/// THURSDAY 1/18/2018 /// >>> <<< /// ECON-200 Microeconomics with Professor Daniel Lin

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1 /// THURSDAY 1/18/2018 /// >>> <<< /// ECON-200 Microeconomics with Professor Daniel Lin Today: Syllabus, Course Description, and Chapter 1 Designed for people without economics experience. Microeconomics vs. Macroeconomics: Macroeconomics: behavior of economy as a whole Microeconomics: behavior of individuals What do people do? Why do people want to buy things when they go on sale? Etc. The unit of analysis is a single person. Required textbook. This is a completely lecture based course. Blackboard has slides and practice questions. The practice questions are old exam questions. Grading: Three exams determine course grade. Every exam is curved. Your worst exam is worth only 20% of your grade. Lots of opportunities for extra credit via class participation and discussion sessions. You can only earn 1 extra credit point per week and up to 4 points per exam. Each exam is worth 50 points total and the extra credit points get added to it. Exams are non-cumulative. Chapter 1: The Big Ideas: Ignore the macro big ideas in this chapter. This chapter covers the concepts that economists use to determine how people behave. Big Idea #1: Incentives Matter People respond to costs and benefits. People are motivated by rational self-interest In the late 1700s in UK if you were sentenced to prison you would be shipped to Australia. Roughly 40% of prisoners died during that long journey, and people were shocked. They were sentenced to prison not death. One small change and the fatality rate plunged to 1%: Pay the ship captains based passengers at arrival point not departure point. Another example from the 1970s: People were dying because they wouldn t wear seat belts, so legislatures passed seat belt laws. Driving unsafely has benefits, but it also has costs. When state legislatures passed these laws they didn t change the benefits, but they changed the costs. People felt safer when they wore seat belts so they drove less safely. In other words: there was a sale on risky driving, and the result was ambiguous.

2 Imagine the alternative: state legislatures require a spike be mounted on the steering wheel. Would you drive more safely or less safely? More safely because you have rational self interest. In one interpretation, safety regulation has decreased the risk f death from an accident by more than an unregulated market would have, but drivers have offset this by taking greater accident risk. This interpretation is broadly supported by the time-series evidence of a shift of the burden of accidents from drivers to pedestrians - and of an increase in property damage. Is this view of the world too based on money? Can we appeal to better angels? There was a study in Japan to compare moralsuasion and peak pricing on energy consumption. The changes in price/consequence was communicated via text message. Both techniques worked but price incentive was more effective and had a lower usage rate even after the higher price was communicated. Economists theorize that the behaviors adopted under peak pricing stayed with people longer than moralsuasion. Big Idea #2: Institutions Affect Incentives Institutions are organizations, customs, and rules. Institutions give boundaries to self-interest. Example: you can t steal a laptop, but you can buy a laptop. Good institutions create socially-beneficial outcomes. If we get institutions right, self interest is a good thing not a chaos element. This is called the invisible hand. If you want something you can get it via voluntary cooperation instead of conflict. Aliens and The Invisible Tentacle. Think: DC only has two days of food on the shelves. Why does the supermarket restock the shelves? How can you sleep at night when you re so close to starvation? People stay fed because of incentives, not because of people s better angels. Forecasters don t expect Hurricane Irene to make landfall until Saturday, but for nearly a week now, big-box retailers like Walmart and Home Depot have been getting ready. The institutions in American have been set up so that you can make money by appealing to what people want. Walmart, etc. moved all of the needed inventory from the West Coast to the East Coast. In the process of making money, suffering can be alleviated. But there are bad institutions. Bad institutions create socially-destructive outcomes, or institutional failure. The entire point of this class is to teach you how to determine the difference between a good institution and a bad institution.

