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{{Economics_Lectures}}

{{Economics_Lectures}}

We’ve covered all the issues concerning individual decisions by companies and consumers.  We’ve discussed supply and demand.  We’ve addressed marginal revenue and marginal cost.  We've discussed numerous other concepts of the free market, including substitutes, complements, consumer surplus, price controls (ceilings and floors), the Law of Demand, normal goods, inferior goods, elasticity, cost measures, utility and indifference curves.

We’ve covered nearly all of the issues concerning individual decisions by companies (firms) and consumers (the public).  We’ve discussed supply and demand.  We’ve addressed marginal revenue and marginal cost.  We've discussed numerous other concepts of the free market, including substitutes, complements, consumer surplus, price controls (ceilings and floors), the Law of Demand, normal goods, inferior goods, elasticity, cost measures, utility and indifference curves.

Television host Stephen Colbert, when interviewing your instructor on the Colbert Report on Tuesday, asked if we learn about "Keynesian economics."  Your instructor answered "no", we learn "free market economics."  What is the difference?

Television host Stephen Colbert, when interviewing your instructor on the Colbert Report on Tuesday, asked if we learn about "Keynesian economics."  Your instructor answered "no", we learn "free market economics."  What is the difference?

Keynesian economics is a theory that began with a liberal British economist named John Maynard Keynes (1883-1946).  Became a favorite of liberals in England 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, "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.

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 it does appear in discussions about the federal budget and overall economy, and its basic meaning is this:  increase government spending to stimulate the economy and reduce unemployment.  It 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 one of the very strongest economies to a distant second behind other world powers.  Does it work any better for the United States today?  The "stimulus bill" passed earlier this year is based on Keynesian economics, and provides a test for its validity.

== Banking the Federal Reserve ==

== Banking and the Federal Reserve System ==

On the same Colbert Report, Stephen Colbert discussed the "Federal Reserve Bank" and interviewed Senator Bernie Sanders, who calls himself a Democratic Socialist (which generated a humorous question).  Senator Sanders called for the resignation or removal of Bernard Bernanke as Chairman of the Federal Reserve.  What, you might ask, is the Federal Reserve?

On the same Colbert Report, Stephen Colbert discussed the "Federal Reserve Bank" and interviewed Senator Bernie Sanders, who calls himself a Democratic Socialist (which generated a humorous question about whether "Democratic Socialist" is an oxymoron).  Senator Sanders called for the resignation or removal of Bernard Bernanke as Chairman of the Federal Reserve.  What, you might ask, is the Federal Reserve?

Created in 1913, the Federal Reserve system is a network of 12 banks (one for each Federal Reserve district around the country) that serve as a "bank for banks."  In each district, hundreds of banks belong to the local Federal Reserve Bank and rely on it for loans and deposits.  The vast majority of all bank deposits in the United States are with banks that belong to the Federal Reserve system.

Created in 1913, the Federal Reserve system is a network of 12 banks (one for each Federal Reserve district around the country) that serve as a "bank for banks."  In each district, hundreds of banks )and thousands of bank branches or offices) belong to the local Federal Reserve Bank and rely on it for loans and deposits.  The vast majority of all bank deposits in the United States are with banks that belong to the Federal Reserve system.

Long ago the economy relied on "commodity monies," which consisted of a commodity (such as silver or gold) serving the function of money.  To buy food or pay rent, someone would pay with silver or gold pieces.  But now we use "bank-debt money," such as paper dollars.  If you read what it says on a dollar bill, can find the bank of which of the 12 Federal Reserve banks issued that dollar bill.

Long ago the economy relied on "commodity monies," which consisted of a commodity (such as silver or gold) serving the function of money.  To buy food or pay rent, someone would pay with silver or gold pieces.  But now we use "bank-debt money," such as paper dollars.  Special markings on each dollar bill signify which of the 12 Federal Reserve banks issued that dollar bill.

The Federal Reserve is supposed to protect the banking system against collapse, while also managing the system in an optimal manner.  It has three basic tools for doing this: First, it can modify the required percentage of deposits that banks must hold in reserves, in case many depositors wanted to withdraw their money at the same time.  This may surprise you but banks ordinarily keep only a small percentage of the deposits on hand; the vast majority of the deposits are loaned by banks to other people at a higher interest rate than what it is paying the depositor.  This is how a bank makes money and can still pay interest to depositors.  But the Federal Reserve (the "Fed") can increase or decrease the percentage that banks must keep on reserves.

