Lecture 2 Microecono mic T

ECF 9210 Intro to International Economics

Dr Rebecca Valenzuela Department of Economics, Monash University Microeconomics Tools and Analyses
Rebecca.Valenzuela@buseco.monash.edu.au
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Lecture 2 Microecono mic T

ECF 9210 Intro to International Economics Thinking Like An Economist Microeconomics Tools and Analyses How Markets Work Supply & Demand:
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LECTURE TOPIC COVERAGE

Week 1. 2. 3. 4. Introduction, How Markets Work Elasticities & Applications, Efficiency of Markets Production, Growth & Other Macro Concerns AD & AS and the World Economy Topic

5.
6. 7.

The Theory of Comparative Advantage

Tariffs Midterm Test

8.
9. 10. 11. 12.

Non-Tariff Barriers
Balance of payments & Exchange Rates Exchange Rate Determination XR Adjustment, BOP & Macroeconomic Policy in an Open Economy Review

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What is International Economics?

International Economics is the area of study in economics that deals with the economic and financial interdependence of nations.

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Globalization
Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved.

Globalization - greater interdependence among countries and their citizens

Globalization
Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved.

What are the Driving Forces of Globalization?

Technological change Liberalization of trade and investments Significance of global production sharing

Globalization
Copyright 2007 South-Western, a division of Thomson Learning. All rights reserved.

Australia: An Open Economy Australia has become increasingly integrated into the world economy
Trade of goods and services Financial markets Labor force Ownership of production facilities Dependence on imported material

Why Study ECF9210?

Aim for ECF9210 student:

learn economic tools of analysis to - analyse flows of goods & services - study the impact of these flows on welfare - analyse policies that regulate these flows

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The Economic Problem

You cant always get what you want

- M. J.

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What is economics?
Lionel Robbins (1932, An Essay on the Nature and Significance of Economic Science, London: Macmillan):

Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

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What is economics? KEY DECISIONS

Key decisions in the economy What to produce? How to produce? For whom to produce?

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Economic Principles #1:

People face trade-offs

Theres no such thing as a free lunch You cannot have your cake and eat it too

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Economic Principles #2:

The relevant cost in economics is the opportunity cost

An opportunity cost is the best valued alternative that is given up when one makes an economic choice

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Economic Principles #3:

Rational people think at the margin

Marginal changes are incremental adjustments to an existing plan of action. Marginal Benefits v Marginal Cost

eg Should you buy another pair or shoes? Should you sleep another hour in the morning? Rare commodities, plentiful commodities implications on price

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Economic Principles #4:

People respond to incentives

People respond to marginal changes in costs or benefits. Incentives affect the balance between marginal benefits and marginal costs

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Thinking Like an Economist

Economics trains you to. . . .
Think in terms of alternatives. Evaluate the cost of individual and social choices. Examine and understand how certain events and issues are related.

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The Economist as a Scientist The economic way of thinking . . .

Makes use of the scientific method. Uses abstract models Develops theories, collects and analyzes data to evaluate the theories.

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Positive v Normative Analysis

Positive Analysis

the use of theories and models to predict the impact of a choice. What is?

Normative Analysis

addresses issues from the perspective of What ought to be?

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THE ECONOMIST AS POLICY ADVISOR

When economists are trying to explain the world, they are scientists.
When economists are trying to change the world, they are policy advisors.

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WHY ECONOMISTS DISAGREE

They may disagree about the validity of alternative positive theories about how the world works. They may have different values and, therefore, different normative views about what policy should try to accomplish.

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Model 1: The Circular Flow

MARKETS FOR GOODS AND SERVICES Firms sell Goods Households buy and services sold Revenue

Spending Goods and services bought

FIRMS Produce and sell goods and services Hire and use factors of production

HOUSEHOLDS Buy and consume goods and services Own and sell factors of production

Factors of production Wages, rent, and profit

MARKETS FOR FACTORS OF PRODUCTION Households sell Firms buy

Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars

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Model 2: The Production Possibilities Frontier

Sacks of Rice

3,000 2,200 2,000 A

B Production possibilities frontier

1,000

300

600 700

1,000

Quantity of Cars
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Main branches of economics

Macroeconomics deals with the functioning

of the whole economy

Microeconomics focuses on individuals such

as households and firms.

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Supply & Demand: How Markets Work

Focus on households and firms - how they make economic choices Supply and Demand Modern microeconomics is about Supply, Demand, and Market Equilibrium.

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What Is a Market?
A market is a group of buyers and sellers of a particular good or service.

The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.
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What Is a Market?
Buyers determine demand.

Sellers determine supply.

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The most famous picture in economics

Price

Supply Equilibrium

Equilibrium price

Demand

Equilibrium quantity 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity

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What Is Competition?
A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.
Perfect Competition Monopoly Oligopoly Monopolistic Competition

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Demand
Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand
The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises.

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Consumer income
Normal goods vs inferior goods
E.g. overseas holiday E.g. second hand furniture

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Prices of related goods

Substitute goods
E.g. movie and DVD rental

Complement goods
E.g. movie and popcorn

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Other factors
Tastes:
eg Are chocolates good for you?

Expectations:
eg Should you enter the housing market now?

Number of buyers
eg Why do companies sponsor the Olympic Games?

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What is the law of supply?

a positive relationship between price and quantity supplied.
Supply of babysitting services
What is the quantity supplied ? Draw the supply curve

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Change in quantity supplied versus change in supply

A change in the price of a product
Causes a change in the quantity supplied of the product Is illustrated by a movement along the supply curve

A change in other factors

Cause a change in the supply of a product Is illustrated by a shift in the supply curve

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What factors affect supply?

Input prices:
eg The price of milk has gone up. Will Peters be more or less willing to sell ice-cream at a given price?

Technology:
eg what would happen to the supply of electric cars should there be a new technology that substantially increase the energy efficiency of batteries?

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What factors affect supply?

Expectations:
eg should you fill up your car today or tomorrow?

Number of sellers:
eg what would happened to the supply of accounting services in Australia if all overseas qualifications were to be recognised?

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What is a market equilibrium?

Market equilibrium
Demand and supply jointly determine market prices and quantity. When the quantity supplied equals the quantity demanded in a market, the market is said to be in equilibrium

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The most famous picture in economics

Price

Supply Equilibrium

Equilibrium price

Demand

Equilibrium quantity 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity

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Markets Not in Equilibrium: SURPLUS

(a) Excess Supply Price of Ice-Cream Cone $2.50 2.00 Supply Surplus

Demand

4 Quantity demanded

10 Quantity supplied

Quantity of Ice-Cream Cones 42

Markets Not in Equilibrium: SHORTAGE

(b) Excess Demand Price of Ice-Cream Cone Supply

$2.00 1.50
Shortage Demand

4 Quantity supplied

10 Quantity demanded

Quantity of Ice-Cream Cones 43

How an Increase in Demand Affects the Equilibrium

Price of Ice-Cream Cone

1. Hot weather increases the demand for ice cream . . .

Supply $2.50 New equilibrium

2.00
2. . . . resulting in a higher price . . . Initial equilibrium D D 0 3. . . . and a higher quantity sold. 7 10 Quantity of Ice-Cream Cones

44

How a Decrease in Supply Affects the Equilibrium

Price of Ice-Cream Cone S2 1. An increase in the price of sugar reduces the supply of ice cream. . .

S1

$2.50

New equilibrium Initial equilibrium

2.00
2. . . . resulting in a higher price of ice cream . . .

Demand

7 3. . . . and a lower quantity sold.

Quantity of Ice-Cream Cones

45