Lecture 01 Handout

1Lecture 1: IntroductionChristine Ho

ECON001 Introductory Economics

Singapore Management University

Outline The Course

What is Economics?

Course information

Assessment

The economic problem

The need for abstraction

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Production Possibilities

Gains from trade

The need for abstraction

PPF

Opportunity cost

Absolute and comparative advantage

The Course

Logistics

C I f

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Course Info

Teaching

Assessment

2Logistics

Course Instructor: Christine Ho Office Hour: Mondays 1100-1200 SESS 5038

Email: [email protected]

Course Website: https://elearn.smu.edu.sg/?logout=1

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Lecture notes, group projects, online quizzes, peer evaluation

Optional publisher website http://pearsonmylab.com Your access code comes with the purchase of the main textbook

Course id: ho50964

Teaching Assistants

Vivian Lau (eLearn) Office Hour: Tuesdays 1130-1230

Venue: SESS Group Study Room 5-1


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Nam Trinh (MyLab)

Office Hour: Fridays 1200-1300

Venue: SESS Group Study Room 5-1


Course Info

Objectives Introduce Economic theories and applications

Prepare Econ-major students to enroll in higher level Economics subjects

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Equip non Econ-major students with economic concepts

Tools for economic analysis

Elementary calculus and algebra Diagrammatic expositions

3Textbooks

Main textbook

Michael Parkin, Economics, Global Edition, Pearson Education

Supplementary textbooks

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pp y

Paul Samuelson and William Nordhaus, Economics, International Edition, McGraw-Hill

William A. McEachern, ECON MACRO 2, Student Edition, Cengage Learning Asia Pte Ltd

Teaching

Weekly 3 hour sessions

Lecture slides will be available via the course website Note that the slides provide only an outline of the course

Those have to be supplemented by

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Those have to be supplemented by

Your own notes taken in class Readings from textbooks

Coursework

Weekly quizzes via the course website

Two Main Sections

Microeconomics Household and firm behaviour

Macroeconomics

Aggregate economy and business cycles

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Taught in weeks 1-5

Mid-term exams in week 7 will be based on Microeconomics topics

Taught in weeks 9-13

Final exams in week 15 will be based on All topics: Microeconomics and Macroeconomics

4Assessment

Work-in-Progress (20%) Class Participation (10%)

Peer evaluationSelf evaluation

Weekly Quizzes (10%)

Group Project (15%) Randomly assigned 20 minutes presentation 5 minutes discussion Written report

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Mid-term exams (25%) On Micro topics taught in Lectures 1 to 5 Section A: quizzes Section B: problem solving

Final exams (40%) On All topics taught in Lectures 1 to 10 Section A: quizzes Section B: problem solving

What is Economics?

The Economic Problem

Th N d f Ab i

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The Need for Abstraction

What is Microeconomics?

What is Macroeconomics?

The Economic Problem

People have _____________ I want a house, a car, food, clothing, movies etc.

However, we have a limited amount of ________ at our disposal

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p e.g. land is limited: shall we use a given plot of land to build more flats or more offices?

Because of scarcity of resources, we have to make ________

Tradeoffs: more of one thing means less of another

5Resources

Resources are the inputs or ________________________used to produce commodities and services that people want

Natural resources: land, oil reserves earns rent

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Labour: human effort, time earns wages Capital: human creations used to produce goods and services e.g. tools, machinery earns interest Entrepreneurial ability: ideas, ability to create and organise a firm earns profit

Economics

Economics is the study of how ________ agents (individuals, firms, government, society) make choices and how those choices ________________

Rational means acting in one's own self-interest e g

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Rational means acting in one s own self-interest e.g. firms want to maximize profits or minimize costs, society wants to maximize welfare

So how do we study Economics?

Abstraction, Theory and Models

The real world is very complicated Need for simplification and abstraction

Different models are adequate for different problems

A non economic example

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A non-economic example You have a foreign friend visiting Singapore for a day

You are currently in your Introductory Econ class and have limited time to show your friend around

You would however like to have some dim sum together before rushing to the library to do homework

6Analogy with the Economic Problem

Wants:

Scarcity:

Tradeoffs:

spend time with your friend

limited time

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Choice:

Options Benefit Cost1 Skip class Have fun Dont learn Econ2 Ignore friend Learn about Econ Lose a friend3 Friend comes to SMU You save time Friend might get lost

friend comes to visit you at SMU

A Non Economic Model

Aim: Due to your limited time, it is up to your friend to come and join you at SMU

Problem: How to get to SMU?

Model: A map

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Model: A map

Issue: Which type of map?

