Changes

Keynesian economics is a theory that began with a British economist named John Maynard Keynes (1883-1946).  He became a favorite of liberals and his theories of economics were one reason England declined from being the greatest power in the world in the 19th century to a weak nation that could not fully defend itself against Germany in World War II (1940-1945).

Keynesian economics is a theory that began with a British economist named John Maynard Keynes (1883-1946).  He became a favorite of liberals and his theories of economics were one reason England declined from being the greatest power in the world in the 19th century to a weak nation that could not fully defend itself against Germany in World War II (1940-1945).

His theory was the opposite of free-market or classical economics.  Keynes  insisted that government interference with the market was desirable and necessary.  Keynes claimed that government spending was needed to reduce unemployment and stimulate economic growth.  Under Keynesian economics, "bigger is better" with respect to government.  Keynes argued that big deficits (excess of government spending over revenue) were actually a good thing to bring an economy out of a recession.

His theory was the opposite of free-market or classical economics.  Keynes  insisted that government interference with the market was desirable and necessary.  Keynes claimed that government spending was needed to reduce unemployment and stimulate economic growth.  Under Keynesian economics, the more government spends, the better it is for the economy.  Keynes argued that big deficits (excess of government spending over revenue) were actually a good thing to bring an economy out of a recession.

This course focuses on Microeconomics, while Keynesian economics is a topic in Macroeconomics, which is the study of national economies rather than individual firms and consumer decisions.  So there will not be any questions on a CLEP Microeconomics exam about Keynesian economics.  But you will see this term used in debates about the federal budget and overall economy, and its basic meaning is this:  increase government spending to stimulate the economy and reduce unemployment.  This did not work well for England in the 20th century, as it went from being one of the very strongest economies to a distant second behind other world powers.

This course focuses on Microeconomics, while Keynesian economics is a topic in Macroeconomics, which is the study of national economies rather than individual firms and consumer decisions.  So there will not be any questions on a CLEP Microeconomics exam about Keynesian economics.  But you will see this term used in debates about the federal budget and overall economy, and its basic meaning is this:  increase government spending to stimulate the economy and reduce unemployment.  This did not work well for England in the 20th century, as it went from being the greatest economy to one that is weaker than the economy of the United States and several other nations.

== Review: Short and Long Run ==

== Review: Short and Long Run ==

The dictionary definitions for "short run" and "long run" are simple.  The "short run" is a time period so brief that a firm is stuck with the resources it has.  It cannot change its plant size or its workforce.  Instead, it must use more expensive options to make changes in its output, since as paying for nightly overtime (when wages are 50% higher per hour), or buying airplane tickets at the last minute when they are more expensive.  If you are traveling in a car and you notice you need gas soon, then you're stuck with the prices charged by the next one or two gas stations, which may not be the lowest price available.  Your short run costs are higher than your long run costs.  '''Short run costs are usually higher than long run costs''', because the short run decisions are not optimal.

The dictionary definitions for "short run" and "long run" are simple.  The "short run" is a time period so brief that a firm is stuck with the resources it has.  It cannot change its plant size or its workforce.  Instead, it must use more expensive options to make changes in its output, since as paying for nightly overtime (when wages are 50% higher per hour), or buying airplane tickets at the last minute when they are more expensive.  If you are traveling in a car and you notice you need gas soon, then you're stuck with the prices charged by the next one or two gas stations, which may not be the lowest price available.  Your short run costs are higher than your long run costs.  '''Short run costs are usually higher than long run costs''', because the short run decisions are not optimal.

In the long run, the opposite is true.  The long run is a period long enough that a firm can optimize its costs as it changes its level of output.  The firm can change the size of its production facility.  Put another way, '''in the long run all costs are variable'''.

In the long run, the opposite is true.  The long run is a period long enough that a firm can optimize its costs as it changes its level of output.  The firm can change the size of its production facility.  Put another way, '''in the long run all costs are variable, and thus can be reduced to their lowest levels'''.

