Economics 310 Price Theory Chapters 1 and 2 Department of Economics College of Business and Economics California State University-Northridge Professor

Economics 310Price Theory

Chapters 1 and 2

Department of Economics

College of Business and Economics

California State University-Northridge

Professor Kenneth Ng

Friday, April 21, 2023

What is science?

Science makes positive statements about the world.– positive statement:

• involves a prediction or statement of fact, i.e. a testable hypothesis.

• Takes the form of an if/then statement. – normative statement:

• involves a value judgment, i.e. something is good or bad.

Physics is a science– The “laws of physics” can be used to make positive

statements about the behavior of the physical universe.

– Example of positive statements from physics.

Suppose you wanted the make the object ball (7 ball) go into the corner pocket by hitting it with the cue ball. How would you accomplish this.?

The object ball will move on line through its’ center and the point of impact between the cue ball and the object ball.

Where will the cue ball go after impacting the 7-ball (neglecting spin and roll)?

The cue ball (neglecting spin and roll) will travel at a 90 degree angle to the path of the object ball

Where will the cue ball go after impacting the end rail?

If you were betting, would you bet that the player would run the table?

The angle of incidence (neglecting spin, friction and the softness of the rail) will equal the angle of rebound.

Example of positive statement from hard sciences

Physics-a science– The “laws of physics” can be used to make positive

statements about the behavior of the physical universe. Proper application of the laws of physics allows highly detailed

and accurate positive statements to be made. Economics is a science like physics, chemistry, biology etc.

Economics is concerned with making positive statements about human behavior.

Identical to "hard" sciences except positive statements are about human beings rather than inanimate objects.

Simple Economic Example Change punishment for DUI to:

– First offence: cut off finger.– Second offence: cut off limb.– Third offence: death penalty.

Positive Statements:– If the law is passed and enforced then:

• Drunk driving convictions will decrease (first law of demand).• Entrepreneurs will bring new products to market (reallocation

of productive resources).– Examples of new products:

» Portable breathalyzers, police scanners, etc. • New knowledge will be produced

– Example of new knowledge:» If you are pulled over for drunk driving do you want a

breathalyzer or blood test? Economics is a science that tries to understand and control human

behavior, i.e. make positive statements about human beings.– Economic Theory can make positive statements about human

behavior as accurate and detailed as physics can make about inanimate objects.

Chapter 2 (Prices, Costs and the Gains from Trade)

Concerns the application of the simplest, most powerful, and central of economic principles to one of the most intellectually interesting questions regarding human behavior.

One of the most interesting questions facing social scientists is why are some societies rich and others poor?

GNP, population, life expectancy data --Some basic facts about the world we live in.

The world we live in.

U.S. the third most populous country in the World--4.45% of the world's population--about 1 in 20 people.

U.S. Rich--Contains 4.45% of the world's population and produces 29% of the world's goods and services.

On a per capita basis the average American is very well off. Average U.S. citizen earns almost 7 times the world's average .

– The average person in the world earns a little over $2/hour. The U.S. is a very rich place and those who live here are very

fortunate.

GNP

COUNTRYPopulation

(1,000's)1995 GNP ( bil. Dol.)

1995 Per

Capita GNP

Life Expectancy at

BrithUnited States 260,714 6,955 $26,438 76.0World 5,851,551 23,723 $4,054

Comparative International Statistics

The World We Live in—U.S. vs.Third World Countries

How does the U.S. compare to third world countries?– Look at food situation in 3rd world countries. A typical 3rd world country has a per

capita income of $300. Example: India.• Lifestyle with $300 of yearly income.

– Can you feed yourself with $300 per year.– $6 per week.– What does it cost to provide a completely nutritious diet?– MRE costs $20-contains 5000 calories and all the vitamins and nutrients

needed to sustain one male doing heavy labor in the field for one day. – U.N studies show that a person can get the RDA of all nutrients for

$3/week.• What about housing, medical care, etc.?

