UMASS Economics Comparative Advantage & Unemployment Rate Questions

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Writing Assignment 1
(Due 2/22 5:30pm)
Q1. Please read the article “Comparative Advantage and American Jobs” from Wall
Street Journal in 2011. According to this article, Former president Obama created a
Council on Jobs and Competitiveness to address the job crisis in the U.S. As pointed out
by the author, one of the principles that can guide the council away from repeating past
errors is that “A competitive America does not mean competitive success for every
American industry.” Based on what we have learned in the class about comparative
advantages and given the globalization of our economy, what is your suggestions to
Former President Obama if you were in the council? What industries are important to us
in which we need to be competitive?
Link:
https://www.dropbox.com/s/wfbu1uvbgjztsh6/Comparative%20Advantage%20and%20Americ
an%20Jobs.pdf?dl=0
Q2. Please read the article “Oil Prices: What’s Behind the Drop? Simple Economics” from
New York Time. In the section “Why did the price of oil drop in the first place?”, the
author explained some reasons for why the oil price dropped. Please use the language
and diagrams we have learned in the class to interpret these reasons. In the section “Who
benefits from the price drop?”, the author mentioned that natural gas price has fallen as
well. Please use the diagrams we have learned in the class explain why so.
Link:
https://www.dropbox.com/s/ano2caj7zunp5ic/Oil%20Prices_%20What%E2%80%99s%20
Behind%20the%20Drop_%20Simple%20Economics%20-%20The%20New%20York%20Ti
mes.pdf?dl=0
Q3. Please read the article “Taiwan Tries to Revive Its Banana Export Industry”. What kind of
impact does the banana industry make to the banana market? Which shifter of the demand or
supply curve they are trying to use?
Link:
https://www.dropbox.com/s/75exg7o3j32mw17/Taiwan%20Tries%20to%20Revive%20Its%20Ba
nana%20Export%20Industry%20-%20The%20New%20York%20Times.pdf?dl=0
Q4. Suppose you are an airline company manager. The total cost of a flight is $100,000.
(fuel, food, beverage, etc.) and 200 seats are installed in the plane. So the average cost of
each seat is $500. The flight is about to take off and there are 10 seats empty. Now a
customer wants to take the flight but only want to pay $300. Should you let this customer
board? Please use one of the ten principles we have learned in the class explain your
answer.
Q5. When unemployment rate is high, some people suggest that the government should
create jobs to help the unemployed workers and lower the unemployment rate. However,
according to some economists, this policy may not be as good as it appears because its
effect on the unemployment rate is limited and it costs taxpayers’ money. Please use the
4th principle we have learned in the class, “people respond to incentives”, discuss this
issue and explain why its effect is limited. Specifically, what kind of incentives does this
policy provide to the unemployed who are looking for a job? How the incentives affect
the unemployment rate? Hint: Unemployment rate is high if many workers who want to have
a job but cannot find one, or they don’t accept the job offers they got and keep searching.
Topics
• Introduction
• Ten Principles of Economics (Chapter 1)
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0
In Chapter 1,
look for the answers to these questions:
• What kinds of questions does economics
address?
• What are the principles of how people make
decisions?
• What are the principles of how people interact?
• What are the principles of how the economy as
a whole works?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
What Economics Is All About
? Scarcity: the limited nature of society’s
resources
? Economics: the study of how society manages
its scarce resources, e.g.
? how people decide what to buy,
how much to work, save, and spend
? how firms decide how much to produce,
how many workers to hire
? how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
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2
The Principles of
HOW PEOPLE MAKE DECISIONS
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3
PRINCIPLE #1:
People Face Tradeoffs
All decisions involve tradeoffs. Examples:
? Going to a party the night before your midterm
leaves less time for studying.
? Having more money to buy stuff requires
working longer hours, which leaves less time
for leisure.
? Protecting the environment requires resources
that could otherwise be used to produce
consumer goods.
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4
PRINCIPLE #1:
People Face Tradeoffs
? Society faces an important tradeoff:
efficiency vs. equity
? Efficiency: when society gets the most from its
scarce resources
? Equity: when prosperity is distributed uniformly
among society’s members
? Tradeoff: To achieve greater equity,
could redistribute income from wealthy to poor.
But this reduces incentive to work and produce,
shrinks the size of the economic “pie.”
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5
PRINCIPLE #1:
People Face Tradeoffs
Case Study: Unemployment Insurance
? US
? 20 and 30% of wages, replacement caps at
40% in some states;
? ends after 26 weeks (about six months) and
extended to 99 weeks during recessions.