The above definitions are good to know, but it is important to learn how to apply them correctly.  When an exam question asks about "long-run equilibrium," then immediately think about how all costs are minimized in the long run.   

The above definitions are good to know, and it is important to learn how to apply them correctly.  When an exam question asks about "long-run equilibrium," then recall that all costs are minimized in the long run.   

''Example'':  The price charged by a perfectly competitive firm in the long run or the short run equals marginal cost, because that is always true when there is perfect competition.  But the relation between that price and the firm's overall costs depends on whether it is in the long run or the short run.  In the long run, the firm's costs are minimized, and thus the price will be equal to the firm's average total cost for a perfectly competitive firm.  This is because the perfect competition drives the price down to its lowest possible level: average total cost.  (On an exam question, assume that costs are "economic costs" that include everything from the owner's salary to the investors' profits to the opportunity costs.)

''Example'':  The price charged by a perfectly competitive firm in the long run or the short run equals marginal cost, because that is always true when there is perfect competition.  But the relation between that price and the firm's overall costs depends on whether it is in the long run or the short run.  In the long run, the firm's costs are minimized, and thus the price will be equal to the firm's average total cost for a perfectly competitive firm.  This is because the perfect competition drives the price down to its lowest possible level: average total cost.  (On an exam question, assume that costs are "economic costs" that include everything from the owner's salary to the investors' profits to the opportunity costs.)

A question probing the difference between the short and long run might ask what the basic difference is.  We learned that in the long run all costs are variable.  What about the short run?  '''In the short run some costs of a firm are fixed and unchangeable'''.  For example, the night before our bus trip to D.C., decisions about the bus must be made on a short-run basis.  It is too late then to change the number of buses.  The cost of the buses is fixed, not variable, in the short run.

A question probing the difference between the short and long run might ask what the basic difference is.  We learned that in the long run all costs are variable.  What about the short run?  '''In the short run, some costs of a firm are fixed and unchangeable'''.  For example, the night before the March for Life bus trip to D.C., decisions about the bus must be made on a short-run basis.  It is too late then to change the number of buses.  The cost of the buses is fixed, not variable, in the short run.

== Review: Monopolistic Competition ==

== Review: Monopolistic Competition ==

How can that be, you might ask.  Recall that "economic cost" includes everything:  salaries for everyone, interest on loans and the equivalent of interest on investments, and even opportunity cost.  So zero profit while paying all those costs is still successful for the owners, investors, and workers connected with the firm.

How can that be, you might ask.  Recall that "economic cost" includes everything:  salaries for everyone, interest on loans and the equivalent of interest on investments, and even opportunity cost.  So zero profit while paying all those costs is still successful for the owners, investors, and workers connected with the firm.

Note also that a firm in monopolistic competition has some market power, and can increase his price above his marginal cost.  So even in the long run, P exceeds MC for monopolistic competition.  In contrast, price equals MC in a perfectly competitive market.

Note also that a firm in monopolistic competition has some market power, and can increase its price above his marginal cost.  So even in the long run, P exceeds MC for monopolistic competition.  In contrast, price equals MC in a perfectly competitive market.

==Tariffs==

==Tariffs==

A tariff is a tax on imports.  A tariff raises the price of imported goods, and the supplier must then reduce its received price to attain the same level where supply meets demand.  This has the effect of reducing supply, which is exactly what the protectionists want.  A tariff on Toyota cars, for example, would reduce the supply of Toyota cars in the market.  Ford and GM like that.

A tariff is a tax on imports.  A tariff raises the price of imported goods, and the supplier must then reduce its received price to attain the same level where supply meets demand.  This has the effect of reducing supply.  A tariff on Toyota cars, for example, would reduce the supply of Toyota cars at a low price in the market.  Ford and GM would like that, because it would reduce their competition from foreign countries.

   

   

But our government used ''quotas'' rather than a tariff to appease Ford and GM.  Instead of imposing a tariff on Toyota’s imports, our government negotiated an agreement with it so that it would not sell more than a fixed quota of certain types of cars each year.  This reduces supply also, but without any revenue to the government.  Many criticize these import quotas by observing that the effect is the same as a tariff, but without the benefits of the revenue that government would receive from a tariff.

