Appendix: Summary of Course Topics

                                                                           Summary of Course Topics

Introduction:  Economics is a social science, using models to test theories.  We explore the circular flow model and the production possibilities model.

2.  Economics is a Social Science: We Use Models to Analyze Real Life:  Economics is the science of the rational allocation of scarce resources. People are not always rational when it comes to money, however, so economic models may not predict outcomes very accurately.

3. How Markets Work: Supply and Demand and Equilibrium: The law of demand says when prices are higher, you demand less. When prices are lower, you demand more, other things held constant. In perfect competition, buyers and sellers are price takers and markets are large enough so that neither side can affect the price. Things that shift demand curves: changes in income, changes in prices of substitutes and complements. The time dimension (short run or long run) shifts supply curves.

4. Diving Deeper into the Curves: Elasticity and Welfare Analysis and What they Offer: Elasticity is responsiveness of supply or demand to changes in price, defined as change in quantity divided by change in price. Consumer surplus is the difference between what you are willing to pay and the market price. Producer surplus is the difference between what you were willing to supply something for, and what the market price is. Total surplus is maximized at market equilibrium.

5. Roles of the Government in the Economy: Price Controls: A binding price floor (minimum wage, agricultural price supports) is above equilibrium and leads to a surplus; a binding price ceiling (rent control) is below equilibrium and leads to shortages. You can’t go below a floor, can’t go above a ceiling.

6. Roles of the Government in the Economy: Market Failures (Public Goods and Externalities) and the Criminal Justice System:  Externalities are costs/benefits that lie outside a private enterprise’s cost calculations, like pollution. When there are externalities, the government has to enter the marketplace to regulate. The criminal justice system is usually a government function, although we have had private enterprise bidding to provide various services.

7. Roles of the Government in the Economy: Taxation and Reducing Inequality: The government taxes people to finance its activities, and to redistribute income. Taxes can be progressive (tax rich at greater rate than the poor), proportional (tax all at same rate) or regressive (tax the poor at greater rate than rich). Some taxes appear proportional but are regressive in impact, like the sales tax. Supply-siders promote the Laffer curve, which argues that you can reduce tax rates and still increase tax revenues.  Kansas tried it and went bankrupt!

8. GDP: What It Is…and What It Isn’t: The market value (p x q) of “all” final goods and services produced within a country in a given period of time. Many things are not included in GDP, especially things about the quality of life. Also, increases in nominal GDP might mean just an increase prices, not any increase of goods and services. We construct a small  GDP deflator, holding prices at base year level and evaluating changes in GDP, creating an index. The total output of the economy can be divided:    Output = Consumption + Investment + Government + Net Exports

9. Evaluating GDP: Does it Measure What We Want It To?  We looked at different ways of measuring the ‘wealth of nations,’ including Bhutan’s Gross National Happiness, and some U.N. measures of quality of life.

10. Measuring the Price Level: The Consumer Price Index: Another way to deal with changes in the price level, particularly useful for adjusting wages/social security benefits, is the Consumer Price Index (CPI). The gov’t surveys consumers to identify a “typical market basket” purchased, and this identical basket is priced over time, to create an index of changes in the price level. The GDP deflator and the CPI measure different things: the former includes goods that consumers don’t buy (weapons systems) and the CPI includes imported goods, which were not produced by the home economy.

11. Employment, Unemployment, and How They Are Measured: If you have a job, you are employed. If you have no job but are actively looking for a job, you are unemployed. If you have no job and are not actively looking for one either, you are NOT in the labor force. This may include discouraged workers (you gave up the job search, so you went from unemployed to out of labor force) or people no longer interested in labor market jobs (retired people, lottery-winners, etc). If the unemployment rate declines, check what has happened to the labor force participation rate before you cheer. The highest unemployment rates in our economy are suffered by younger workers (16-19 yrs old), especially youth of color. Unemployment might be a result of a binding price floor, caused by the minimum wage, union wage, or the efficiency wage.

12. The Future of Work: Male labor force participation is declining, perhaps because men won’t consider pink collar jobs. Automation and artificial intelligence now  threaten jobs (blue collar, white collar, anything repetitive) more than competition from cheap labor in foreign countries. A Universal Basic Income might be a solution, severing the connection between the job and access to a basic income.

13. Production and Growth: The production function defines how much our economy can produce. Output = t* f {physical capital, human capital, labor, natural resources}. We explore what happens if we try to increase each input.  Adding more and more units of physical capital can result in diminishing returns (output increasing at a slower rate). Patents and copyrights may boost technological change by turning public goods (knowledge) into private property. Open source may stimulate growth and creativity in different sectors.

14. Tools of Finance: Stocks, Bonds, Mutual Funds, InsuranceTools of Finance: Firms raise funds for expanding investment by issuing debt (bonds), by selling equity (stock).  Risk can be addressed in different ways–mutual funds and derivatives . Insurance does not prevent bad things from happening, it just spreads the cost over a larger pool of customers. Moral hazard and adverse selection are always a problem with insurance.

