Economics: What is GDP???

Difficulty: 1/3 (Not a bad way to start macro-economics)
Review: 4/5 (Pretty well explained)

With the new year coming around, this blog's focus will shift from microeconomics to macroeconomics. But what is the difference? Microeconomics focuses on how individual households and firms make decisions and how they interact with one another. On the other hand, macroeconomics is the study of entire economies, where changes simultaneously affect many households, firms, and even markets.

The first topic of macroeconomics we will learn is GDP - gross domestic product, the most important economic statistic because it is thought as the best single measure of a country's economic well-being. GDP is the total income of a country and also the total expenditures of a country. This is because income equals expenditure, since every transaction has a buyer and a seller.

GDP per capita is the average person's income.

Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time.

-GDP adds all products together to one measurement, for example if an apple was priced twice an orange, an apple contributes twice as much to GDP.

-It also tries to be comprehensive, including intangible and tangible products and services. The government has to estimate the GDP of some things like owned houses, in this case as if the owner was self-renting. It also excludes illicit transactions like illegal drugs.

-The GDP only counts final goods, meaning it doesn't count intermediate goods. For example, if there was paper produced only to be made into a Hallmark greeting card, the GDP only calculates the value of the greeting card. There is an exception to this principle if the intermediate good is going to be stored for the future, in this case, its value as an inventory investment is added to GDP.

-GDP is confined to the country in which it is calculated. An American-owned factory in Haiti is part of Haiti's GDP rather than America's. A Canadian temporarily working in the U.S. contributes to American GDP for the duration he stays in America.

-GDP is measured in a specific time interval. Usually that interval is a year or a quarter (three months). Quarterly calculated GDP is then multiplied by 4 to represent annual GDP. Statisticians also use something called seasonal adjustment to account for holiday shopping season and other miscellaneous patterns in order to look past them.

The components of GDP are consumption, investment, government purchases, and net exports. Consumption is spending on goods and services. Investment is spending on capital equipment, inventories and structures (including new housing). Government purchases (otherwise called government consumption expenditure and gross investment) is spending by the government. Note that this does not include transfer payments like Social Security because it is not an exchange for a currently produced good. Finally, net exports are domestically produced goods shipped to foreign countries minus imports.

Nominal GDP is calculated using the current prices, Real GDP sets a previous GDP's prices as a base price, and calculates GDP based off of those old prices. Real GDP reflects changes in output and is more useful. GDP deflator is Nominal GDP divided by Real GDP multiplied by 100, and shows percent change in price.

Why does GDP matter? It matters because a larger GDP has positive correlation with a better quality life. This is because nations with larger GDP can afford better healthcare, education, and more. They can focus on laudable attributes instead of acquiring material necessities for living.

However, GDP is not a perfect measure of well-being. One incredibly high income person could offset the rest of the population by appearing to give them a high GDP. Transactions taking place within the home are not calculated either (for example a chef making dinner for the family). Volunteer work is also excluded.

Still, GDP is an important measurement to economists. But measurement is only a starting point. In the future, we will learn how governments use GDP to promote growth, why Japan has more GDP than Nigeria, and other interesting topics in the grand scale of macroeconomics.

Economics: Facts of Factors of Production

Difficulty: 1/3 (See below)
Review: 4/5 (It's because 80% of the chapter should be review, haha, get it?)

This chapter focuses on factors of production: land, labor, and capital; the three inputs used to produce good and services. The demand for these inputs is known as derived demand, since it is derived from its decision to supply the good these inputs provide in another market.

Assuming the firm is competitive and profit maximizing, the market for the firm's good has a normal sloping supply and demand curve as well. Since it is competitive, it is a price taker for its good and its wages.

As learned before, the production function shows output with respect to input. It has diminishing marginal product due to coordination costs. Marginal product is the increase in amount of output with one more unit of input, downward sloping. Value of marginal product is marginal product multiplied by price, also downward sloping.

Logically, such a firm will hire workers until value of marginal product of a worker is equal to to wages.

Some things that shift the demand curve for labor (value of marginal product slope) is the output price, since price * marginal product = value of marginal product. Technological change usually makes demand shift right, but mechanized labor might reduce demand. Supply of other factors could also affect demand for labor.