? Euro
? 50% of wages (e.g. Spain 70%+);
? For up to 5 years or more!
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6
PRINCIPLE #1:
People Face Tradeoffs
Case Study: Unemployment Insurance

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7
PRINCIPLE #2:
The Cost of Something Is
What You Give Up to Get It
? Making decisions requires comparing the costs
and benefits of alternative choices.
? The opportunity cost of any item is
whatever must be given up to obtain it.
? It is the relevant cost for decision making.
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8
PRINCIPLE #2:
The Cost of Something Is
What You Give Up to Get It
Examples:
The opportunity cost of…
…going to college for a year is not just the tuition,
books, and fees, but also the forgone wages.
…seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.
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9
PRINCIPLE #3:
Rational People Think at the Margin
Rational people
? systematically and purposefully do the best they
can to achieve their objectives.
? make decisions by evaluating costs and benefits
of marginal changes, incremental adjustments
to an existing plan.
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10
PRINCIPLE #3:
Rational People Think at the Margin
Examples:
? When a student considers whether to go to
college for an additional year, he compares the
fees & foregone wages to the extra income
he could earn with the extra year of education.
? When a manager considers whether to increase
output, she compares the cost of the needed
labor and materials to the extra revenue.
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11
ACTIVE LEARNING
1
Applying the principles
You are selling your 2006 Mustang. You have already
spent $1000 on repairs.
At the last minute, the transmission dies. You can
pay $600 to have it repaired, or sell the car “as is.”
In each of the following scenarios, should you have
the transmission repaired? Explain.
A. Blue book value (what you could get for the car) is
$6500 if transmission works, $5700 if it doesn’t
B. Blue book value is $6000 if transmission works,
$5500 if it doesn’t
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING
Answers
1
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission works,
$5700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700).
It’s worthwhile to have the transmission fixed.
B. Blue book value is $6000 if transmission works,
$5500 if it doesn’t
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.
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ACTIVE LEARNING
Observations
1
? The $1000 you previously spent on repairs is
irrelevant. What matters is the cost and benefit
of the marginal repair (the transmission).
? The change in incentives from scenario A
to scenario B caused your decision to change.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE #4:
People Respond to Incentives
? Incentive: something that induces a person to
act, i.e. the prospect of a reward or punishment.
? Rational people respond to incentives.
Examples:
? When gas prices rise, consumers buy more
hybrid cars and fewer gas guzzling SUVs.
? When cigarette taxes increase,
teen smoking falls.
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15
The Principles of
HOW PEOPLE INTERACT
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16
PRINCIPLE #5:
Trade Can Make Everyone Better Off
? Rather than being self-sufficient,
people can specialize in producing one good or
service and exchange it for other goods.
? Countries also benefit from trade and
specialization:
? Get a better price abroad for goods they
produce
? Buy other goods more cheaply from abroad
than could be produced at home
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17
PRINCIPLE #6:
Markets Are Usually A Good Way to
Organize Economic Activity
? Market: a group of buyers and sellers
(need not be in a single location)
? “Organize economic activity” means determining
? what goods to produce
? how to produce them
? how much of each to produce
? who gets them
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
PRINCIPLE #6:
Markets Are Usually A Good Way to
Organize Economic Activity
? A market economy allocates resources through
the decentralized decisions of many households
and firms as they interact in markets.
? Famous insight by Adam Smith in
The Wealth of Nations (1776):
Each of these households and firms
acts as if “led by an invisible hand”
to promote general economic well-being.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
19
PRINCIPLE #6:
Markets Are Usually A Good Way to
Organize Economic Activity
? The invisible hand works through the price
system:
? The interaction of buyers and sellers
determines prices.
? Each price reflects the good’s value to buyers
and the cost of producing the good.
? Prices guide self-interested households and
firms to make decisions that, in many cases,
maximize society’s economic well-being.
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20
PRINCIPLE #7:
Governments Can Sometimes
Improve Market Outcomes
? Important role for govt: enforce property rights
(with police, courts)
? People are less inclined to work, produce,
invest, or purchase if large risk of their property
being stolen.
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21
PRINCIPLE #7:
Governments Can Sometimes
Improve Market Outcomes
? Market failure: when the market fails to allocate
society’s resources efficiently
? Causes of market failure:
? Externalities, when the production or consumption
of a good affects bystanders (e.g. pollution)
? Market power, a single buyer or seller has
substantial influence on market price
(e.g. monopoly)
? Public policy may promote efficiency.
