Ranjit S. Dighe
Fall 1999

[Owing to time limitations, these are still in a much cruder form than I'd like.  I will refine them very soon.  They were last revised on Sun., Sept. 5, at 6 pm.]

Mon., Aug. 30, 1999

I.  Introductions
II. What is (macro)economics?
III. Outline of course


[Get syllabus, fill out questionnaire.]

How to pronounce my name:

RUN jet   dig GAY

Why I make my notes available to you: so that in class, you can focus on trying to comprehend or ponder over what I'm saying, instead of frantically trying to jot down everything I say and feeling like you're on a treadmill. If there's something you don't understand, the time to ask me is ... anytime. Go ahead and interrupt me. The only stupid question is the one you don't ask.


Q:  What is economics?
A:  The study of the allocation of scarce resources, both by individuals and societies.

Does that definition seem a bit vague?  A resource is scarce is there is less of it than we (or some of us) would like. Time is scarce, food is scarce, land is scarce, goods are scarce.  Good colleges in warm climates are scarce. Even government spending is scarce.

-- How do we allocate society's resources? Political debate is largely an argument over the allocation of scarce resources: government vs. private sector, current vs. future, guns vs. butter.

-- But it's not always a zero-sum game. Society's resources are not always used efficiently. Great Depression an obvious example: ten million unemployed, thousands of shut-down factories --> How do we reallocate those resources from "idle" to "in use"?

Two "flavors" of economics: MICRO and MACRO

-- MICRO is the study of individual firms, households, markets, and industries
-- MACRO is the study of aggregates like Gross Domestic Product (GDP), unemployment, and inflation

We'll spend most of the next week learning a little micro, since macro grew out of micro, and it's hard to understand any part of economics without understanding basic micro concepts like supply and demand, equilibrium, and opportunity cost.

A question you might have: Will this course help me make a lot of money? Well, I've got two things to say to you:
*    (1) If you "make a lot of money," you'll go to jail. Only the Bureau of Engraving and Printing -- and the banks, thru the magic of deposit creation -- are empowered to make money.
*    (2) Now that we've got the terminology down, will this course help you get rich? Make a killing on the stock market, or run a business? Well, not exactly. We'll be learning about economic aggregates like GDP, inflation, unemployment, and interest rates -- it's extremely useful stuff to know, but it probably won't make you any richer. At some point I may work in a lecture on the stock market -- to how it relates to the macroeconomy as a whole -- but no, economics probably won't teach you much more about how to get rich than, say, history or philosophy or psychology. --> PARADOX (?) -- lots of people do major in econ because they want to go to business school later on, and business schools seem to like econ majors --> an econ major serves as a SIGNALING DEVICE.

Why I decided to study economics, back when I was a college freshman: Was very interested in politics, and economics seemed more concrete than political science, maybe would provide a means to back up my rash assertions.

Politics and economics: A lot of people thinking taking economics makes you more conservative. There may be a little something to that, but it's a very little. I prefer to think of the political continuum as having two dimensions, not just liberal-vs.-conservative but also (and here's where the economics comes in) castor-oil-vs.-snake-oil (or, no-free-lunch vs. there-IS-a-free-lunch).

         free lunch (politicians)
          no free lunch (economists)

III. OUTLINE OF COURSE [here we just went over the syllabus]


What is the economy?
-- Write a one-or-two paragraph answer, without consulting the book or any other resource. Due at the beginning of the next class.


Wed., Sept. 1, 1999

I. Intro to macroeconomics
II. Intro to economic theory
III. The economic way of thinking -- scarcity; rationality and marginal analysis


Parting question from last time: What is the economy?

My best definition: The ECONOMY is the vast network of production and distribution of all the different goods, services, and assets that we purchase. Note that it is a decentralized network -- it's both everywhere and nowhere.
-- Since the main organizing mechanism in the U.S. economic system is the market (the forces of supply and demand), the U.S. economy is, to some extent:
the tens of thousands of product and asset markets in this country, taken both individually and collectively.
+ government production of goods and services, which often occurs independently of the market. (Add those in, and you're pretty close to the total picture. In a country like the old Soviet Union, government production of goods and services was nearly all of the economy.)