Now, we discuss supply of labor. There is obviously a trade-off between work and labor, where opportunity cost of leisure is what you could've earned. We assume here that higher wages means working more for simplicity (supply curve slopes upward). Shifts in supply happen when there is a change in tastes, alternative opportunities, immigration, etc.

To connect these both, we must realize that a change in supply or demand for labor changes the equilibrium wage and the value of marginal product the same amount because these values must be equal.

Since the value of marginal product = wages, more productive workers earn more money and thus higher wages means better productivity and better standards of living.

Capital = the stock of equipment and structures used for production (accumulation of goods made in the past now being used the produce more goods). For example, ladders to climb trees, apple transport trucks, storage buildings, and the apple trees themselves.

There's rental price and purchase price too, you should know the difference. The equilibrium price of land or for capital also is equivalent to the value of marginal product those factors bring to the purchasing firm.

Economics: Oligopolies

Difficulty: 2/3 (A lot of content)
Review: 5/5 (Love the introduction of game theory)

Perfect competition, Monopolistic competition, oligopoly, monopoly. That is the scale of competition, where oligopoly is basically a market controlled by a few firms. It, along with monopolistic competition is known as imperfect competition.

A concentration ratio is the percentage output of a market for the top four firms, i.e. the breakfast cereal has a concentration ratio of 83%.

A duopoly is a market with only 2 firms, hence, 'duo'. When multiple firms cooperate and collude in collusion, they form a cartel. The Nash equilibrium is where one economic participant chooses a strategy based off of the strategies of the other participants. For example, in a duopoly, if profit maximization took place at output of 30 for each of them for a total of 60, and one firm chose to produce at 40, the other firm would choose to find the Nash equilibrium and produce 40 as well.

This tension between cooperation and self-interest causes the price and quantity in an oligopoly market to be in between the socially optimum (competitive) and monopolistic price and quantity.

Each firm makes decisions off of the output effect, raising production by 1 raises profit if price is above marginal cost; and the price effect, since quantity increases, profits decrease on average for all other units sold. Notice that as the oligopoly grows in size (in firms), the price effect disappears and leaves only the output effect and then every firm produces where P = MC. Thus, the more sellers there are in an oligopoly, the more it becomes like a competitive market.

To understand oligopolies, we must understand game theory: the study of how people behave in strategic situations. The prisoner's dilemma highlights the concept of cooperation vs. self-interest. It's where two prisoners choose to confess because whether the other prisoner confesses or not, the prisoner gets a better result if he/she confesses. This happens although the best scenario for the both of them occurs when neither confess. The individual strategy that is best for each player, in this case confessing, is called the dominant strategy.

The prisoner's dilemma relates back to oligopolies because although initially the firms may be outputting at the scenario where profits are maximized for all, a firm will eventually defect because it brings them more profits even though total profits for all decreases. This happens in OPEC, arms races, common resources (like oil drilling, one or two wells?), and more. It seems the best strategy is called tit-for-tat in the long term. A player should start by cooperating and then do whatever the other player did last time, basically, an eye for an eye.

The Sherman Antitrust Act of 1890 (declaring collusion as illegal) and the Clayton Act of 1914 (encourage lawsuits against legitimate economic conspirators) fight mergers and trusts and etc.

There are some other controversial business practices. They are controversial because some business practices that appear to reduce competition may in fact have legitimate purposes. One is resale price maintenance/fair trade, when a firm requires retailers to charge a certain higher price. Some argue that it doesn't allow for the retailer to compete on price, but others argue that the firm wants the retailer to invest more in sales force. Another is predatory pricing, changing prices like attempting to make price cuts in order to knock out rival firms from the market. It seems predatory pricing actually isn't profitable. Finally, there is tying, basically packaging two products together for sale. Some argue that companies pair unwanted products with more popular ones in order to sell more, while others argue that tying doesn't change willingness to pay and that it provides a form of price discrimination.

'Twas a long chapter.

Economics: Monopolistic Competition

Difficulty:  1/3 (many repeated concepts)
Review: 4/5 (average)

Monopolistic competition occurs when there are no barriers to entry, but all firms create different products, e.g. authors and books. Like a monopoly, profit is maximized at  MR and MC's intersection point. In the short term, a firm can make profits or losses, but over time, ATC drifts toward price at the profit maximization point, similar to like in competitive markets so they make normal profit.

