Principle of microeconomics

PRINCIPLES OF MICROECONOMICS Professor Karen Leppel Widener University P D S Q Resource Utilization Economics: The study of the allocation of scarce resources The Economic Problem: How we use scarce resources to best satisfy unlimited human wants? To say that a good is scarce means that less of the good is freely available than consumers would like examples of scarce goods: bread, spinach, clean water, parks MACRO OR MICRO ? Macroeconomics: analysis of the economy as a whole Microeconomics: analysis of the behavior of individual decision-making units, such as individual households or businesses positive economics: what is or will be normative economics: what ought to be ceteris paribus: other things constant apples $0.30 At a particular price of apples, people buy a certain quantity of apples apples $0.30 $0.50 Ceteris paribus, when the price of apples increases, people buy fewer apples But suppose people’s incomes increase at the same time that the price of fruit goes up Perhaps, originally we had a little income Comparative Advantage and Gains from Specialization and Trade Consider two people, Carl and Sam Both are in the construction business Suppose that Carl can build brick houses in a month If he makes frame houses instead, he can build frame houses in that month Sam can build brick house in a month If he makes frame houses instead, he can build frame house in that month Person A has an absolute advantage over person B in the production of a good if person A can produce the good with fewer resources than person B or equivalently, that person A can produce more of the good than person B with the same resources In our example, Carl has an absolute advantage over Sam in the construction of both frame and brick houses For Carl, the opportunity cost of producing one brick house is two frame houses For Sam, the opportunity cost of producing one brick house is one frame house So the opportunity cost of the production of a brick house is lower for Sam than for Carl For Carl, the opportunity cost of producing one frame house is 1/2 brick house For Sam, the opportunity cost of producing one frame house is one brick house So the opportunity cost of the production of a frame house is lower for Carl than for Sam Person A has a comparative advantage over person B in the production of a good if person A has a lower opportunity cost of producing the good person Sam Carl comparative advantage brick frame Law of Comparative Advantage: The total output of a group, an economy, or a group of nations will be greatest when the output of each good is produced by the person (or firm or nation) with the lowest opportunity cost Let’s see how this law applies to Carl and Sam 12 Months Production without Specialization Carl Sam Total frame 16 22 brick 16 22 11 Months Production with Specialization Carl Sam Total frame 22 22 brick 11 11 22 Recall that the opportunity cost of brick house for Sam is frame house If Sam can trade some of his brick houses for at least one frame house per brick house, he will be happy The opportunity cost of brick house for Carl is frame houses If he can get some brick houses from Sam for less than frame houses per brick house, he will be happy So the terms of trade will be between and frame houses per brick house After construction, Carl and Sam have the following: Sam brick frame build 11 Carl brick frame 11 22 Suppose that Carl and Sam agree to trade frame houses for brick houses So we have Sam Carl brick build 11 trade -5 frame +6 brick 11 +5 frame 22 -6 The result is: Sam Carl brick build 11 trade -5 result frame +6 brick 11 +5 16 frame 22 -6 16 Now Carl and Sam each have the same number of houses as before specialization and trade However, they are better off now because they get a month of vacation Alternatively, if they worked a 12-month year, they could produce more houses than before Comment: It is comparative advantage, not absolute advantage, that makes gains from trade possible [...]... unit of clothing? This amount is the slope of the production possibility frontier slope = ( ∆Food / ∆Clothing) |slope| option Food Clothing A 11 4 | ∆F/∆C | 1/1 = 1 2/1 = 2 3/1 = 3 B 10 5 C 8 6 D 5 7 As the amount of clothing increases and the amount of food decreases, the amount of food that you have to give up in order to get another unit of clothing increases Why? When you are producing a lot of. .. opportunity cost of going to a basketball game may be the five or ten extra points that you might have earned on an exam by staying home and studying that night Production Possibilities Frontier or Production Possibilities Curve (PPF or PPC): a curve that outlines all possible combinations of total output that could be produced assuming ◆ fixed resources ◆ full and efficient use of resources ◆ fixed... negatively sloped, reflecting the tradeoff between your History and Economics grades You can only do better in one course if you do worse in the other 84 72 60 48 60 72 84 96 Economics Grade The Production Possibility Frontier shows the best you can do in current circumstances You have fixed resources your brain and your time ◆ You are making full and efficient use of those resources You are not getting... price of apples has gone up The ceteris paribus assumption (other things constant) has been violated Income is not constant Association is not Causation Suppose we see both wages and prices rising Did the increase in wages cause the increase in prices? Did the increase in prices cause the increase in wages? Perhaps neither Other factors could be causing both wages and prices to rise Fallacy of Composition:... fixed resources your brain and your time ◆ You are making full and efficient use of those resources You are not getting up to get a snack every five minutes ◆ You have fixed technology Your knowledge of study techniques is fixed ◆ Suppose your circumstances change Perhaps you quit your job, so you now have more time for studying Before, the only way you could get an A in Economics is if you flunked... a few resources used to produce food These are the ones that are much better at making food than at making clothing If you move those resources from food to clothing production, you will give up a lot of food for only a little clothing food Production Possibility Frontier (PPF) 11 10 8 5 0 4 5 6 7 clothing The concave shape reflects the changing slope we just described We see this shape when resources... reasonable, we will usually draw our PPFs with the concave (rather than straight-line) shape Production Possibility Frontier (PPF) food Points below the PPF represent unemployment or inefficient use of resources X clothing Production Possibility Frontier (PPF) food Points above the PPF represent unattainable combinations Y clothing Production Possibility Frontier (PPF) food If economic growth occurs,