Some key definitions:
Gross domestic product (GDP) [or "national output" or "aggregate output"]-- The total quantity of "final" goods and services produced in an economy in a given period.
* Unemployment rate-- The percentage of the labor force that is not working and is actively looking for work.
Inflation-- The rate of increase in the overall price level

Two types of economic questions: POSITIVE and NORMATIVE:

Def. Positive-- "what is" & how does it work.
-- Ex.: Since Bill Clinton took office in 1993, the U.S. unemployment rate has fallen by more than a third (from 7.3% to 4.3%).

Def. Normative-- "what should be"(more touchy-feely); evaluates outcomes as good or bad, & possibly prescribes solutions or different policies
-- Ex.: The unemployment rates of certain segments of the population (blacks, teenagers) are still way too high, and the government should take corrective action-- say, federal jobs programs or expanding the money supply.

Both micro and macro have elements of the positive and the normative.
The distinction between positive & normative is not always a clear one.
-- Ex.: The sharp drop in the unemployment rate is evidence that Bill Clinton's economic program has worked. (Some would disagree; regardless, it's a loaded statement w/ policy implications. As Clinton himself might say, it depends on what your definition of "worked" is...)

Macroeconomics is typically in a state of flux. Micro is relatively more stable; microeconomists tend to agree with each other about a lot more than macroeconomists do. When people say economists always disagree (George Bernard Shaw: "If all the world's economists were laid end to end, they still wouldn't reach a conclusion"), they typically mean macroeconomists.
-- Or maybe you've heard about the economists' version of Trivial Pursuit: It has 300 questions ... and FIVE THOUSAND answers!

Why is macro so controversial?
1) It's a relatively new field, dating back to 1930s (the Great Depression; J.M. Keynes's The General Theory). Micro, by contrast (just "economics" before 1930s-1940s) has been around since 1776 (Adam Smith's The Wealth of Nations). Before Keynes, everyone was basically a microeconomist and the government rarely intervened directly in the economy.
2) The issues tend to be more socially and politically charged than in micro. Exs.: taxes, interest rates, and inflation are issues that affect people directly, and virtually any policy will benefit some people and hurt others.


In these first two weeks we'll be learning some basic microeconomic theory. Now, what exactly is theory?

Economic theory: a statement, or set of related statements, about cause and effect or action and reaction in economic life

* Model: a formal statement of a theory, often mathematically

* Empirical testing: the use of real-life observation to test economic theory

Why do we need all this theory? What does it have to do with the real world? The answer is that it offers a way of explaining the real world. Without it, someone once said, we could only stare stupidly at the world, the way cows look up at the sky. Theory is (ideally) based on observation of the real world. Naturally, any theory is going to have to leave a few things out. The goal is to "simplify, simplify" in order to expose and analyze certain aspects of how things operate.
-- Economics without theory is kind of like rock music without guitars. It can be done, but what's the point?



SCARCITY (recall previous definition)
-- Most resources have more than one use.

--> OPPORTUNITY COST: The use of a scarce resource has an OPPORTUNITY COST, which is the (forgone) value of its next best alternative use.
-- What is the opportunity cost of going to class?
-- "no free lunch" (other uses of that time: shopping a class, going to the gym, buying your course books...)
-- no "free love"
-- tradeoffs (if you want more of one thing, you have to settle for less of another)


How people (are assumed by economists to) behave: RATIONALLY (they know what they want. They know what their preferences are, and they are consistent in their preferences.)

Economic reasoning (cost-benefit analysis): For any decision, people compare the costs and benefits.
-- If benefits > costs, do it.
-- If costs > benefits, don't do it.


Fri., Sept. 3, 1999


Today: Review of microeconomics, Part I
I.     Rationality and marginal analysis (finish)
II.   Scarcity, tradeoffs, and efficiency
III.  Demand

[Slight change of plans: The lecture on critical thinking in economics will be next Friday.]