From the big picture to the specifics

From the specifics to the big picture

Satellite Image of Singapore

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7A General Model: Map of Singapore

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A More Specific Model: Map of SMU

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Micro and Macro

Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments.

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Macroeconomics is the study of the performance of the national and global economies.

8Microeconomics

How do individuals make decisions?

Shall I buy a house or a car?

How may hours should I work in a day?

H d fi k d i i ?

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How do firms make decisions?

How many workers to employ?

How much to produce?

How does the government make decisions?

Interaction between Markets

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Economic Model

An Economic model is a description of some aspect of the economy

It includes only those features that are needed for the purpose at hand

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E.g. in our non-economic example, a map of SMU was a more appropriate model as opposed to the satellite picture of Singapore

Ceteris Paribus: if all other things remain the ____ To focus on some aspect of the economy, we have to be

able to ignore the other details

9The Scientific MethodIdentify the question

Specify assumptions

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Formulate a hypothesis

Test the hypothesis

Positive and Normative Statements

A positive statement is a ________ statement Predictions from economic models are testable against

facts

E.g. A rise in income taxes will lead to a lower supply

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of labour

A normative statement is a statement about ______ ________ or ________

Not testable since they express an opinion

E.g. We should increase income taxes

Some Economic Terminology Goods: commodities that people value and produce to satisfy wants

Services: tasks performed for people e.g. haircuts, babysitting

Agent: an entity who makes choices in the economy e.g. people, firms

Consumer: an agent who wants or demands goods or services

i di id l h b di i f di

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An individual who buys dim sum is a consumer of dim sum

A firm which employs workers is a consumer of labour services

Supplier: an agent who provides goods or services

An individual who supplies labour hours

A firm which supplies commodities

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Class Exercise 1

Assignment1. Think of an issue in your everyday life

2. Provide the analogy to economics in terms of wants scarcity of resources trade offs

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of wants, scarcity of resources, trade-offs and choice

3. Try to come up with an adequate model to study your issue

You can discuss with your neighbour

Production Possibilities and Opportunity Cost

P d i P ibili i

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Production Possibility Frontier

Opportunity Cost


Scarcity: the quantities of goods and services that we can produce are limited by available resources and technology

Th t f d ti ibiliti h th

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The set of production possibilities shows us the combination of goods and services that can be produced given available resources and technology

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Production Possibility Frontier

The production possibilities frontier (PPF) is the ________ between those combination of goods and services that can be produced and those that cannot

Production efficiency: the PPF illustrates the

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combinations of goods and services that can be produced at the ________ possible costs

Trade-off: producing more of one good means producing less of another

Diagrammatic Illustration of PPF

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Numerical Example 1

Two goods: rice and meat

One factor of production: 40 hours of labor available

Productivity and labor requirement:

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Kg per hour Hours per kgRice 0.1 10Meat 0.05 20

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Numerical Example 1 Contd

Production possibilities with 40 hours of labour:

40 hours on rice0 hours on meat



Rice 4 2 0

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If I devote 40 hours on rice, I can produce 4kg of rice and 0kg of meat

If I devote 20 hours on each, I can produce 2kg of rice and 1kg of meat

If I devote 40 hours on meat, I can produce 0kg of rice and 2kg of meat

Meat 0 1 2

Numerical Example 1 ContdMeat

2

Production Possibility FrontierRiceMeat 5.02

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1Production possibility set

Opportunity Cost

The slope of the PPF is negative because more of one good means less of another

The opportunity cost of a good or an action is the ________ valued ________ forgone

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The slopes of the PPF are the negative of the opportunity costs

actioncurrent in gain ealternativ luedhighest vain loss OC

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PPF and Opportunity Cost

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The opportunity cost of 1 kg of meat is 2 kg of rice

ricein gain meatin loss OCrice meatin gain

ricein loss OCmeat

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The opportunity cost of 1 kg of rice is 0.5 kg of meat

Opportunity CostRice 0.5 kg of meatMeat 2 kg of rice

Gains from Trade

Absolute Advantage

C i Ad

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Comparative Advantage

Specialisation

Gains from trade

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Specialization

Individual agents seldom produce for themselves everything they use

Instead, they ________ in the production of certain goods and then ________

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Export goods that they produce

Import goods produced by others

Specialization and trade enable individuals to ________ consumption relative to the case where they try to be self-sufficient

Absolute and Comparative Advantage

A person has an absolute advantage in an activity if that person can ______________ than anyone else given the same amount of resources

A person has a comparative advantage in an

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activity if that person can perform the activity at a _____________________ than anyone else

Note that it is possible for a person to have an absolute advantage in an activity but not a comparative advantage in that activity

