• Demand: The relationship between the price of a good and the amount of that good that consumers are willing and able to purchase.

• Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded at each price.

• Demand Curve: A graphical representation of demand, drawn with price on the y-axis and quantity on the x-axis

The demand curve on the right…


…plots the data from the demand schedule on the left.

All Demand curves slope downward. There are two primary reasons for this phenomenon

• Substitution Effect: The more expensive a good is, the more consumers switch and purchase a substitute product.
• Income Effect: The more expensive a good is, the less consumers can afford.

• Supply: The relationship between the price of a good and the amount of that good that producers are willing and able to sell.

• Supply Schedule: A table that shows the relationship between the price of a good and the quantity supplied at each price.

• Supply Curve: A graphical representation of supply, drawn with price on the y-axis and quantity on the x-axis

The supply curve on the right…


…plots the data from the supply schedule on the left.

All Supply curves slope upward. The primary reason for this phenomenon is:

• Increasing Opportunity Costs: As the price of a product rises, more people find it profitable to produce it.

The fact that markets tend toward equilibrium is a very powerful result

• This means that the model of Supply and Demand is predictive.

What creates this tendency?

• This is the role of prices in the economy

Ceteris Paribus is a Latin phrase that means “all else equal.” Economists use the expression ceteris paribus a lot!

• A demand curve only looks at the relationship between the price of a product and how much people will buy, but price is not the only thing that affects how much of that product people will buy!

  -This is true of supply as well

• When we draw a supply or demand curve, we are holding all those other factors constant, hence ceteris paribus

• If these other factors change, the entire curve shifts.

  • An increase in demand and/or supply is modelled as a shift to the right

  • A decrease in demand and/or supply is modelled as a shift to the left

• Income
• Price of other goods
• Taste
• Expectations
• Number of Demanders

• A normal good is a good you consume more of as your income rises
• An inferior good is a good you consume less of as your income rises

Most goods are normal goods. What goods might be inferior?

• cheap beer
• ramen
• spam
• store brand/generic products

• Goods are substitutes if you generally choose between one or the other.
  
• Goods are complements if you generally consume them together.

People tend to buy what they like, and what they like can change.

• You might simply decide that you like a product more (or less) than before–this would change your demand for that good.
• You could discover a new product that you didn’t know existed.

The increasingly common calling for boycotts of various companies (for any number of reasons) can radically alter preferences.

• Increasing the number of demanders shifts the demand curve to the right.
• Decreasing the number of demanders shifts the demand curve to the left.

• Input prices
• Technology
• Expectations
• Number of Suppliers

Input prices are the main driver of shifts to supply curves.

• Decreased input prices shift supply to the right.
• Increase input prices shift supply to the left.

• Positive technological shocks tend to shift the supply curve to the right (increase in supply).
• Expectations of future input prices, future technological shocks may effect supply curves.

• Increasing the number of suppliers shifts the supply curve to the right.
• Decreasing the number of suppliers shifts the supply curve to the left.

Comparative statics is comparing equilibria.

1. Start with a market in equlibrium.
2. Determine whether or not some shock shifts the supply curve, demand curve, or both.
   • Remember: curves only shift when something other than the price of the good changes!
3. Shift the curve as appropriate
4. Compare the new equilibrium with the old equilibrium

• What happens in the market for vacations if income levels rise?
• What happens in the market for the current generation iPhone if Apple announces the next generation will come out in a month?
• What happens in the market for Big Macs if the price of beef falls and Burger King raises the price of a Whopper?
• What happens in the market for BMWs if the price of steel falls and the economy goes into a recession?

Welfare Analysis seeks to examine the costs and benefits of various economic policies to the participants within the economy.

This means we need a way to measure the economic well-being of people in the economy.

• Consumer Surplus
• Producer Surplus

• Consumer Surplus is the difference between the a person’s reservation price and the actual price.
  • Reservation Price: The highest price a person is willing to pay for a product.
• Consumer surplus measures consumers’ gains from trade.

Producer Surplus is the difference between the a seller’s reservation price and the actual price.

• Reservation Price: The lowest price a seller is willing to accept for a product.
• Producer surplus is analogous to consumer surplus and measures producers’ gains from trade.

Price controls are government mandated legal minimum or maximum prices set on specific goods.