Excess capacity is the region where ATC continues to decrease as quantity increases, while efficient scale is the point where ATC is minimized. Markup is the difference between marginal cost and price. This makes monopolistically competitive firms more willing to accept customers since P > MC.

When firms enter this type of competition, there is the product-variety externality which is positive as consumers see a new product, while there is also the business-stealing externality, negative as one firm takes customers from another.

Advertising is an example of monopolistic competition, with differentiation between products. Some say advertising is just psychological, impedes competition by paying more for similar goods, etc, while others say that it fosters competition by telling information, make entry easier, etc.

Advertising is also a signal of quality, the more expensive the ad, the better the product usually. There's also brand names. Firms with famous brand names gives them incentive to keep up their good quality, but also allowing them to charge more

Economics: Monopoly (not the board game)

Difficulty: 1/3 (Similar concepts compared to the previous chapter)
Review: 4/5 (Could use more explaining why MR is less than P)

A monopoly is created if it is the sole seller of a product without close substitutes- other firms can't enter because of barriers of entry. These entries are (1) a key resource is owned by a single firm, (2) the government gives a single firm exclusive right to produce a good/service like through a copyright or patent, (3) the cost of production makes a single producer more efficient than multiple producers.

Earlier, we discussed natural monopolies. These goods are excludable not rival in consumption. They are also created when a single firm can supply a good/service at a cost lower than with multiple firms. This also means that economies of scale, with more output in the single firm, ATC is minimized; however, when multiple firms are producing, ATC is greater amongst each of them.

The monopoly's demand curve is downward sloping because it is the price maker, and with changes in price the quantity demanded of course changes. On the other hand, as described previously, a competitive firm's demand curve is flat as a price taker.

A monopolist's marginal revenue is always less than the price of the good. This is because the downward sloping demand curve contributes to the marginal revenue decrease as more is produced. Revenue (P x Q) is affected by the output effect when more output is sold, Q is higher, but also the price effect, the price falls, so P is lower.

Profit maximization occurs where marginal cost and marginal revenue intersect. Since marginal revenue is less than demand, the profit maximization point for monopolies results in a quantity less than the equilibrium efficiency point, creating a deadweight loss. Thus, monopolies maximize producer surplus but not total surplus. Note that the only reason why there is a social cost is because of the deadweight loss, the "economic pie" is smaller, not just only skewed towards the producer.

The monopoly's profit can be measured by (P - ATC) * Q where Q is determined by the intersection of MC and MR and P is determined by demand curve at that Q.

There are 4 policies to respond to monopolies the government can do. (1) They can increase competition in the market, with antitrust laws, (2) regulation like setting the price to be marginal cost, (3) public ownership, (4) and doing nothing.

Price discrimination can also be employed by the monopolist, perfect if they know the willingness to pay of every customer and the producer gets all the surplus- effectively removing deadweight loss but giving all surplus to the producer.

Economics: Firms in a Competitive Environment

Difficulty: 2/3 (Not enough numbers; math is easy but concepts are hard)
Review: 4/5 (I guess it's okay)

We return to the definition of the competitive market: goods offered are identical for all the firms and there are so many buyers and sellers there is no market power. Added to the definition is that firms can freely join and exit the market.

We define average revenue as total revenue over output and marginal revenue as the change in total revenue with one additional output. Average revenue equals the price of the good.

Firms maximize profit by creating and selling until the marginal cost is equal to marginal revenue.

Firms can shut down or exit the market if conditions are not suitable. To shut down is to temporarily not create anything (still pay fixed costs) while to exit is long term. A sunk cost is something committed that cannot be recovered, like lost money. You shut down if P < AVC and you exit if P < ATC. This means firms consider exiting before shutting down, since there is a sunk cost if shutting down only.

Profit here is measured by (price - average total cost) * quantity. In the long run, exit and entry stops when price and average total cost are equal. This takes place at the efficient scale since its at the lowest point on ATC curve. Even if economic profit is zero, accountable profit is positive so that's why some business stay in the market even if they just meet the minimum.

When demand increases, in the short run there is profit, but over time more firms are created and equilibrium is stored so the intersection is at the no profit point. But, sometimes long run supply curve slopes upward because of limited land, pickiness of new entrants, etc. so economic profit could still exist even in the long run.