COUNTRYPopulation (1,000's)

1995 GNP ( bil. Dol.)

1995 Per Capita GNP

Life Expectancy

at BrithUnited States 260,714 6,955 $26,438 76.0World 5,851,551 23,723 $4,054

Mexico 97,563 261 $2,521 74.0Iraq 22,219 26 $1,435 67.4Egypt 64,792 46 $746 60.8India 967,613 326 $348 60.2Kenya 28,803 7 $274 54.4Bangladesh 125,340 29 $240 55.1Madagascar 14,062 3 $205 54.0Uganda 20,605 3 $157 38.1Tanzania 29,461 4 $134 41.7Ethiopia 36,413 5 $96 46.6Mozambique 18,165 1 $74 44.9

Third World Countries

The World We Live in---U.S. vs. Other Industrialized Nations, Communist Countries, and the Pacific Rim.

Compared to Communist Countries, the U.S. is rich.– How did U.S. win the cold war?

• Look at the size, population, and per capita income of Russia.• Ronald Reagan figured out that if we spent 5% OF GNP on national defense. The

USSR would have to spend 14% of GNP to match. Compared to Pacific Rim Countries (except Japan), the U.S. is rich.

– Is the U.S. about to lose it’s global dominance to the expanding countries of the Pacific Rim?

Even compared to other industrialized countries, the U.S. is rich.

COUNTRYPopulation (1,000's)

1995 GNP ( bil. Dol.)

1995 Per Capita GNP

Life Expectancy at Birth

United States 260,714 6,955 $26,438 76.0World 5,851,551 23,723 $4,054

Germany 85,684 1,674 $20,497 76.3France 59,079 1,159 $19,939 78.2Japan 126,582 2,737 $21,795 79.3Spain 39,303 558 $14,226 77.7

Russia 148,081 2,531 $4,478 63.8Mainland China 1,253,438 1,528 $2,303 70.0North Korea 25,491 $894 70.6

South Korea 47,351 425 $9,437 73.6Taiwan 264 $12,390 75.3Philippines 76,104 77 $1,052 66.1Thailand 59,451 1,310 $2,806 68.8

Other First World Countries

Communist Countries

Pacific Rim Countries

The world we live in --The U.S. over time.

U.S. has always been rich– Most communist countries have not achieved the GNP per capita enjoyed by the

average American living in 1930. – Many 3rd world countries have not achieved the standard of living enjoyed by the

average American in 1710. Results are mirrored in the 2nd standard measure of economic performance-life expectancy

at birth.– Life expectancy at birth vs. age 40.

• What are the most dangerous periods of a person’s life?• Life expectancy at age 40 in the U.S. is 84.• How is this information useful?

– Lower standard of living due to perverse income effect-smoking and unhealthy eating.

COUNTRYPopulation

(1,000's)1995 GNP ( bil.

Dol.)1995 Per Capita

GNPLife Expectancy at

BirthUnited States 260,714 6,955 $26,438 76.0Spain 39,303 558 $14,226 77.7Taiwan 264 $12,390 75.3

U.S. in 1960 $11,100U.S. in 1945 $10,450U.S. in 1929 $6,150Russia 148,081 2,531 $4,478 63.8

U.S. in 1880 $2,650Mexico 97,563 261 $2,521 74.0Mainland China 1,253,438 1,528 $2,303 70.0

U.S. in 1840 $1,350Indonesia 209,774 177 $931 62.1

U.S. in 1775 $750U.S. in 1710 $550India 967,613 326 $348 60.2

Economics attempts to make positive statements about human behavior.

The human behavior that constitutes the subject of 99% of economic study is the activity of voluntary exchange (the operation of the market).

– Of all the varied types of human behavior why study voluntary exchange?