• Price Ceilings are legal maximum prices.
  • Governments typically use price ceilings to maintain the affordability of various items.
  • Examples include:
    • staple goods (gas, water, etc) during an emergency
    • rent in high cost-of-living cities
• Price Floors are legal minimum prices.
  • The most common price floor is a minimum wage

Overall, the impact of these policies is that the economic losses will outweigh the economic benefit due to deadweight loss.

Because price controls prevent prices from rationing the available supply, some other mechanism must take its place. Examples incldue:

• Government Rationing
• Lines
• Corruption
• Discrimination
• A Change in the Nature of the Product
• A Change in the Forms of Payment

That minimum wages generate unemployment or underemployment is often thought to be an instance of the law of unintended consequences.

Many people who advocate for the minimum wage do so precisely because it generates unemployment!

• In the late 1960s, Otis Elevator pushed for an increase in the minimum wage in New York state because it had begun to specialize in converting human-operated elevators to automatic elevators and wanted an increase in demand for its services.

• Most union members make substantially more than the minimum wage yet they push for it. Perhaps it is not because they care about low income individuals but rather to make them more expensive so people will hire union labor instead.

The Progressive movement, particularly in the early 20th century, had a strong eugenic element. They argued for the minimum wage to help create a racially pure society.

The operation of the minimum wage requirement would merely extend the definition of defectives to embrace all individuals [who are] incapable of adequate self-support…If we are to maintain a race that is to be made of up of capable, efficient and independent individuals and family groups we must courageously cut off lines of heredity that have been proved to be undesirable by isolation or sterilization.
—Henry Rogers Seager, 1913

Some have argued that John F. Kennedy’s advocacy for the minimum wage in the 1950s had racial undertones as well.

Of course, having on the market a rather large source of cheap labor depresses wages outside of that group, too – the wages of the white worker who has to compete. And when an employer can substitute a colored worker at a lower wage – and there are, as you pointed out, these hundreds of thousands looking for decent work – it affects the whole wage structure of an area, doesn’t it?
—John F. Kennedy speaking in favor of minimum wages, 1957

Does the minimum wage at least help the poor?

The evidence is mixed at best. For example, Sabia and Burkhauser (2010) argued that if the minimum wage were increased by roughly $2:

• Nearly \(\frac{2}{3}\) of the people who gain live in middle/high income homes.
  • e.g. they are 2nd/3rd earners in households.
• Only 11% of those who would gain live in poor households.
• The majority of minimum wage earners are high school/college aged young adults who live at home with their parents.

The public popularity of rent control is on the rise.

And with predictable consequences.

Thanks to Craigslist, we have a decent idea of what gas prices might have risen to.

There are three major benefits generated from trade:

• Trade allows for the division of knowledge.
• Trade allows for economies of scale and fosters competition.
• Trade increases wealth through the principle of comparative advantage.

What benefits are there from international trade?

• Trade allows for specialization.
  
• Speicalization creates the division of knowledge
• This, in turn, generates increases in productivity
• Increased productivity is only valuable in a world where trade exists.

Thus, without trade, there will be little (if any) economic growth.

Increased specialization generates economies of scale: the ability to reduce average cost by producing more.

Example:

• When the EU formed and created a free trade zone, countries became more specialized, larger firms emerged to produce for all of Europe (as opposed to just one country), reducing average costs and consumer prices, and EU products became more competitive.

Trade creates competition. International competition keeps domestic firms competitive, and threat of international competition keeps domestic prices down.

Example:

• In the 1980s, Japan limited car exports to the US
• Not surprisingly, the price American consumers paid for cars produced in Japan rose…
• as did the price of US produced cars. Without Japanese competition, US producers didn’t compete as hard to make good cars and sell them at low prices.

The logic of comparative advantage implies that:

• Both trading partners are expected to benefit from trading with each other.
• The greater the comparative advantage, the greater the benefits of trade (to both parties)
• There are likely many cases in which international trade is likely to generate bigger comparative advantages than domestic trade.