Where we left off:  Economists assume that people are rational (refer to previous definition).

Optimization (a bit stronger than merely saying people compare costs and benefits): Individuals (and firms) make the best decisions for themselves. People know ~what's best for themselves, and that's what they do. (No $500 bills on the sidewalk.)
-- Obviously not the most realistic model of human behavior, but it is about the simplest, because you don't have to worry about people's errors. Modeling mistakes is hard.

What is it that people optimize?
-- Individuals maximize "utility" (happiness/satisfaction)
-- Firms maximize profits (revenues - costs)

--> Marginal analysis (not a separate assumption, but rather something that can be deduced from the assumption that everyone optimizes): "optimal," "rational" decisions are generally made at the margin (e.g., in cost-benefit analysis, does marginal benefit exceed marginal cost?)
-- Ex.: selling a house in Oswego: Do I wait for prices to rise back up to what I paid for the house, so that I can break even (or, better yet, sell it at a profit)? Or do I just sell the house now, cut my losses, and move on? If you don't expect prices to rise anytime soon, you cut your losses and move on. What you paid for the house is a sunk cost -- it cannot easily be recovered. A rational decision about whether to sell it now or later is not affected by what you paid for the house, but where prices are now and where they'll be in the future.
-- Ex.: airlines' student travel discounts. I once used these to fly to the West Coast for only $189. Suppose the average cost is about $300.  Why would an airline go along with a program like that?
---- A: For a plane that's about to take off with some seats empty, the marginal cost of another passenger is essentially zero (or whatever the Coke and peanuts are worth); the total cost of the trip is essentially unchanged by an extra passenger. --> Setting aside a few seats for discounts (incl. standby) can be profitable even if the fare for those seats is far below the average cost per seat. As long as the marginal revenue ($189) exceeds the marginal cost ($0), setting aside an extra seat is profitable.


Scarcity and opportunity costs imply ...
"tradeoffs" (if you want more of one thing, you have to settle for less of another)

a graph that shows all the combinations of goods (in a 2-good economy) that can be produced if all of society's resources are used efficiently (i.e., no waste)
[A graph of a typical PPF, showing society's production possibilities for guns and butter, was drawn in class and will eventually be added to these notes.  For now, you could refer to the PPF in your notes or on p. 27 of McConnell's textbook.]

-- Efficiency: producing at the least possible cost (no waste)

-- Q: What's wrong with the point inside the PPF?
-- A: It's inefficient -- it's possible to have more of both goods, so why not just produce more of both?

-- Along the PPF, the slope (rise over run, Dy/Dx) is negative
----> TRADEOFF: more of one good means less of the other

-- slope = opportunity cost (of producing one more unit of the good on the horizontal axis)

Diminishing returns: as you produce more and more of a good, the cost of producing that good increases. That is, producing an extra unit of output requires more inputs than it did before.
-- Why: Production generally exhibits diminishing returns in the short run because some factors (capital, land) tend to be fixed in the short run
[A graph of a typical PRODUCTION FUNCTION, showing the quantity of guns produced as a function of gun-factory workers, was drawn in class.  I will add such a graph to these notes eventually.]

Q: So now we've seen scarcity, in a picture. Now how do we allocate all those scarce resources?
-- Microeconomic theory is often called PRICE THEORY, because in a free-market system the basic coordinating mechanism is price.


Someone once said an economist is nothing more than a trained parrot that says "Supply and demand... Supply and demand..." over and over again. But, there are worse things you could teach a parrot to say, and we hear them every day.

Let's start with demand, which is really the simpler of the two concepts.

DEMAND CURVE: a graph showing how much of a given product people will be willing to buy at different prices
-- "Law" of Demand: As the price of a good goes up, the quantity demanded of that good goes down
--> demand curves slope downward
[I drew a demand curve in class.  I will add one to these notes eventually; for now, you could refer to the one on p. 44 of McConnell's textbook.]

Parting question: Why do demand curves slope downward? If the price of potato chips falls from $1.50 to $1.25 a bag, why is it that people will buy more?