Economics: The Cost of Production

Difficulty: 2/3 (So many names for so many curves)
Review: 4/5 (Boring chapter, as Mankiw at least honestly puts it)

What are the costs for the supplier? There's profit, revenue - total cost. Total cost includes explicit costs which are direct costs that an accountant would know and implicit costs like what you could've been earning, only something an economist would take into account.

Random Fact: Industrial organization is the study of how firm's make decisions based off market conditions.

The production function graphs quantity of output in respect to number of workers and the total-cost curve graphs total cost in respect to quantity of output. The production function curves upwards steeply then more flatly because of diminishing marginal production as coordination becomes more difficult. The total cost curve curves upward slowly then steeply as marginal cost increases just as explained in production function.

There's fixed costs like rent but some costs are variable as output changes like number of workers hired or amount of supplies to make the product needed. This introduces average total cost, which includes average fixed cost and average variable cost too, each with their own unique curve on the total cost curve.

The average total cost curve is more steeply u-shaped in the short run, and is also dependent on size of the firm. In the long run, the ATC forms a very flat u-shape.

Economies of scale is when in the long run as output increases, ATC decreases, as shown with specialization. On the other hand, it is said to be diseconomies of scale if ATC increases as output increases, as shown with difficulty of coordination.

More information on the actual shapes of the curve can be found online.

Economics: The Public Sector

Difficulty: 3/3 (It is difficult to cleanly define the four types of goods)
Review: 3/5 (Some of the examples they give for the four types of good are hard to grasp)

Everything we have learned up to this point is just the private market. What if something was free though? The private market wouldn't be able to make itself efficient. Thus, government policy can potentially save the market by deciding the cost vs benefit.

Products are either excludable or not excludable. A good is excludable if people can be prevented from using this good. An example of an excludable good is toll roads, and an unexcludable good is like the environment.

Goods are also either rival in consumption or not. This means that someone having the good limits other's ability to have that good. Clothes are rivals in consumption while a cable TV show is not.

In this chapter, Mankiw discusses the non-excludable goods, called common resources if they are rival in consumption and public goods if they are not rival in consumption.

Public goods have a problem because there tend to be free riders, so the government can find ways to tax to pay for the costs of that public good. Examples include national defense, free knowledge (theorems, etc.), and fighting poverty. Governments use cost benefit analyses to determine the value of these goods.

Common resources are summed up in The Tragedy of the Commons. Sheep grazers raise too many sheep and the land becomes barren and unusable. This is because although the land was not excludable, it was rival in consumption because one grazer's use of the land limited the other's use. Other examples include clean air and water, congested roads, wildlife (like poached animals), etc. To solve this, governments can make taxes, regulate, give permits, or change the good into a private one by making it excludable.

Whew, this chapter has a lot to tell.

Economics: Externalities

Difficulty: 2/3 (Graphs are a bit hard to grasp, other than that, easy concepts)
Review: 4/5 (Externalities are reviewed well in this chapter, but graphs are not explained as well)

We return to the Ten Principles of Economics for this chapter, where we discuss how externalities cause market failure. An externality, whether positive or negative, is when the market doesn't take into account the affects of transactions on bystanders. An example of a negative externality is like pollution, and a positive one is technology spillover.

Since externalities cause market failures, there has to be solutions. One type of solution is the private solution, where people trade or make contracts, as stated in the Coase theorem to satisfy each other. This doesn't always work due to transaction costs (translators, lawyers, etc.)

The government can also make solutions. There can be Command-and-Control by regulation, like only allowing a certain amount of pollution to be legal. There's also Market-Based like using corrective taxes/subsidies, so parties get to decide what is efficient to them for a price. Another Market-Based policy is permits, where people trade rights to continue these externalities, e.g. tradable pollution permits.

All in all, a free market sometimes will not work out due to these externalities. Fortunately, suppliers, consumers, and the government can help to solve them.

Economics: The Costs of Taxation

Difficulty: 1/3 (Talks about the application of concepts discussed in earlier chapters)
Review: 5/5 (Mankiw does a great job of providing real world examples of the discussion of tax)

Earlier, the book described the detrimental effects of taxes, shrinking the market and reducing efficiency. But taxes are necessary for funding education, enforcement, and more.