The Federal Reserve is supposed to protect the banking system against collapse, while also managing the system in an optimal manner.  It has three basic tools for doing this. First, the "Fed" can modify the required percentage of deposits that banks must hold in reserves, in case many depositors wanted to withdraw their money at the same time.  This may surprise you but banks ordinarily keep only a small percentage of customer deposits on hand; the vast majority of the deposits are loaned by banks to other people at a higher interest rate than what it is paying the depositor.  This is how a bank makes money and can still pay interest to depositors.  To guard against a "run on the bank" (when many depositors panic and demand to withdraw all their money at once), the Federal Reserve (the "Fed") can increase the percentage that banks must keep on reserves.  Such an increase has the effect of "tightening the money supply," or making money more scarce.

The second policy tool -- and the one that attracts the most attention -- is when the Fed changes the interest rate it charges (its "discount rate") to banks.  The higher that rate, the higher the interest becomes for many other types of borrowing. from mortgages to deposit rates.

The second policy tool -- and the one that attracts the most attention -- is when the Fed changes the interest rate it charges (its "discount rate") to banks.  The higher that rate, the higher the interest becomes for many other types of borrowing, from mortgages to deposit rates.  Increasing interest rates also reduces the supply of money, making it harder to obtain mortgages and business loans.

Finally, the third way that the Fed affects the economy is in its market operations: it buys and sells U.S. government securities.

Finally, the third way that the Fed affects the economy is in its market operations: it buys and sells U.S. government securities, the instruments the government uses to finance itself. Buying these securities is the same as loaning the federal government itself money.  Keep in mind that the Federal Reserve is not the government itself, but operates as an independent agency set up by the government.  On its website, as Stephen Colbert humorously observed on his show, the Fed states that it "is not owned by anyone"!

So why are some politicians calling for Bernard Bernanke to resign as Chairman of the Federal Reserve?  Operating with virtually no oversight or accountability, Chairman Bernanke does not seem to have helped the economy much.  National unemployment is 10% (as of December 2009) and many businesses are failing.  In addition, American taxpayers were socked with nearly a trillion dollar bailout package to save many banks from collapse, which is what the Fed was supposed to be making sure did not happen.

So why are politicians calling for Bernard Bernanke to resign as Chairman of the Federal Reserve?  Operating with virtually no oversight or accountability, Chairman Bernanke does not seem to have helped the economy much.  National unemployment is 10% (as of December 2009) and many businesses are failing.  In addition, American taxpayers were socked with nearly a trillion dollar bailout package to save many banks from collapse, which is what the Fed was supposed to be making sure did not happen.

Undeterred, however, students from Rutgers University just won second place in the annual College Fed Challenge, which requires an analysis of about 40 economic indicators like unemployment, inflation, and gross national product (GNP), which is the total market value of all goods and services produced by a nation's economic during the year.  

Undeterred, however, students from Rutgers University just won second place in the annual College Fed Challenge, which requires acting like the Fed in analyzing about 40 economic indicators like unemployment, inflation, and gross national product (GNP), which is the total market value of all goods and services produced by a nation's economic during the year.  

== Review: Short and Long Run ==

== Review: Short and Long Run ==

On the CLEP exam, at least 20% of the questions mention the "short run" or the "long run," or both.  That is a big chunk of the exam.  Do we fully understand the differences, and what they signify?  Let's review this so you can feel comfortable when these terms pop up one exams.

On the CLEP exam, at least 20% of the questions mention the "short run" or the "long run," or both.  That is a big chunk of the exam.  Do we fully understand the differences, and what they signify?  Let's review this so you can feel comfortable when these terms pop up on exams.

The dictionary definition for "short run" and "long run" are fairly 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 buy 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 fairly 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'''.

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 price charged by a perfectly competitive firm in the long run or the short run will still be equal to marginal cost, because that is always true when there is perfect competition, but the relation between that price and the firm's 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 greater than or equal to the firm's 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, and realize that the competition will drive the price to its lowest level possible also: price will equal average total cost as well as marginal cost.  The answer is different for monopolistic competition (see the second on that below).

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.   

A question probing the difference between the short and long run might ask what the basic difference is.  We learned about that in the long run all costs are variable.  So what does that leave for the short run?  '''In the short run some costs of a firm are fixed and unchangeable'''.  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, for example to change the number of buses.  The cost of the buses is fixed, not variable.

 

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, for example 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 ==