Archive for April, 2012

Apr 30 2012

Seeing the forest through the trees – An intro to Macroeconomics!

At this point in the course, you may find yourself asking, “what is the difference between microeconomics and macroeconomics?” It has been a long time since we first defined these terms at the beginning of the course. The purpose of this post is to introduce some basic Macro concepts help clear up the confusing and not so obvious differences between these two areas of economics.

A teacher of mine once explained the difference between micro and macro using the example of a tree and a forest. Microeconomics is the like the study of an individual tree, standing in a thick forest of thousands of individual trees of different species. A microeconomist might study the systems that make an individual tree function efficiently, providing it with the sustanence it needs to thrive in the forest. A macroeconomist, however, will take a broader look at the forest as a whole, and observe how the thousands of trees work together in conjunction with the sun, the soil, the oxygen, nitrogen, and H2O in the environment that make the entire forest function efficiently as one giant organism.

Put literally, the tree is like an individual market. This may be a product market like the market for apples, or a resource market like the market for apple pickers. Microeconomists will study the characteristics of an individual market: the firms and their costs, tradeoffs, challenges presented by competition or the inefficiencies that result from a lack thereof, and the buyers in the market: the alternatives and trade-offs they face, the utility they receive and the decisions they make based on these factors. Microeconomics concerns itself not with the health of the economy as a whole, rather with the individual markets, firms, and consumers within the economy, and the challenges of efficiency and resource allocation faced by those markets.

Macroeconomics, on the other hand, studies the health of the economy as a whole. Macro deals with aggregates, or “collections of specific economic units treated as if they were one. ” For example, instead of studying price of a product, as a microeconomist would, a macroeconomist looks at the price level in the whole economy. Whereas a microeconomist looks at supply and demand in a particular market, a macroeconomist studies aggregate supply and aggregate demand, assessing the collective marginal benefit of all consumers and marginal costs of all producers. Instead of quantity supplied, the macroeconomist examines aggregate output, or gross domestic product. Instead of underallocation and overallocation of resources, the macroeconomists concerns himself with unemployment and inflation.

When it comes to the role of government, macroeconomics has a lot more to say about the role a central government should play in managing the economy as a whole. One major theme of microeconomics is that competitive markets, when left alone by government, tend to achieve efficient allocations of resources. You’ll find that in Macro, however, the government often plays a central part in stimulating and slowing down the level of economic activity in the economy, using tools such as fiscal and monetary policy.

Also in macroeconomics, we’ll study in more depth the role that comparative advantage plays in the economic exchanges that take place between nations. International trade also involves the exchange of foreign currencies, which we’ll try to understand by studying exchange rates and the role that governments play in manipulating and controlling the values of their currencies.

Macroeconomics will prove to be particularly relevant to the events going on in the recent turbulent global economy.  If have listened to the news lately you’ve heard world leaders, political pundits and commentators from all political and economic leanings use words like “bailout”, “fiscal stimulus”, “monetary easing”, “deficit spending” and others; all concepts having to do with macroeconomics. In the next few months, you will begin to see the forest through the trees as we take on the exciting  and challenging field of macroeconomics.

Assignment: Using your economics text and the Economic Dictionary at Econclassroom.com, complete the table below.

  • On the left are microeconomics concepts you have already studied as part of the course. Each of these  concepts needs to be defined or explained. 
  • In the right column are the macro concept that corresponds with each of the micro concepts. Each of these terms or concepts needs to be defined and/or explained. 
Definitions and explanations can be entered into the spreadsheets linked below: (my students: you must be logged in to your school Google Docs account to edit this document!)

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Apr 21 2012

Resources for AP Economics and IB Economics Exam Review

Visit my new site, The Economics Classroom, for review videos, an Economics glossary, worksheets and practice activities and countless other resources to help you prepare for your exams in Introductory, AP or IB Economics. Or go straight to the Economics Exam Review page.

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Apr 20 2012

UPDATE: Golden Balls, Game Theory, the Prisoner’s Dilemma, and the cold rationality of human behavior!

In my original “Golden Balls” blog post (see below), written almost three years ago after I saw a clip of the finale in an episode of the British game show, Golden Balls, I analyzed the actions of Sarah and Steve, who  had to decide whether they would split or steal a jackpot of 100,000 British pounds. The contestants had one minute to try to convince one another that they would split the money; but when it came down to it Sarah stole and Steve split, meaning Sarah got to keep the whole jackpot and Steve went home with nothing.