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22
PRINCIPLE #7:
Governments Can Sometimes
Improve Market Outcomes
? Govt may alter market outcome to
promote equity.
? If the market’s distribution of economic well-being
is not desirable, tax or welfare policies can
change how the economic “pie” is divided.
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23
The Principles of
HOW THE ECONOMY AS A WHOLE
WORKS
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
24
PRINCIPLE #8:
A Country’s Standard of Living Depends
on Its Ability to Produce Goods & Services
? Huge variation in living standards across
countries and over time:
? Average income in rich countries is more than
ten times average income in poor countries.
? The U.S. standard of living today is about
eight times larger than 100 years ago.
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25
PRINCIPLE #8:
A Country’s Standard of Living Depends
on Its Ability to Produce Goods & Services
? The most important determinant of living
standards: productivity, the amount of goods
and services produced per unit of labor.
? Productivity depends on the equipment, skills,
and technology available to workers.
? Other factors (e.g., labor unions, competition from
abroad) have far less impact on living standards.
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26
PRINCIPLE #9:
Prices Rise When the Government Prints
Too Much Money
? Inflation: increases in the general level of prices.
? In the long run, inflation is almost always caused
by excessive growth in the quantity of money,
which causes the value of money to fall.
? The faster the govt creates money,
the greater the inflation rate.
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27
PRINCIPLE #10:
Society Faces a Short-run Tradeoff
Between Inflation and Unemployment
? In the short-run (1–2 years),
many economic policies push inflation and
unemployment in opposite directions.
? Other factors can make this tradeoff more or less
favorable, but the tradeoff is always present.
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28
SU MMA RY
The principles of decision making are:
• People face tradeoffs.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People respond to incentives.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
SU MMA RY
The principles of interactions among people are:
• Trade can be mutually beneficial.
• Markets are usually a good way of coordinating
trade.
• Govt can potentially improve market outcomes if
there is a market failure or if the market outcome
is inequitable.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
SU MMA RY
The principles of the economy as a whole are:
• Productivity is the ultimate source of living
standards.
• Money growth is the ultimate source of inflation.
• Society faces a short-run tradeoff between
inflation and unemployment.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
In Chapter 2,
look for the answers to these questions:
• What are economists’ two roles? How do they differ?
• What are models? How do economists use them?
• What are the elements of the Circular-Flow Diagram?
What concepts does the diagram illustrate?
• How is the Production Possibilities Frontier related
to opportunity cost? What other concepts does it
illustrate?
• What is the difference between microeconomics and
macroeconomics? Between positive and normative?
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0
The Economist as Scientist
? Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
? In the first, economists employ the
scientific method,
the dispassionate development and testing of
theories about how the world works.
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1
Assumptions & Models
? Assumptions simplify the complex world,
make it easier to understand.
? Example: To study international trade,
assume two countries and two goods.
Unrealistic, but simple to learn and
gives useful insights about the real world.
? Model: a highly simplified representation of
a more complicated reality.
Economists use models to study economic
issues.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
Our First Model:
The Circular-Flow Diagram
? The Circular-Flow Diagram: a visual model of
the economy, shows how dollars flow through
markets among households and firms
? Two types of “actors”:
? households
? firms
? Two markets:
? the market for goods and services
? the market for “factors of production”
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3
Factors of Production
? Factors of production: the resources the
economy uses to produce goods & services,
including
? labor
? land
? capital (buildings & machines used in
production)
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4
FIGURE 1: The Circular-Flow Diagram
Households:
? Own the factors of production,
sell/rent them to firms for income
? Buy and consume goods & services
Firms
Households
Firms:
? Buy/hire factors of production,
use them to produce goods
and services
? Sell goods & services
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5
FIGURE 1: The Circular-Flow Diagram
Revenue
G&S
sold
Markets for
Goods &
Services
Firms
Factors of
production
Wages, rent,
profit
Spending
G&S
bought
Households
Markets for
Factors of
Production
Labor, land,
capital
Income
6
Our Second Model:
The Production Possibilities Frontier
? The Production Possibilities Frontier (PPF):
a graph that shows the combinations of
two goods the economy can possibly produce
given the available resources and the available
technology
? Example:
? Two goods: computers and wheat
? One resource: labor (measured in hours)
? Economy has 50,000 labor hours per month
available for production.
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7
PPF Example
? Producing one computer requires 100 hours labor.
? Producing one ton of wheat requires 10 hours labor.