Now, we learn how to measure the benefits and losses from the tax. The money the government gets is called tax revenue, the area of the rectangle with a height equivalent to the size of the tax and a width equivalent to the quantity demanded after the tax. Of course, since the market shrinks, total surplus is also reduced; the amount of total surplus lost is known as the deadweight loss of tax, represented by the triangle with the three points: the equilibrium, the price buyers pay, and the price sellers receive.

The deadweight loss occurs because some buyers are discouraged by the increased cost from the tax. The size of the deadweight loss is affected by the elasticities of supply and demand, and the size of the tax.

The Laffer curve represents the shape of the tax revenue as tax size increases. This concept sparked much debate in the United States as government policymakers wondered if they were taxing too much and discouraging labor or taxing too little to provide the government more revenue for helping the nation.

Economics: Consumers, Producers, and the Efficiency of Markets

Difficulty: 1/3 (Very little confusing opposite concepts like normal vs. inferior, etc.)
Review: 3/5 (Repetitive for a chapter, felt like the chapter was too simple to really be a chapter)

The chapter starts off with the simple concept of 'willingness to pay', all in the name really. It's how much the buyer values the good, at a certain price, the buyer won't be willing to buy it any more. Since the price drifts towards the equilibrium, the buyer's purchase price is often going to be below the buyer's maximum (willingness to pay value). Mankiw now introduces consumer surplus, the difference of the willingness to pay to what the buyer actually pays- this means the greater the consumer surplus, the better deal the buyer thinks they get.

Mankiw uses staircase graphs to show this, but to put in terms more mathematically, one can envision integrals as learned in calculus, where the x-axis can be represented by the equilibrium price line and the integral represents the area between the sloping demand and the price. Mankiw only uses rectangular staircases to demonstrate small scale examples of this as to simplify the explanation.

Lower prices will not only benefit new consumers now willing to pay but initial consumers save more as well.

There is also producer surplus which corresponds to cost and willingness to sell, really the same explanation as the consumer surplus except instead the surplus area is above the upwards sloping supply curve.

Higher prices will not only benefit new suppliers but also benefits initial suppliers who now ear more as well.

Again, the book demonstrates the perfect free market where equilibrium once again triumphs with providing the best scenario with giving both buyers and sellers maximum surplus. But this will not always be the case, Mankiw notes, foreshadowing the coming complex chapters.

Economics: Supply, Demand, and Government Policies

Difficulty: 1/3 (Easy read, graphs may be somewhat difficult to decipher)
Review: 5/5 (The taxing part is hard to explain, but Mankiw does his best and it's good)

This chapter's focus is on policies, policy-making being the other role that economists take on other than being scientists. A variety of different policies affect the economy, including those of taxes, price floors/ceilings, minimum wage, etc. What are the effects?

For price ceilings, one above the equilibrium is non-binding, while one below the equilibrium is binding, and very detrimental to the market, causing shortage. It's the vice versa for price floors, they should be below the equilibrium to not be binding. (Minimum wage ends up falling in this category as a price floor for the labor market)

Next, Mankiw discusses taxes and tax incidence, the distribution of a tax burden. Taxes on buyers turn out to reduce the demand of the good by the amount of tax and reduces market size. Taxes on sellers reduce the supply of the good by the amount of tax and also reduces market size. Although in these two cases the buyer or the seller is taxed, it turns out both share the same tax incidence. So when the government tries to set tax incidence to fifty fifty, they should take into account supply and demand forces first.

Again, we turn to elasticity to measure whether the buyer or seller takes on more of the tax burden. Of course whichever curve is more elastic takes on less of the tax burden.

All in all, an economist policy maker must take into account elasticity and the laws of supply and demand if they are too successfully architecture a policy that does as intended.

Crisis Actors? Economics? What?

Difficulty: 3/3 (Requires a lot of historical knowledge to read)
Review: 4/5 (Really interesting article, except the quotes and pictures at the beginning should have been dispersed throughout the article instead of before, very confusing)

*This blog post is not on Mankiw's Economics textbook. Rather, this is an exception, and will be an analysis of the Salient article: Crisis Actors and a Reichstag Fire. The link can be found here: http://www.salientpartners.com/epsilon-theory/crisis-actors-reichstag-fire/ *


There was once this Danish folktale about a foolish emperor. When a clever merchant told him of a beautiful garment that was transparent, the emperor gladly purchased it. Now, wearing this "garment", the emperor flaunted it around his people. Up front, the people would all praise the emperor for his fashion, but behind his back, they laughed at the silly naked emperor. Finally, a truly loyal friend reveals the truth to the emperor and he suicides in his own shame.