Governments often restrict trade. The primary means are:

• Tariffs – taxes on imported goods
• Import Quotas – restrictions on the amount of imported goods

Here are 6 of the most common arguments against international trade:

• Trade needs to be “balanced”
• Trade reduces the number of jobs in the U.S.
• It’s wrong to trade with countries with lax workplace standards/regulations.
• We need to keep some industries for reasons of national security.
• We need to keep some “key” industries because of beneficial spillovers onto other sectors.
• Infant Industry

A trade deficit is when the value of a country’s imports exceeds the value of its exports.

A trade surplus is when the value of a country’s exports exceeds the value of its imports.

There are two types of trade deficit people are concerned with:

• Bilateral trade deficit – when a country runs a trade deficit with a single country.

• Overall trade deficit – When a country runs a trade deficit with the rest of the world as a whole.

Bilateral trade deficits are a consequence of specialization and trade; it’s nearly impossible for them not to exist.

• I run a trade deficit with the grocery store
• I run a trade surplus with my employer

If I didn’t do both, I’d be forced to be self sufficient or rely entirely on barter. Also, I’d be super poor.

The same is true for most people, companies, states, cities, and, of course, countries.

What about overall trade deficits?

If the US has a trade deficit with the rest of the world, then the rest of the world is doing some combination of:

1. Giving the US free stuff
2. Hording US cash
3. Buying US capital

For the most part, the answer is: 3. Buying US capital

When people talk about trade deficits, they are typically talking about the current account.

• Current Account = trade in goods + trade in services + investment income

A current account deficit implies a capital account surplus.

• Capital Account = foreign direct investment (FDI) + portfolio investment + loans to US gov’t and businesses

In fact, the absolute value of the capital account is roughly equal to the absolute value of the current account!

If having a trade deficit simply implies having a capital surplus, it bears asking: is having a capital surplus a problem for the US?

Two views:

1. No; this simply means the us is a great place to invest, and foreign investment in the US leads to more economic growth.

2. Yes; this implies Americans don’t save enough and suggests America will have slower future growth than otherwise.

The bottom line is that most economists believe that the trade deficit is not a problem. If anything is a problem, it’s the low rate of savings, and trade restrictions are unlikely to solve a savings problem.

What happens when the US government uses tariffs to protect American jobs?

1. The tariffs increase the price of the protected goods.
2. Consumers now have less money to spend on other goods.
3. This implies that there will be fewer jobs in the industries that produce those other goods.

Moreover,recall from before that one implication of trade is that imports lead to either exports or more US capital.

Protecting jobs with tariffs therefore reduces jobs in:

• exporting industries
• jobs that receive foreign capital

Overall, does trade kill jobs?

Yes and no. But mostly no.

Trade kills certain jobs, but creates others at the same time.

The logic of comparative advantage implies that the jobs created by trade are more productive than those lost due to trade.

Should the US trade with countries with weak workplace standards and regulations?

Examples:

• Use of child labor
• Lack of workplace safety
• Weak environmental standards

Or is trade with these countries unethical and thus should be prohibited?

If the concern is truly ethical, it is likely worse to not trade with them!

Consider child labor. Children in poor countries typically work out of necessity, so what sort of jobs will they get if tariffs cause businesses like clothing factories to shut down?

The alternative is often worse ethically:

An 1997 Oxfam study followed a group of young girls who were fired from a Bangladeshi sweatshop due to foreign tariffs.

• They found that many “were found working in more hazardous situations, in unsafe workshops where they were paid less, or in prostitution.”

Some industries should probably be protected.

• e.g., vaccines, military hardware

The problem is that this argument is prone to significant abuse

• For example, military hardware includes mohair

Arguments of this sort look like:

• Industry X is the next super productive industry so we want it here.
  • e.g. biotech, AI -Some industries are characterized by large spillovers to other industries.
  • e.g. the tech industry trains high-skill workers which benefits a large number of firms

To the extent these are plausible, OK, but:

• Subsidies are better options than tariffs.
• It is hard to determine which industries are “key” industries, so you might hamper the economy for no reason.

“Young” industries don’t have economies of scale, so protection in their early stages from foreign competitors with economy of scale will allow them to build.

• Problem: Abused by those who want protection
• Problem: Impossible to tell which industries might actually “grow up”
  • Example: In the 1980s, Brazil protected their nascent computer industry
  • Brazil never made computers, so protectionism hurt their economy.

Globalization is not new

Periods of increased trade and the spread of ideas have been among the best for human progress.