Micro Economics Notes Week 2
Micro Economics Notes Week 2 ECON 2106
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This 7 page Class Notes was uploaded by Chapman Lindgren on Thursday August 25, 2016. The Class Notes belongs to ECON 2106 at University of Georgia taught by Till Schreiber in Fall 2016. Since its upload, it has received 92 views. For similar materials see Principles of Microeconomics in Economics at University of Georgia.
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Date Created: 08/25/16
Microeconomics (ECON 2106) Week 2 Notes PPF and Opportunity Costs Production Possibilities and Opportunity Cost The quantities of goods and services that we can produce are limited by our available resources and by technology o Tradeoff: increased production of 1 good = decreased production of something else Production Possibilities Frontier (PPF): the boundary between those combinations of goods and services that can be produced and those that cannot The PPF illustrates scarcity because the points outside the frontier are unattainable. However, any point Production Efficiencyis considered We achieve production efficiency if we produce goods and services at the lowest possible cost Production efficiency occurs are all points on the PPF o Points inside the PPF production are considered inefficient, meaning we are giving up more than necessary of a good to produce “x” number of another good Production inside PPF is inefficient because resources are either unused, misallocated or both o Resources are unused when they are idle but could be working o Resources are misallocated when they are assigned to tasks for which they are not the best match (having a chef cut grass all day) Tradeoff along PPF and Opportunity Cost Tradeoffs involve an opportunity cost. The opportunity cost of an action is the highest-valued alternative forgone There are only 2 goods along the PPF so there is only 1 alternative foregone o Ex: To produce more pizzas we must produce less cola. The opportunity cost of producing additional pizza is the cola we must forgo decrease∈quantityof good produced Opportunity cost is a ratio: increase∈quantityof other good produced Microeconomics (ECON 2106) Week 2 Notes The slope of PPF measure opportunity cost Using Resources Efficiently We achieve production efficiency at every point on the PPF, but which is best? o Allocative efficiency: when goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit The PPF and Marginal Cost The marginal cost of a good is the opportunity cost of producing one more unit of it o Simply put, marginal cost is the cost of moving from one point on the frontier to another On the graph to the right, moving from point “Q” to point “R”, we can see that the marginal cost of going from 5 computers The expansion of production possibilities is called economic growth. Economic growth increases our standard of living The Cost of Economic Growth What causes economic growth? Technological change and capital accumulation o Technological Change: development of new goods and of better ways of producing goods and services o Capital Accumulation: growth of capital resources, including human capital If we use our resources to develop new technologies and produce capital, we must decrease our production and consumption of goods and services o New technologies and new capital have an opportunity cost Gains from Trade Microeconomics (ECON 2106) Week 2 Notes Producing only one or a few goods is called specialization. People gain by specializing the production of the good in which they have a comparative advantage and trading with others Comparative Advantage and Absolute Advantage A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost that anyone else. A person has an absolute advantage if that person is more productive than others Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. You can always have a comparative advantage even if you have no absolute advantage Achieving the Gains from Trade ( Liz and Joe example from textbo)k Liz and Joe produce the good in which they have a comparative advantage: o Liza produces 30 smoothies and 0 salads o Joe produces 30 salads and 0 smoothies Liz and Joe Trade: o Liza sells Joe 10 smoothies and buys 20 salads o Joe sells Liz 20 salads and buys 10 smoothies After trade: o Liz has 20 smoothies and 20 salads o Joe has 10 smoothies and 10 salads Both trade lines (red) have an equal slope because their exchange was of an equal ratio Economic Coordination Microeconomics (ECON 2106) Week 2 Notes To reap gains from trade, the choices of individuals must be coordinated To make coordination work, four complimentary social institutions have evolved over the centuries: o Firms: an economic unit that hires factors of production and organizes them to produce and sell goods and services. Ex: Wal-Mart buys or rents large buildings, equips them with storage shelves and checkout lanes, and hires labor o Markets: any arrangement that enables buyers and sellers to get information and to do business with each other. A place where people buy and sell goods such as fish, meat, fruits, and vegetables o Property rights: the social arrangements that govern the ownership, use and disposal of anything people value. Real property includes land and buildings Financial property includes stocks and bonds and money in the bank Intellectual property is the intangible product of creative effort o Money: any commodity or token that is generally acceptable as a means of payment. In the book’s example of Liz and Joe, they didn’t need money because they exchanged salads and smoothies. Circular Flows Through Markets The figure below illustrates how households and firms interact in the market economy Factors of production and goods and services flow in one direction (red). Money flows in the opposite direction (green). Microeconomics (ECON 2106) Week 2 Notes Example Problem 1 : My neighbor and I have the same value of Saturday afternoon leisure. But, our cars need oil changes and lawns need mowing. Time to change oil Time to mow lawn Jim 15 minutes 30 minutes Till 60 minutes 45 minutes a) Who has an absolute advantage in chores? Jim, he’s better and more productive at doing both chores. b) In a no trade scenario, Jim works for 45 minutes, Till works for 105 minutes. c) What are the opportunity costs? a. Jim: 2 oil changes. The opportunity cost of Jim mowing 1 lawn is 2 oil changes b. Till: ¾ of an oil change. i. Till has comparative advantage in mowing the lawn because he has a smaller opportunity cost. Jim has to give up more to mow the lawn. Till has comparative advantage in mowing lawns Jim has comparative advantage in changing oil d) Specialization and Gains from Trade a. Till mows both lawns; Jim changes oil for both cars b. Till works for 90 minutes; Jim works for 30 minutes i. Both are now better off than how they were in part b Microeconomics (ECON 2106) Week 2 Notes Example Problem 2 : Suppose Virginia and Nebraska both produce Tobacco and Corn. Assume that Virginia and Nebraska have the same amount of productive inputs. a) What is the opportunity cost of producing one bushel of corn in both states? (Opportunity cost can be found by calculating the slope of the PPF. Linear PPF = constant opportunity cost). 600 6 3 a. Virginia: 400= 4 2 tons of tobacco (for every 1 bushel of corn) 4 b. Nebraska: tons of tobacco (for every 1 bushel of corn) 5 b) Nebraska has the comparative advantage in producing corn because it has lower opportunity cost. Virginia has the comparative advantage in producing tobacco c) Suppose they trade. What is the price range of corn you might expect to see (in terms of tobacco)? a. Trade line moves from (0,600) to (1000,0). The slope of this line would be in between 3/2 and 4/5. The actual location of the point depends on how good the negotiators from each state are. Example Problem 3 : According to the theory of comparative advantage, country x would find it most advantageous to...? Wheat Corn X 10 5 Microeconomics (ECON 2106) Week 2 Notes Y 8 8 a) Export both wheat and corn b) Import both wheat and corn c) Not trade d) Export wheat and import corn e) Export corn and import wheat Coordinating Decisions Markets coordinate decisions through price adjustments o Suppose a ton of people who want to buy ice cream can’t. To make buying and selling plans the same, more ice cream must be offered or fewer people can want ice cream. Increasing the price of ice cream will force this equilibrium When the price is right, buying plans and selling plans match
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