# Lecture 01 Introduction and Math Review

## Marginalism

• Average Cost -- total cost divided by quantity
• If I spend 300 hours preparing 30 lessons for you, then my average cost is 10 hours per lesson.

• Sunk Cost -- costs that can no longer be avoided because they have already been "sunk"
• If I teach this class again next semester, I will have already sunk 300 hours into preparation.

• Marginal Cost -- cost of producing one more unit
• Next semester I can recycle my notes, so my marginal cost per lesson will equal 75 minutes.
• (Compare that with my current 10 hours!)

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## Opportunity Cost

• We all face choices because resources are "scarce."
• We cannot spend more time or money than we have, so we have to give up one opportunity to take advantage of another.

• If I have a choice between earning $1000 per month by teaching this course OR earning$500 per month by working at McDonald's, then:
• It takes me one month to produce $1000 worth of teaching. • It takes me one month to produce$500 worth of hamburgers.

• Q:   What's my opportunity cost of teaching?
• A:   Half a hamburger per unit of teaching.

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## Math -- Tools for Economic Analysis • point plotting (X,Y):
• the first point in a pair lies on the X axis (horizontal axis)
• the second point in a pair lies on the Y axis (vertical axis)
• The following equation is plotted in red squares:
$y=-5x+20$
• and its line is drawn by connecting points: (0,20), (1,15), (2,10), (3,5) and (4,0)
• the slope of a line is the change in y divided by the change in x
• y decreases from 15 to 10 when x increases from 1 to 2
• so the slope is -5
$\frac{\Delta y}{\Delta x}=\frac{10-15}{2-1}=\frac{-5}{1}=-5$
• the y-intercept is the value of y, when x=0
• y=20 when x=0
• so the y-intercept is 20

... • slope is positive if y increases as x increases
• the equation below (and plotted in blue circles) has positive slope:
$y=4x+1$

• slope is negative if y decreases as x increases
• the equation below (and plotted in red triangles) has negative slope:
$y=-2x+15$

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## Analyzing Graphs • Suppose that the relationship between income and consumption is:
$C=0.60Y+14000$
• where:
• C = consumption
• Y = income

• The income coefficient (0.60) is the marginal propensity to consume.
• consumption increases as income increases, but
• a $1000 increase in income only increases consumption by$600

• At higher income levels, consumption is less than income. (Higher income households save).
• At lower income levels, consumption is greater than income. (Lower income households dissave).

• Along the 45 degree line, income equals expenditure.

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## A Few More Definitions

$C=0.60Y+14000$
• Model -- formal statement of a theory (often presented mathematically)

• Variable -- a measure that can change (for example: income and consumption)
• dependent variable
• independent variable
• In the example above, consumption depends on income.

• Parameters -- value which remain constant in an equation (in the example above: 0.60 and 14,000)
$Y=C+I+G+\left(X-M\right)$
• Ceteris Paribus -- "all else equal"

• How does an increase in investment, I, affect national income, Y?
• To determine the effect of investment alone (on income), we must hold all other variables constant.

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## Micro vs. Macro

### Microeconomics

• Studies the decision-making of individuals, households and firms
• Studies the distribution of wealth and income

### Macroeconomics

• Studies the behavior of the economy as a whole
• Explores the factors that affect:
• Gross Domestic Product
• the price level
• the unemployment rate

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## Positive vs. Normative Economics

### Positive

• No judgements
• Just asking how the economy operates

### Normative

• Makes judgements
• Evaluates the outcomes of economic behavior
• Makes policy recommendations

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## Economic Policy

• Positive -- economic policy starts with positive theories and models to develop an understanding of how the economy works
• Then economic policy normatively evaluates outcomes on the basis of:
• Efficiency -- Is the economy producing what people want at the least possible cost?
• Equity -- Is the distribution of wealth fair?
• Growth -- Increase in total output of the economy.
• Stability -- steady growth, low inflation and full employment
• And recommends (normative) courses of action to policy-makers (presidents, congressmen, etc.)