ECN 201_Lecture 3- Updated !

8/10/2019 ECN 201_Lecture 3- Updated !

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ECN 201PRINCIPLES OF

MICROECONOMICS LECTURE 314/09/2014

Topic: The Economic Problem


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Production Possibility Frontier (PPF)

Production Possibility Frontier PPF) shows the maximum amount of goods aservices that can be efficiently produced by an economy, given its technologicalknowledge and available resources

To illustrate PPF focus on only two goods at a time holding production of all otgoods/services constant ( ceteris paribus assumption)

Any point inside the PPF can be produced (attainable)

Produce more of both goodsProduce more of one good without giving up some other goodProduction is inefficient - unused and/or misallocated resources

Production efficiency - at every point on the PPF

Trade-off along the PPF- to produce more of one good we must give up some good ....opportunity cost


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Opportunity Cost

Highest valued alternative forgoneExample: pizza vs. burger. Opp. cost of producing an additional pizza is the nburgers we must forgo.

To produce 1 additional pizza you need to give up 3 burgers. To produce 1additional burger you need to give up 1/3 pizza.

Opp. cost is a ratio:

Inverse relationship

PPF is bowed outwardOpp. cost of a good increases as quantity produced of the good increasesResources are not equally productive in all activities


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Marginal Cost (MC)

MC is the opp. cost of producing one more unit of a good

Calculate MC from the slope of PPF Slope of the PPF increases as we move down Starting from the origin, MC curve increases

MC curve shows the relationship between MC of a good and quantityproduced of that good

Draw MC curve with quantity on x -axis and MC on y -axis; so the Mis upward sloping


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Marginal Benefit (MB)

Comes from the concept of preference- someones likes and dislikes

Benefit received from consuming one more unit of a good/service

MB measures the maximum amount that people are willing to pay for additional unit of the good/service- marginal willingness to pay (MW

MB curve shows the relationship between MB from a good/service anquantity of that good/service consumed

Draw MB curve with quantity on x -axis and MB or MWTP on y -axis

Principle of decreasing MB - the more we have of one good the less wwilling to pay for an additional unit of that good (the smaller is the MB


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Production efficiency & allocative efficiency

Recall production efficiency

Allocative efficiency - preference comes in here. Produce at the pointthe PPF that is preferred among all other points.

Bring in MC curve and MB curve in one graph

The intersection of the two curves is the allocative efficient point


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Economic Growth

Expansion of production is called economic growth

Technological change and capital accumulation

Economic growth shifts PPF outward enabling increased consumption of bothgoods

More consumption today means less capital investment today- PPF remains althe sameMore current investment enables PPF to shift outward and more economic grois achieved

The nearer a country is to the consumption goods side on PPF the slower theeconomic growth is for that country.


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Trade

Specialization- concentrate on producing goods/services one does the b

Comparative advantage- ability to produce a good at a lower opportunicost than another producer

Absolute advantage- ability to produce a good using fewer resources (fewer labor, capital etc.) than another producer.being more produ

Gains from specialization and trade are based on comparative advantagnot absolute advantage


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Trade

Comparative advantage reflects relative opportunity cost of two produproducing the same good

The person having lower opportunity cost specializes in that sector andsells (export) that good in exchange for the other good (import)


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Practice problem

There are two countries- Home and Foreign, both countries produce Good 1 and Good 2.Each country has unit labor requirement as follows:

a) Which country has absolute advantage in producing Good 1 and Good 2?b) The maximum amount of Good 1 and Good 2 produced by Home are 100 and 50respectively and those of Foreign are 200 and 50 respectively. Draw their PPFs andcalculate the opportunity costs of Good 1 and Good 2 for both Home and Foreign.

c) Which country has comparative advantage in producing Good 1 and Good 2?

d) Which country should specialize in producing a good?

Good 1 Good 2

Home 1 2

Foreign 1 4


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Announcement

QUIZ 1 on next Sunday, 21 st September

Syllabus- lecture 1, 2, 3

MCQ & short question/graphs

Documents

ECN 201_Lecture 3- Updated !