15. Investment: The Market for Loanable Funds and Alternative Systems: The market for loanable funds shows the supply of funds (from private savings and government savings) and the demand for funds (firms wanting to expand investment). This market determines the real interest rate and the quantity of loanable funds in the economy, and is a useful tool for evaluating the impact of changing policy on taxing savings, investment incentives, and government budget deficits. We consider economies that do not charge interest, and place ethical limits on various types of investment—Islamic Finance.

16. Money: What It Is and How It Works: The three functions of money (store of value, unit of account, means of exchange); three types of money (commodity, commodity-backed, and fiat money); how economists organize the money supply (M0-M3) according to liquidity; increases in the money supply through fractional reserve banking.

17. The Federal Reserve: After more than a century of financial instability, our central bank, the Federal Reserve, was created in 1913. It regulates the orderly operation of the banking system, and conducts monetary policy. The traditional tools of monetary policy: setting the reserve requirement, setting the discount rate, and conducting open market operations.  (Newer tools include paying interest on reserves at the Fed, IOBR. )  When the Fed Open Market Committee buys bonds, for example, it stimulates the economy by putting more liquidity into banks, and by bidding up the price of bonds it reduces their yield, or the interest rate. Lowered interest rates mean increased Investment.

18. Monetary Policy and Inflation: We relate the purchasing power or the value of money (1/ the price level) and the quantity of money: In the high price level economy (nightmare scenario), the purchasing power of money is low, so you need to carry more of it to finance your transactions. In the fantasy world of a low price level, the purchasing power of money is high so you need less of it: this results in a downward sloping demand curve for money.   The supply of money is set by the Fed. So when  the Fed increases the money supply, this reduces its purchasing power, its value. We consider the costs of inflation and deflation, and the need to focus on the real, not the nominal.

19. The Future of Money: Cryptocurrencies like Bitcoin offer  some anonymity but uncertain value. For unbanked people, access to money transfer on phone-based platforms like m-pesa are important. Some economies go cashless to reduce crime, fraud, tax evasion. Central banks have been exploring blockchain for increased security.

20. The Aggregate Model: Aggregate Demand, Long-Run Aggregate Supply, and Short-Run Aggregate Supply: The aggregate model relates the price level and real output, a nominal and a real variable, so it’s neo-classical. The vertical axis is the Price Level, representing the prices of all goods and services, so it’s not possible to substitute away from some good that got more expensive.  All prices are moving in the same direction. The aggregate model also includes a time dimension, a short run and a long run. Aggregate Demand is determined by the equation learned earlier:  Output = C + I + G +NX.  When the price level is high, all components of aggregate demand are lower. When the price level is low, all components of aggregate demand go higher. This results in  a downward-sloping Aggregate Demand curve. The Long Run Aggregate Supply curve is a vertical line at full employment, determined by the production function. Changes in the price level do not change its position. The Short Run Aggregate Supply curve slopes upward from stickiness, or variables that do not adjust immediately. 

21. The Aggregate Model: Equilibrium:  The aggregate curves can indicate an economy in recession, an overheated economy, or a balanced economy in short run and long run equilibrium.   When the economy is NOT in equilibrium, there are some automatic stabilizers (workers accepting lower wages/demanding higher wages; government  budget surpluses or deficits) that might kick in.

22. The Aggregate Model: Discretionary (Monetary and Fiscal) Policy: According to where the Aggregate Demand curve intersects the SRAS, to the left or to the right of LRAS, we will need to stimulate or to dampen economic activity. We could use fiscal policy, spending/cutting measures proposed by Congress and approved by the President, shifting the  Aggregate Demand curve.  Or we could have monetary policy (when the Federal Reserve increases or decreases the money supply, lowering or raising interest rates) impacting Investment and therefore shifting the Aggregate Demand curve.

23. The World Economy: International Trade in Theory and Reality: Much of trade theory is based on the concepts of comparative and absolute advantage.  With comparative advantage, each side specializes in what it does best and trades; total output increases. Absolute advantage means one side is better at producing everything, but it still pays to specialize and trade. This is the theory supporting free trade, but realities of the world mean domestic manufacturers demand protective tariffs when the world price is much lower than their domestic price. With welfare analysis, you can see the gainers and losers when a country opens itself to trade.

24. The World Economy: Globalization and Its Problems: Trade brings challenges to economies trying to build up their own industries.  Trade displaces workers.  Global trade has its benefits and costs.  We then consider the valuation of currencies. Free floating currency exchange rates equilibrate trade imbalances, since when a country is importing more than it is exporting, the value of its currency should drop, which will discourage its citizens from importing more in the future, since imports will have gotten more expensive. But some countries set the value of their currencies low, so that other countries will find their products cheap: export-led growth results! The Big Mac index can be used to see what currencies are over-valued and undervalued.

25. The World Economy: The Challenges of Development: Comparing per capita average incomes in the world reveals big differences between the rich and the poor countries. There are structural causes: climate, institutions, resources, etc. Economist Duflo argues for an evidence-based approach to helping developing countries: seeing what works best by trying controlled experiments. Microcredit and self-help groups are other approaches to development aid.