What Is the Government's Role?

What is the Government's Role?

*Smith conceived the ideal government as one that, without prejudice, adjudicated the law and encouraged reasonably unfettered trade.

*He advocated the latter because, in his famous words (paraphrased), "it is not by virtue of the butcher's or baker's kindness that we et our dinner, but by virtue of their self-interest

*government should ideally be like a good umpire- effectively invisible.

*Smith knew that trade was good, especially for the lower classes, and saw the Government's role as enabling free and fair trade.

*He was not naive, however. He well recognized that merchants and politicians were often "in bed together" in order to defraud the public; this was called mercantilism, and it is an ongoing problem to this day.

Ten Principles of Economics

1. People Face Trade-offs

2. The Cost of Something Is What You Give Up to Get It--opportunity cost.

3. Rational People Think at the Margin

4. People Respond to Incentives

5. Trade can Make Everyone Better Off

The Practice of Economics Today

*Microeconomics is the study of how the individual (person or firm) behaves in the larger economy

*Macroeconomics is the study of the larger economy

*One should not think of these two areas as independent; this would be a falls dichotomy

*Never forget that, when we speak of the larger economy, we're really speaking about the collective actions of MILLIONS of people in a market

*Economists perform two types of analysis

1. positive analysis- involves describing the whorl as it is; it entails the studying the economy so as to understand how it really works

2. normative analysis involves advocating for policies that lead to a particular conclusion; in this type of analysis, the economist "picks a side"

*normative analysis attempts to describe the world as the economist thinks it should be

*positive analysis has to do with facts; normative analysis has to do with values (which should be in sync with the facts).

CH. 3: INTERDEPENDENCE AND THE GAINS FROM TRADE

Comparative Advantage

*absolute advantage- produce a good using fewer inputs than another producer.

*opportunity cost- whatever must be given up to obtain some item. measures the trade-off between the two goods that each producer faces.

*comparative advantage- produce a good at a lower opportunity cost than another producer. reflects the relative opportunity cost.

-Principle of comparative advantage= each good- produced by the individual that has the smaller opportunity cost producing that good.

*One person:

-can have absolute advantage in both goods

-cannot have comparative advantage in both goods

*For different opportunity costs

-one person= comparative advantage in one good

-the other person= comparative advantage in the other good

*Opportunity cost of one good- inverse of the opportunity cost of the other

*gains from specialization and trade- based on comparative advantage. total production in economy rises (increase in the size of the economic pie; everyone=better off).

*Trade can benefit everyone in society- allows people to specialize

*The price of trade- must lie between the two opportunity costs

*Principle of Comparative Advantage explains: a) interdependence and b) gains from trade.

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*Opportunity Cost of One Good

-inverse of the opportunity cost of the other

*Gains from Specialization and Trade

-based on comparative advantage

-total production in economy rises

*increase in the size of the economies pie

*everyone better off

*Trade benefits everyone in society:

-allows people to specialize

*The Price of Trade

-must lie between the two opportunity costs

*Principle of Comparative Advantage explains:

-interdependence

-gains from trade

CH. 4: THE MARKET FORCES OF SUPPLY AND DEMAND

Markets and Competition

*Market

-a group of buyers and sellers of a particular good or service

-buyers: determine the demand for the product

-sellers: determine the supply of the product

*Competitive Market

-Market in which there are many burs and many sellers

-Each has a negligible impact on market price

-Price and quantity are determined by all buyers and sellers (as they interact in the marketplace).

*Perfectly Competitive Market

-Goods offered for sale are all exactly the same

-Buyers and sellers are so numerous that:

a) no single buyer or seller has any influence over the market price

b price takers

-At the market price

a) Buyers can buy all they want

b)