In that original post, I proposed that Steve’s best chances for going home with any money would have been “for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent.”

In a recent episode of the same game show, a contestant followed a similar strategy to that I suggested Steve should have taken. Watch the clip below, from a February 2012 episode of Golden Balls.

In this episode, Nick immediately takes control of the negotiations by insisting that he is going to steal, which is a very unorthodox approach to this game, in which the traditional strategy is to try and convince your opponent that you are going to split. By establishing a credible threat to steal, Nick puts all the pressure on Ibraham to decide only one of two things:

  1. Does Ibraham trust that Nick will split the money with him after he has stolen the full jackpot, and
  2. Would Ibraham rather both of them go home without any money at all than Nick win the jackpot and possibly not split it with him later on?
Nick’s strategy is brilliant. By the end of the negotiation, Nick has convinced Ibraham 100% that he is going to steal the money. Ibraham may only have had a confidence level of 50% that Nick was honest about splitting the money with him after the show, but with a 50% confidence level, Ibrahim’s possible payoffs are:
  • Choose steal and go home with nothing.
  • Choose split and have a 50/50 chance of going home with half the jackpot (based on his level of confidence in Nick’s promise to split the money after the show).
In other words, with a jackpot of 14,000 pounds, the payoffs for Ibrahim became:
  • If he splits: 0 pounds or 0.5(14,000) = 7,000 pounds
  • If he steals: 0 pounds or 0 pounds (assuming his confidence level in Nick’s intention to steal is 100%).
Clearly Ibraham now has a dominant strategy: to split. In the typical version of this game, a player’s dominant strategy is always to steal (as explained below), since the possible payoffs are:
  • If you split: 0 pounds or half the jackpot
  • If you steal: 0 pounds or the whole jackpot.
But because Nick has convinced his opponent that he will steal, and then split the winnings, Ibraham’s dominant strategy shifted to split, since the possible payoffs have changed. Ultimately, Ibraham does what is most rational given his confidence in Nick’s threat to steal, and that is to split. Ibraham then chooses split (as he should), but then to everyone’s surprise, Nick chooses split, not steal as he had threatened to do throughout the negotiation. This a surprising twist, since from Nick’s perspective stealing is clearly now a dominant strategy! Nick had convinved Ibraham to split, which means Nick faced a greater payoff by stealing. But by splitting, Nick shows that he had intended to split all along, but first needed to convince Ibraham otherwise to establish splitting as Ibraham’s dominant strategy.
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What a thrilling game! I won’t even bother getting into how this relates to economics today, I’m still shaking with excitement over the outcome!
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Original Golden Balls post:
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Teaching the Prisoners’ Dilemma Will Never Be the Same Again « Cheap Talk

Rarely does such a perfect illustration of the Prisoner’s Dilemma come along for Econ teachers to use in their classroom:

The payoffs are clear:

Each player has a weakly dominant strategy, which is to choose to steal. By choosing to steal, the player has a chance at maximizing his own payoff, but will do no worse than he would if his opponent also chooses to steal and at least will have the satisfaction of thwarting his opponent’s attempt to steal the money.

There are three Nash equilibria in the game, which are outcomes at which a player can not do better on his or her own by changing his or her strategy. The outcome Steve was hoping for by chosing “split” (50/50) was not a Nash equilibrium because Sarah knows she can do better if she chooses steal when Steve chooses split. Steve doomed himself by choosing split because he should know that Sarah’s dominant strategy is to choose steal. However, Sarah would also have doomed herself by choosing split because she should assume that Steve would also chose steal since steal is a dominant strategy for him too.

John Nash, who pioneered the field of Game Theory, assumed that humans were coldly rational, self-interested, deceptive creatures that would not hesitate to stab one another in the back to get what was best for themselves. His theory of human behavior is only partially proven correct in this game, in which Steve is shown to be the sucker and Sarah the coldly rational self-interested player. The best chance for Steve to go home with any money would have been for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent. Then again, any promise Sarah makes she could later break, thus further empowering the players to choose steal.

Discussion questions:

  1. What in the world is going on here? Why did Sarah choose steal rather than collaborate with Steve and share the $100,000?
  2. Was Steve totally wrong to choose split? What would you have done in his situation?
  3. How do the choices faced by Steve and Sarah relate to the choices faced by firms in oligopolitic markets? Now that you’ve seen this video, can you explain why collusive agreements between oligopolists often fall apart? Why do cartels such as OPEC often fail to achieve the high price targets agreed upon in meetings of their leaders?

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