– Answering the question “why are we rich?” is tied to understanding ramifications of unrestricted voluntary exchange, a free market or capitalist economic system,

– Answering the question “why are we rich?” involves understanding the interaction of simple economic concepts of mutually beneficial voluntary exchange, comparative advantage, specialization in production, and the role of price in dividing the gains from trade.

Define Comparative Advantage:

– A person or country has a comparative advantage if it can produce a good at lower opportunity cost than others.

– Comparative advantage is just an observation about the way the world is just the like the world is round or the sun rises in the east.

• Differences in climate. • Physical differences between people.• Etc.

Define Specialization:

– A person or country specializes in production when it produces more of a good in which it has a comparative advantage and exchanges it for goods in which it has a comparative disadvantage.

• The opposite of self-sufficiency.

– Countries or individuals can enrich themselves collectively and individually if they specialize in the production of goods in which they have a comparative advantage and exchange for goods in which they have a comparative disadvantage.

The “Do Nothing Principle.”

If individuals or countries are left unrestricted to pursue their own self interest they will have an incentive to specialize according to comparative advantage thus making themselves and others better off.– Advantages of a policy of Laizze Faire or benefits of a free

market or allowing unrestricted exchange.– Best economic policy is usually “do nothing.”

Numeric Demonstration of Benefits to Specialization and Exchange and the Do Nothing Principle.

Electrician Carpenter

Rewire House 10 hours 20 hours

Repanel House 15 hours 18 hours

Number of Hours Required to Accomplish Task





Rewire House2/3 rds Repaneling

10/9ths Repaneling

Repanel House 3/2 Rewiring 9/10th Rewiring


Opportunity Cost of Accomplishing Each Task

Opportunity Cost:

Whatever must be given up to obtain some item.

Do opportunity costs differ in the example?

Does comparative advantage exist?

The opportunity cost for the electrician of rewiring his house is 2/3rds of a repanel job because in the time it takes him to rewire his house, he could repanel 2/3rds of his house.






10/9ths Repaneling


W/O Trade With Trade

Gain From Trade

Electrician 25 hours 20 hours 5 hours

Carpenter 38 hours 36 hours 2 hoursTotal 63 hours 56 hours 7 hours

Total Hours Required to Rewire and Repanel House



Compare the number of hours it takes the electrician and the carpenter to accomplish both tasks if the engage in specialization and exchange according to comparative advantage vs. self sufficiency.

Effects of Specialization and Exchange

according to comparative advantage. By specializing in the production

of goods in which they have a comparative advantage and exchanging for goods in which they have a comparative disadvantage, the electrician and carpenter were able to make themselves individually and collectively better off.

– Effects of specialization and exchange.

– Electrician saves 5 hours– Carpenter saves 2 hours– Collectively they save 7 hours.






10/9ths Repaneling



Gain From Trade






Do Nothing Policy, free markets, capitalism,

or policy of laizze faire. We have proven that if

specialization and exchange according to comparative advantage occurs, collective and individual enrichment will occur, but what policy will cause people to behave in this wealth enhancing way?

If people are allowed to pursue their self interest free from outside influence or coercion through voluntary exchange, they will “do the right thing” because it is in their private self interest to do so.

The “best” government policy is not to interfere in the operation of the market, do not inhibit voluntary exchange.






10/9ths Repaneling



Gain From Trade






Summary People can enrich themselves if they behave in a certain way.

– Positive statement 1: If people, groups of people, countries, or societies specialize in the production of goods in which they have a comparative advantage and exchange for goods in which they have a comparative disadvantage, the total amount of goods produced will increase.

People can be induced to behave in the “right way.”

– Positive statement 2: If people, groups of people, countries, or societies are left alone to pursue their self interest they will specialize and exchange according to comparative advantage.

– Positive statement 3: After specialization and exchange according to comparative advantage both parties will be individually as well as collectively enriched.

The policy that will induce specialization and exchange is to “do nothing”.

– Free market policy.

– Capitalism.

– Market solutions.

Consider a slightly different example illustrating another simple and powerful economic principle.

