Economics 2 Spring 2018 Christina Romer David Romer LECTURE 27 The Lessons and Tools of Economics May 1, 2018
Announcements Suggested answers for Problem Set 6 are available on the course website.
Final Exam Logistics When: Monday, May 7 th, 11:30 2:30. Where: Wheeler Auditorium.
Final Exam Format and Content Roughly the length of two midterms. Cumulative, but with one section specifically on material since the second midterm. Mixture of short-answer questions, problems, and multiple choice questions.
Some Advice on Taking the Final Exam Read questions carefully. Figure out what tool is appropriate. Watch your time. Think of trying to convince the person grading the exam that you understand the material.
Some Advice on Studying Focus on the posted slides and your lecture notes. Also the suggested answers to the problem sets. Study actively; don t just keep reading over your notes. Redraw diagrams; think of different cases and examples and then work them out. Focus on really understanding the tools.
Places to Get Help before the Final Review session: Today (May 1 st ), 5 7 p.m. in 2050 VLSB. Professor office hours this week: Thursday, 4 6 in 683 Evans. GSI office hours: Your GSI will let you know their office hours during RRR week.
I. OVERVIEW
II. LESSONS AND TOOLS OF MICROECONOMICS
Lesson 1 Trade-offs are everywhere.
Good x Production Possibilities Curve PPC Good y
Lesson 2 There are gains from specialization and trade.
Good x Production Possibilities Curve PPC Good y
Consumption Possibilities Curve Good x Gains from Specialization and Trade PPC CPC Good y
Lesson 3 In a market system, prices play a crucial role.
Supply and Demand Diagram P S P 1 D Q 1 Q
Lesson 4 Households and firms make choices to maximize their well-being. Corollary: People respond to incentives.
Utility Maximization: Rational Spending Rule MU x P x = MU y P y
Profit Maximization for a Competitive Firm Market Typical Firm P S P ATC MC P 1 MR D Q Profits are largest at q 1, where MR=MC. q 1 q
Lesson 5 A market system has many benefits. Allocative efficiency. Dynamic efficiency.
Welfare Analysis P Consumer Surplus S 1,MC P 1 Producer Surplus Q 1 At Q 1, MB = MC. D 1,MB Q
Welfare Analysis of Trade P S US P 1 US Gains from Trade P World US US US Q S Q 1 Q D Imports D US Q
Diagram for a Competitive Industry Market Typical Firm P S P ATC MC P 1 MR D Q q 1 q
Lesson 6 Interfering with the market has consequences.
Effect of a Tax P S 2 S 1 P 2 P 1 P 2 tax Tax Deadweight Loss Q 2 Q 1 D 1 Q
Lesson 7 Market failures are important, and government interventions can often improve market outcomes.
Monopoly P MC P 1 Deadweight Loss D,MB Q 1 MR At Q 1, MB > MC. Q
Negative Externality P SMC 1 S 1,PMC 1 External MC Deadweight Loss D 1,PMB 1,SMB 1 Q * Q 1 Q At Q 1, SMB < SMC.
Lesson 8 Market forces are a fundamental determinant of what workers are paid.
Labor Market Diagram W S 1 W 1 D 1, MRP L1 L 1 L
III. LESSONS AND TOOLS OF MACROECONOMICS
Lesson 1 In the long run, output is determined by the inputs to the production process.
Aggregate Production Function (1) (2) (3)
Lesson 2 Improvements in average labor productivity are the key source of long-run growth, and technological progress is the key sources of improvements in average labor productivity.
Aggregate Production Function
Saving and Investment Diagram r* S r 1 I I 1 S*, I*
Lesson 3 Changes in planned spending cause output to deviate from potential in the short run.
Keynesian Cross Diagram PAE Y=PAE PAE Y 1 Y
Lesson 4 Monetary and fiscal policy affect planned spending, and so can cause or mitigate short-run fluctuations.
Keynesian Cross Diagram PAE Y=PAE PAE Y 1 Y
Money Market Diagram i MS i 1 MD M 1 M
Lesson 5 Inflation responds gradually to the deviation of output from potential, and this behavior of inflation (working through the Fed s reaction function) brings the economy back to Y*.
The Fed s Reaction Function r Reaction Function π
Returning to Potential Output PAE Y=PAE PAE 2 PAE 1,PAE LR Y* Y 2 Y
Lesson 6 Net exports are determined by factors affecting asset flows, not goods flows.
Foreign Exchange Market for Dollars Price of $ in Euros ( per $1) S e 1 Q 1 D Q of $ Traded
Balance of Payments NX + KI = 0