3 Venezuela tried profits not people and mandated a price drop on staples. In the same store you could see good institutions and bad institutions. Stores were disincentivized from providing staples. Big Idea #3: Tradeoffs are Everywhere When you want to choose to do something, you always give up something else. You give up more than just $10 when you want to go see a movie. Opportunity cost ; why do people walk away from long lines even if they can get things for free? People don t pull back spending on college during a recession. Why do college enrollments rise during recessions? Because the opportunity cost goes down. People aren t working or they are making less money so they find it more palatable to attend school full time. The cost of going to college drops during a recession. Another question: why do more students want make-up exams for midterms than finals? If you take a makeup exam for a final you lose time from your break. Big Idea #4 Thinking at the Margin People compare benefits and costs from small adjustments. There are marginal benefits and costs. Example: pieces of candy. 1 piece of candy 80 marginal benefit 20 marginal cost 2 pieces of candy 45 marginal benefit 20 marginal cost 3 pieces of candy 22 marginal benefit 20 marginal cost 4 pieces of candy 10 marginal benefit 20 marginal cost Do you like peanut butter cups? It depends on which one you re talking about. Remember: total benefits and costs are unimportant to decision making Total benefits and costs are the totals of the column, but we don t consider them. We only consider the marginal trade-offs. Why are diamonds worth so much money, but water isn t. Water is like the fourth peanut butter cup. Diamonds are the first peanut butter cup. Scarcity, scarcity, scarcity. Marry me, Aquafina. No lecture on Monday, January 22nd. /// THURSDAY 1/25/2018 /// >>> <<< /// Benefits of Trade: Different Preferences

4 Trade moves resources from low-value to high-value uses Different Production Costs Trade moves production from high-cost to low-cost producers Division of Knowledge Trade allows total people to specialize, increasing total knowledge available Imagine a simple society of just two people, Alice and Bob. They could simply produce everything they need for their entire life. The cosmic library, and the limited space in your mind. Without trade, the total knowledge of society equals the knowledge of one person. With trade, total knowledge of society is larger than the knowledge of one person. The more trading partners, the more knowledge you have at your disposal. Think: Drexel University suit making experiment ( The 100 Mile Suit ). Economists say trade is a good thing, and we should trade more. Comparative Advantage: Today is the most math we ll have all semester. Let s go back to our two person society of Alice and Bob. Meat Bread Alice Bob Above is minutes to produce 1 ounce of the product. Absolute advantage is the ability to produce something using fewer inputs. Alice has no absolute advantage. Bob has an absolute advantage in both. Self-sufficient: let s imagine each person produces meat for 5 hours and bread for 3 hours. Meat Bread No Trade Alice m, 12b Bob m, 18b Can they consume more by trading? Yes, thanks to comparative advantage. Comparative advantage is the ability to produce something at a lower opportunity cost. When Alice produces 1 meat, she gives up 4 bread. When Bob produces 1 meat, he gives up 2 bread. Thus, Bob has a comparative advantage in meat because his opportunity cost is lower.

5 When Alice produces 1 bread, she gives up ¼ meat. When Bob produces 1 bread, he gives up ½ meat. Thus, Alice has a comparative advantage in bread because her opportunity cost is lower. Benefits of Trade: The true cost of something is what you give up. Imagine a system of complete specialization*, and use a trade ratio of 6m for 18b: No Trade Complete* With Trade Alice 5m, 12b 0m, 32b 6m, 14b Bob 15m, 18b 24, 0b 18m, 18b Notice how both parties benefit from trade. You are taught to think that if someone is gaining, someone else must be losing. Why do we know this? Because trade is voluntary. The double thank you. Don t give to American University. There are two ways for Alice to consume 6m: 1. Produce 6m at a cost of 6 hours. 2. Produce 18b and trade (at a cost of 4.5 hours). Technology is what makes hard-to-produce products easier to make. Trade is like technology and it converts easy-to-produce goods into hard-to-produce goods. What if there was a way to change a ear of corn into a Prius? Trade is like alchemy that can spin wheat into gold. Rate of Exchange: How do we know that 1m = 3b is the correct exchange rate? Let s go back to the table with Alice and Bob and evaluate their opportunity costs: Meat Bread Opp. Cost of Producing 1 oz of Meat Alice b Bob b Alice isn t stupid. She s looking for a price lower than 4b. Bob wants to make a profit. He s looking to sell for a price that is above 2b. Trade makes both sides better off when the price is between the opportunity costs. Can one person have a comparative advantage in everything? Meat Bread Alice Super Bob 20 1