Electrician Carpenter Electrician Carpenter

Rewire House 10 hours 20 hours Rewire House 5 hours 28 hours

Repanel House 15 hours 18 hours Repanel House 20 hours 10 hours



10/9ths Repaneling Rewire House

Repanel House 3/2 Rewiring 9/10th Rewiring Repanel House


Gain From Trade W/O Trade With Trade Gain From Trade

Electrician 25 hours 20 hours 5 hours Electrician

Carpenter 38 hours 36 hours 2 hours CarpenterTotal 63 hours 56 hours 7 hours Total





Opportunity Cost of Accomplishing Each Task Opportunity Cost of Accomplishing Each Task

Note: Without specialization and exchange, it would take the same total hours for the carpenter and electrician to rewire and repanel both houses. Therefore in both examples they are entering the market from the same position. The difference is where they end up after specialization has occurred.

Electrician Carpenter Electrician CarpenterRewire House 10 hours 20 hours Rewire House 5 hours 28 hoursRepanel House 15 hours 18 hours Repanel House 20 hours 10 hours



10/9ths Repaneling Rewire House 1/4paneling 2.8 paneling

Repanel House 3/2 Rewiring 9/10th Rewiring Repanel House 4 rewirings 10/28 rewirings



Electrician 25 hours 20 hours 5 hours Electrician 25 hours 10 hours 15 hoursCarpenter 38 hours 36 hours 2 hours Carpenter 38 hours 20 hours 18 hoursTotal 63 hours 56 hours 7 hours Total 63 hours 30 hours 33 hours




EXAMPLE 1 EXAMPLE 2

Number of Hours Required to Accomplish Number of Hours Required to Accomplish

What has happened to the collective and individual gains from specialization and exchange?

The more different the sides to an exchange the greater the collective and individual gain from specialization and exchange.

Electrician Carpenter Electrician CarpenterRewire House 10 hours 20 hours Rewire House 5 hours 28 hoursRepanel House 15 hours 18 hours Repanel House 20 hours 10 hours



10/9ths Repaneling Rewire House 1/4paneling 2.8 paneling

Repanel House 3/2 Rewiring 9/10th Rewiring Repanel House 4 rewirings 10/28 rewirings



Electrician 25 hours 20 hours 5 hours Electrician 25 hours 10 hours 15 hoursCarpenter 38 hours 36 hours 2 hours Carpenter 38 hours 20 hours 18 hoursTotal 63 hours 56 hours 7 hours Total 63 hours 30 hours 33 hours




EXAMPLE 1 EXAMPLE 2

Number of Hours Required to Accomplish Number of Hours Required to Accomplish

Features of the world explained by more different principle.

The greater the difference in opportunity costs between two people, groups of people, or countries, the greater the potential gain from specialization and voluntary exchange according to comparative advantage.

The “correct” immigration policy– U.S. Constitution and the requirements for citizenship.– Immigration Policy before 1910’s.

• National Origins Immigration Policy.– Restrictions on voluntary exchange-move and countermove. – Application of More Different Principle.

• Does the National Origins Immigration Policy correctly apply the more different principle?

Geographic distribution of Jews.– Why have Jews distributed themselves in small pockets around

the world rather than concentrating in one area?– Application of More Different Principle.

A Look at Supply and Demand Analysis.

Economic analysis most often uses the tools of supply and demand.

The principles we have discussed are embedded in supply and demand analysis. – Collective and individual enrichment from voluntary

exchange.– Do nothing principle.– More different principle.

Homework due Feb. 14th in class. Defer discussion of these points until after the homework is

turned in.

Equilibrium: Supply equals Demand

Price Quantity10 19 28 37 46 55 64 73 82 91 10

Price Quantity10 119 108 97 86 75 64 53 42 31 2

Demand

Supply

Documents

Economics 310 Price Theory Chapters 1 and 2 Department of Economics College of Business and Economics California State University-Northridge Professor