Employment of
labor hours
Production
Computers
Wheat
Computers
Wheat
A
50,000
0
500
0
B
40,000
10,000
400
1,000
C
25,000
25,000
250
2,500
D
10,000
40,000
100
4,000
E
0
50,000
0
5,000
PPF Example
Production
Point
on
Comgraph puters Wheat
A
500
0
B
400
1,000
C
250
2,500
D
100
4,000
E
0
5,000
Wheat
(tons)
6,000
5,000
E
D
4,000
3,000
C
2,000
B
1,000
A
0
0
100 200 300 400 500 600
Computers
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9
ACTIVE LEARNING
1
Points off the PPF
A. On the graph, find the point that represents
(100 computers, 3000 tons of wheat), label it F.
Would it be possible for the economy to produce
this combination of the two goods?
Why or why not?
B. Next, find the point that represents
(300 computers, 3500 tons of wheat), label it G.
Would it be possible for the economy to produce
this combination of the two goods?
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ACTIVE LEARNING
Answers
? Point F:
100 computers,
3000 tons wheat
? Point F requires
40,000 hours
of labor.
Possible but
not efficient:
could get more
of either good
w/o sacrificing
any of the other.
1
Wheat
(tons)
6,000
5,000
4,000
3,000
F
2,000
1,000
0
0
100 200 300 400 500 600
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Computers
ACTIVE LEARNING
Answers
? Point G:
300 computers,
3500 tons wheat
? Point G requires
65,000 hours
of labor.
Not possible
because
economy
only has
50,000 hours.
1
Wheat
(tons)
6,000
5,000
4,000
G
3,000
2,000
1,000
0
0
100 200 300 400 500 600
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Computers
The PPF: What We Know So Far
Points on the PPF (like A – E)
? possible
? efficient: all resources are fully utilized
Points under the PPF (like F)
? possible
? not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF (like G)
? not possible
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13
The PPF and Opportunity Cost
? Recall: The opportunity cost of an item
is what must be given up to obtain that item.
? Moving along a PPF involves shifting resources
(e.g., labor) from the production of one good to
the other.
? Society faces a tradeoff: Getting more of one
good requires sacrificing some of the other.
? The slope of the PPF tells you the opportunity
cost of one good in terms of the other.
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14
The PPF and Opportunity Cost
Wheat
(tons)
6,000
–1000
slope =
= –10
100
5,000
4,000
3,000
2,000
1,000
0
0
100 200 300 400 500 600
The slope of a line
equals the
“rise over the run,”
the amount the line
rises when you
move to the right by
one unit.
Here, the
opportunity cost of
a computer is
10 tons of wheat.
Computers
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15
ACTIVE LEARNING
2
PPF and Opportunity Cost
In which country is the opportunity cost of cloth lower?
FRANCE
ENGLAND
Wine
Wine
600
600
500
500
400
400
300
300
200
200
100
100
0
0
0
100 200 300 400
Cloth
0
100 200 300 400
Cloth
ACTIVE LEARNING
Answers
2
England, because its PPF is not as steep as France’s.
FRANCE
ENGLAND
Wine
Wine
600
600
500
500
400
400
300
300
200
200
100
100
0
0
0
100 200 300 400
Cloth
0
100 200 300 400
Cloth
Economic Growth and the PPF
With additional
resources or an
improvement in
technology,
the economy can
produce more
computers,
more wheat,
or any combination
in between.
Wheat
(tons)
6,000
Economic
growth shifts
the PPF
outward.
5,000
4,000
3,000
2,000
1,000
0
0
100 200 300 400 500 600
Computers
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
The Shape of the PPF
? The PPF could be a straight line or bow-shaped
? Depends on what happens to opportunity cost
as economy shifts resources from one industry
to the other.
? If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of a
computer was always 10 tons of wheat.)
? If opp. cost of a good rises as the economy
produces more of the good, PPF is bow-shaped.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
19
As the economy
shifts resources
from beer to
mountain bikes:
Beer
Why the PPF Might Be Bow-Shaped
? PPF becomes
steeper
? opp. cost of
mountain bikes
increases
Mountain
Bikes
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20
At point A,
most workers are
producing beer,
even those who
are better suited
to building bikes.
Beer
Why the PPF Might Be Bow-Shaped
A
At A, opp. cost of
mtn bikes is low.
So, do not have to
give up much beer
to get more bikes.
Mountain
Bikes
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
21
At B, most workers
are producing bikes.
The few left in beer
are the best brewers.
Beer
Why the PPF Might Be Bow-Shaped
Producing more
bikes would require
shifting some of the
best brewers away
from beer production,
causing a big drop in
beer output.
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