Numerical Example 2 Two individuals: Mary and Tom

Two goods: rice and meat

Each individual has one factor of production: 40 hours of labor available

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Productivity and labor requirements:

Mary: kg per hour Tom: kg per hourRice 0.1 0.125Meat 0.05 1

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Tom has an absolute advantage in both production of rice and meat

Production possibilities with 40 hours of labor:

Mary Tom

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Mary Tom40 hours on rice

20 hours on each

40 hours on meat

40 hours on rice

20 hours on each

40 hours on meat

Rice 4 2 0 5 2.5 0Meat 0 1 2 0 20 40

Meat

40

Toms Production possibility frontier

Marys Production possibility frontier

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2

4 5


Opportunity costs:

Mary TomRice 0.5 kg of meat 8 kg of meatMeat 2 kg of rice 0.125 kg of rice

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Mary has a comparative advantage in rice

Tom has a comparative advantage in meat

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Notice that even though Tom has an absolute advantage in both rice and meat, he has a comparative advantage only in meat

Each individual needs to specialize in the production

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of the product where he/she has a comparative advantage

Mary needs to specialize in rice production

Tom needs to specialize in meat production


Suppose that under self-sufficiency, Mary devotes 20 hours to production of each

Tom devotes 8 hours to production of rice and 32 hours to production of meat

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Consumption in kg under self-sufficiency:Mary Tom

Rice 2 1Meat 1 32


A potential outcome with trade:

Mary TomProduce Trade Consume Produce Trade Consume

Rice 4 -1.5 2.5 0 +1.5 1.5M 0 6 6 40 6 34

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Relative price: 1 kg of rice = 4 kg of meat

Gains from trade: with trade, both parties can consume more of both goods than under self-sufficiency

Meat 0 +6 6 40 -6 34

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Meat

40

Toms Production possibility frontier

Marys Production possibility frontier

Marys Consumption possibilities at

24

Toms Consumption possibilities at 4

meat

rice

PP

4meat

rice

PP

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2

4 5

16

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Relative Prices In our numerical example

If 1 kg of meat cost $1, then 1 kg of rice would cost $4

meat of kg 41.56 rice of kg 1

4Price

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For trade to be beneficial to both parties, relative prices must lie between the opportunity costs

4P

meat

rice

2PP125.08

PP.50

rice

meat

meat

rice

Intuition Behind Relative Prices Recall

Mary specializes in rice due to her comparative advantage (lower opportunity cost) in rice

Tom specializes in meat due to his comparative advantage (lower opportunity cost) in meat

If relative price of rice is lower than 0 5 then Mary would have no

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If relative price of rice is lower than 0.5, then Mary would have no incentive to sell rice to Tom since the price of rice is lower than her opportunity cost of producing rice Otherwise Mary would be making a loss

Conversely, if relative price of rice is higher than 8, then Tom would have no incentive to buy rice from Mary since the price of rice is higher than his opportunity cost of producing rice Otherwise Tom would save money by producing the rice himself

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Class Exercise 2 Suppose that China can produce 160 cars per month or 400 tons of

rice per month. India can produce 160 cars per month or 200 tons of rice per month.

1. Draw the production possibility frontiers for both countries

2. What is the opportunity cost of a car in each country? What is the opportunity cost of a ton of rice in each country?

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opportunity cost of a ton of rice in each country?

3. Which country has a comparative advantage in producing cars? Rice?

4. Suppose that under self- sufficiency, each country devotes half of their resources to the production of cars and the other half to the production of rice. How many cars and tons of rice do each country produce?

5. Give an example where trade could be beneficial to both countries.

Take Home

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Main Lessons People have unlimited wants but scarcity of resources implies that they need to make choices

Economics study how agents make choices

Microeconomics focuses on the specifics or agent's individual decisions

Macroeconomics focuses on the big picture or aggregate variables

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Macroeconomics focuses on the big picture or aggregate variables

An economic model describes some aspect of the economy

Ceteris Paribus is latin for if all other things remain the same

Positive statements are testable

Normative statements are about what ought to be

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Main Lessons Contd Production possibility frontier shows the maximum combination of goods that can be produced

Opportunity cost is the highest valued alternative foregone

Absolute advantage involves comparing productivity

Comparative advantage involves comparing opportunity cost

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Comparative advantage involves comparing opportunity cost

Specialization can lead to gains from trade

For there to be gains from trade, relative prices must lie between the opportunity costs of the different agents

Next

Homework: Please refresh your maths skills! Solving a system of equation e.g.

y = 10 + x (1)

x = 50 2y (2)

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y ( )

How much is x and y?

Graphs e.g. plot equations (1) and (2) with y on the vertical axis and x on the horizontal axis.

Next Lecture: Demand and Supply

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