But in the 1980s, our government used ''quotas'' rather than a tariff to appease Ford and GM.  Instead of imposing a tariff on Toyota’s imports, our government negotiated an agreement with it so that it would not sell more than a fixed quota of certain types of cars each year.  This would also reduces supply, but without the tariff revenue to the government.  Many criticize these import quotas by observing that the effect is the same as a tariff, but without the benefits of the revenue that government would receive from a tariff.

For most of our country’s history (until the Sixteenth Amendment legalized the income tax), our federal government’s major source of revenue was tariffs.  The issue of the tariff was a recurrent controversy that divided the pro-tariff North from the anti-tariff South and was a major cause of the Civil War.

For most of our country’s history (until the Sixteenth Amendment legalized the income tax), our federal government’s major source of revenue was tariffs.  The issue of the tariff was a recurrent controversy that divided the pro-tariff North from the anti-tariff South, and was a cause of the Civil War.

==General Review==

==General Review==

The key to mastering economics is to learn to quiz yourself on the principles to make sure you understand them fully.  

The key to mastering economics is to learn to quiz yourself on the principles to make sure you understand them fully.  

What is the most important concept of this course?  Perhaps it is the obvious desire of companies to maximize their profits.  Whether it is a monopoly or a perfectly competitive firm, each firm shares this common goal with all other firms: it wants to make more profits.  You can answer 20% or more of the questions on any microeconomics exam simply by applying that basic rule.  And at what point does any company maximize its profits?  Where marginal revenue (MR) declines to the point where it equals marginal cost (MC).  When marginal revenue declines further (or marginal cost increases more), then the company is losing profits.  It won’t do that.

What is the most important concept of this course?  Perhaps it is the obvious desire of companies to maximize their profits.  Whether it is a monopoly or a perfectly competitive firm, each firm shares this common goal with all other firms: it wants to make more profits.  You can answer 20% or more of the questions on any microeconomics exam simply by applying that basic rule.  And at what point does any company maximize its profits?  Where marginal revenue (MR) declines to the point where it equals marginal cost (MC).  When marginal revenue declines further (or marginal cost increases more), then the company is losing profits.  A company won't want to lose money this way.

You need to understand the supply and demand curves thoroughly.  Know what elasticity is, in all its forms.  Appreciate what substitutes and complements are.

You need to understand the supply and demand curves thoroughly.  Know what elasticity is, in all its forms.  Appreciate what substitutes and complements are.

2.  Which is true about the average fixed costs (AFC) of a firm?

2.  Which is true about the average fixed costs (AFC) of a firm?

(a)a firm can eliminate these costs by shutting down in the short run.

(a) a firm can eliminate these costs by shutting down in the short run.

<br>(b) as output increases, AFC decreases

<br>(b) as output increases, AFC decreases

<br>(c) as output increases, AFC increases

<br>(c) as output increases, AFC increases

6.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.

6.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.

7.  Review:  is the cost of the bus for a trip to D.C. a "fixed cost" or a "variable cost"?  Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we may have several buses).

7.  Review:  is the cost of the bus for the March for Life trip to D.C. a "fixed cost" or a "variable cost"?  Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we used several buses).

8.  Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually.  How much should you pay me today to receive $1000 in two years?  Show your work.

8.  Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually.  How much should you pay me today to receive $1000 in two years?  Show your work.

12.  An agreement by different firms with each other to reduce output is illegal.  Why should that be illegal?

12.  An agreement by different firms with each other to reduce output is illegal.  Why should that be illegal?

13.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situation immediately across the street from each other?  In other words, what price do they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".

13.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other?  In other words, what price do they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".

<br><br><br>

<br><br><br>

[[Category:Economics lectures]]

[[Category:Economics lectures]]

{{DEFAULTSORT: Economics Lecture 12}}

{{DEFAULTSORT: Economics Lecture 12}}