable intellectual
support for the proposition that markets, by
themselves, lead to efficient, let alone
equitable outcomes. Whenever information is
imperfect or markets are incomplete that is,
essentially always interventions exist that in
principle could improve the efficiency of
resource allocation. Joseph E.
Stiglitz, Forward to The Great Transformation by
Karl Polanyi (1947, Boston Beacon Press
paperback, 1992, p. viii)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
21
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Monopoly Externalities Public
Goods Asymmetric Information
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
Categories of Market Failure
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity.
5. Markets are usually a good way to coordinate
economic activity because they tend to make the
most efficient use of information.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes .
SL151, Principles of Economics / K. Christ
22
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
Mechanisms of Choice
Markets
Public
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
Market Capitalism
Centrally Planned Capitalism
Private
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
Ownership of Resources
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
Centrally Planned Socialism
Collective
Market Socialism
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
23
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
For my part, I think that Capitalism, wisely
managed, can probably be made more efficient for
attaining economic ends than any alternative
system yet in sight, but that in itself it is in
many ways extremely objectionable. Our problem
is to work out a social organization which shall
be as efficient as possible without offending our
notions of a satisfactory way of life. John
Maynard Keynes The End of Laissez Faire (1927)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ
24
Foundational Principles
1. The standard of living for an individual,
group, or entire society depends heavily on an
ability to produce goods and services.
The preservation and expansion of freedom are
today threatened from men of good intentions
and good will who wish to reform us. Impatient
with the slowness of persuasion and example to
achieve the great social changes they envision,
there are anxious to use the power of the state
to achieve their ends and confident of their own
ability to do so Concentrated power is not
rendered harmless by the good intentions of those
who create it. Milton Friedman Capitalism and
Freedom (1962)
2. Scarcity imposes restrictions on individuals,
groups, and societies, forcing them to consider
tradeoffs and alternatives.
3. People act purposefully as they allocate their
resources or as they try to influence resource
allocation within groups or societies.
4. The marginal approach to cost-benefit analysis
offers a rational way of evaluating efficiency of
economic activity / resource allocation.
5. Markets are usually a good way to coordinate
economic activity because they tend to use
information efficiently but they are not
infallible.
6. Generally, a mix of market-driven and
collectively determined resource allocation seems
to produce the best outcomes.
SL151, Principles of Economics / K. Christ