"...acting AS IF doesn't mean acting AS" This short quote is my favorite line in the article. It summarizes much of the main idea the author wanted to convey. The author's intent was to inform the people to not be like patsies, like the emperor described above. He tells us how the media is plagued with various self-interests, persuading rather than informing; it's just the way of human nature. But the author, Ben, tells us to be cautious and self-aware. Although we as individuals may not have it in our best interests if we do not comply with the messages, we should always keep the truth and look through the crisis actors (patsies putting a show up for the broadcaster), and instead keep in mind that everyone has a bias or a motive.

What has this patsy nonsense have to do with economics, you ask? Well, in keeping your mind above the crisis actors and twisted truths, you are more likely to identify actual problems in the world of politics and economics. Although central banks and such may blame various scapegoats, by following their motives and not falling for their narratives, one can possibly identify the catalysts and prepare for when the actual crisis hits.

Economics: Elasticity and Its Application

Difficulty: 2/3
Chapter Review: 3/5 (Not enough discussion on using the midpoint method. Having trouble answering the problems at the end of the chapter involving elasticity calculations due to lack of example problems)


Last chapter we learned of the forces of supply and demand. This chapter is about measuring that force, determined by the price elasticity.

What is elasticity? Before studying economics, one might think of the word flexibility. And that is essentially what it means in economics. One type of elasticity, the price elasticity of demand, is essentially the flexibility of the demand in response to a change in price. Factors that affect this are availability of close substitutes, whether it is a necessity vs. a luxury, narrowness of definition of the market, and time horizon. To calculate, simply take percent change of quantity demanded over percent change in price.

Mankiw also introduces total revenue, a.k.a. Price x Quantity of a market. In inelastic markets, price and total revenue have a positive relationship, elastic ones have a negative relationship, and n unit elasticity, total revenue remains constant.

Some other "elasticities" include the income elasticity of demand, the cross-price elasticity of demand, and the price elasticity of supply.

All in all, using elasticity in economics is very important. It can be used in a variety of situations, like to analyze how technology really affects farmers, how OPEC controls oil prices, and possible options to fight drug related crime. Armed with this newfound information, an economist can do so much more.

Economics: The Market Forces of Supply and Demand

Difficulty: 1/3
Chapter Review: 4/5 stars

The phrase "supply and demand" is indeed a well known one, and quite a simple, reasonable concept as well. Mankiw really goes in depth to explain and analyze this pattern in economics. The only issue I have with this chapter is that the figures are often placed on a different page from the explanations, and some figures are hard to read, especially the ones defining surplus and shortage.

One of the first things that Mankiw brings up is that the forces of supply and demand only occur in a competitive market (multiple sellers opposed to only one seller). This is very essential since without competition, such a monopoly would have sole control over prices and thus supply and demand.

Mankiw does a wonderful job of dissecting the force into demand curves and supply curves. He describes the factors that affect shifts in them, such as number of buyers, prices of related goods (substitutes vs. complements), expectations, and more.

Finally, the chapter concludes with the actual definition of this invisible "supply and demand" force. It is that supply and demand curves meet at an equilibrium where the supply and demand are equal so that there is no surplus or shortage. The market tends to move towards the equilibrium over time, and it is this movement that defines the supply and demand force. This invisible hand is exceptionally important in economics because many factors such as weather and input prices and technology could shift the demand and/or supply curves and thus shift the equilibrium, ultimately affecting the productivity and economic activity of a market.

Greetings!

Greetings! My name is Kevin, and I am a junior taking AP Economics this year. This blog will be completely dedicated to the study of economics and will be based off of N. Gregory Mankiw's Principles of Economics, a detailed textbook that hopefully teaches all I need to know about how economics affects the world. Each post will be about a chapter in the book, and I will do my best to provide an explanation of each. Even if you aren't taking economics, please feel free to take a look at my blog, for I am sure there will be treasure troves of useful information regarding the economic cycle that everyone is a part of. Have fun!