economics 1 2011-12
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Economics 1 2011-12. (Lecture 1) Welcome!. Economics 1. Accompanying Resources Module Website (with links) MyEconomics Portal Module Manual (with reading list) Seminar Work and Problem Sets Departmental Handbooks and Web-Sites. Economics 1. Organisation Lecture timetable - PowerPoint PPT PresentationTRANSCRIPT
Economics 1 (EC107) 2011-12: Micro (Term 1)
Robin Naylor, Department of Economics, Warwick
1
Economics 12011-12
(Lecture 1)
Welcome!
Robin Naylor, Department of Economics, Warwick
2
Economics 1
Accompanying Resources
• Module Website – (with links)
• MyEconomics Portal
• Module Manual– (with reading list)
• Seminar Work and Problem Sets
•Departmental Handbooks and Web-Sites
Robin Naylor, Department of Economics, Warwick
3
Economics 1
Organisation
• Lecture timetable
• Seminar arrangements
• Personal Essays
• Examination and Assessment
Robin Naylor, Department of Economics, Warwick
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Economics 1
• Term 1 Microeconomics
• Term 2 Macroeconomics
Robin Naylor, Department of Economics, Warwick
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Economics
Readings (Micro)
• Frank, R., Microeconomics and Behaviour, 8th Edition, 2010,
McGraw- Hill
• Estrin, Laidler and Dietrich (ELD), Microeconomics, 2008
+ Many other textbooks plus other literature: see Module Manual
Robin Naylor, Department of Economics, Warwick
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Term 1: Micro Topics
• Introduction Scarcity and Trade
• Topic 1 Household behaviour
• Topic 2 Firm behaviour
• Topic 3 Product markets
• Topic 4 Factor markets
• Topic 5 Market Structure, Efficiency and Failure
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
– Cause: excess of wants over ‘natural’ supply– Consequences:
(i) Choices over production
(ii) Trade-offs and opportunity costs
(iii) Rationing of distribution (Markets etc . . .)
Consider a 2-good economy:
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max The Production Possibility Curve
The Production Possibility Set
See Handout
Robin Naylor, Department of Economics, Warwick
9
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta MaxOn what does the position of the Production Possibility Curve depend?
Robin Naylor, Department of Economics, Warwick
10
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
What can you say about point ‘a’?
Robin Naylor, Department of Economics, Warwick
11
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
‘a’ is not ‘technically’ efficient. A ‘Pareto’ improvement can be made.
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
What can you say about point ‘b’?. b
Robin Naylor, Department of Economics, Warwick
13
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
There can be no Pareto Improvement from ‘b’. It is Pareto Efficient.
. b
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
What can you say about point ‘c’?. b
. c
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
How could we get to point ‘c’?. b
. c
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
If we are at ‘a’, how can we have more Tractors?. b
See Handout
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
If we are at ‘b’, how can we have more Tractors?. b
See Handout
Robin Naylor, Department of Economics, Warwick
18
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
If we are at ‘b’, how can we have more Tractors?. b
. d
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
We have shown a PPC which is concave: what does this depend on?
. b
. d
See Handout
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
The slope of the PPC is called the Marginal Rate of Transformation (MRT).
Why?. b
. d
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
The MRT is the amount of one good (Ta) we have to give up in order to have an extra unit of the other good (Tr).
. b
. d
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
The MRT is the amount of one good (Ta) we have to give up in order to have an extra unit of the other good (Tr).
. b
. d
So the MRT is increasing in the case of the concave PPC. Why?
Robin Naylor, Department of Economics, Warwick
23
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
The MRT is the amount of one good (Ta) we have to give up in order to have an extra unit of the other good (Tr).
. b
. d
So the PPC and the MRT describe the Trade-off we have to make between the 2 goods.
Robin Naylor, Department of Economics, Warwick
24
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
The MRT is the amount of one good (Ta) we have to give up in order to have an extra unit of the other good (Tr).
. b
. d
So the PPC and the MRT describe the Opportunity Cost of the extra Tr.
Robin Naylor, Department of Economics, Warwick
25
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
The PPC shows us the trade-off that Society has to make between 2 goods. But what about the trade-off that the Society is prepared to make?
See Handout
Robin Naylor, Department of Economics, Warwick
26
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
What about the trade-off that the Society is prepared to make?
This is shown by an Indifference Curve.
IC
See Handout
Robin Naylor, Department of Economics, Warwick
27
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
What about the trade-off that the Society is prepared to make?
This is shown by an Indifference Curve.
IC
Robin Naylor, Department of Economics, Warwick
28
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
An Indifference Curve.
It’s slope shows us how much of one good the society is prepared to give up in order to have an extra unit of the other good.
IC
Robin Naylor, Department of Economics, Warwick
29
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
The slope of the IC shows us how much of one good the society is prepared to give up in order to have an extra unit of the other good:
This is the Marginal Rate of Substitution (MRS).
IC
Robin Naylor, Department of Economics, Warwick
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Introduction (Lecture 2)
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
The Marginal Rate of Substitution describes the trade-off society is prepared to make.
Why might it be convex, as shown?
IC
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
Why might the PPC be convex, as shown?
IC
Robin Naylor, Department of Economics, Warwick
32
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
A set or family of Indifference Curves
IC1
IC2
IC3
See Handout
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
‘a’ is not technically efficient.
‘b’ is.
So is ‘d’. So how can we choose between ‘b’ and ‘d’?
They are both ‘technically’ efficient.
But they are not both Allocatively Efficient . . .
. b
. d
See Handout
Robin Naylor, Department of Economics, Warwick
34
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
. b
. d
On which IC would society like most to be?
See Handout
Robin Naylor, Department of Economics, Warwick
35
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
. b
. d
On which IC would society like most to be?
At what point is this?
Robin Naylor, Department of Economics, Warwick
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Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
. b
. d
On which IC would society like most to be?
At what point is this?
. e
Robin Naylor, Department of Economics, Warwick
37
Introduction
• The fundamental problem of scarcity
Tractors
Tanks
0 Tr Max
Ta Max
. a
. b
. d
At ‘e’, MRS = MRT.
Discuss.
. e
Robin Naylor, Department of Economics, Warwick
38
Introduction
Gains from Trade• Consider now 2 economies, Red and Blue:
• Let’s assume they have the same inputs.
X
Y
PPC-R
PPC-B
See Handout
Robin Naylor, Department of Economics, Warwick
39
Introduction
Gains from Trade• Consider 2 economies, Red and Blue:
X
Y
PPC-R
PPC-B
Who has an absolute advantage in producing X?
And Y?
See Handout
Robin Naylor, Department of Economics, Warwick
40
Introduction
Gains from Trade• Consider 2 economies, Red and Blue:
X
Y
PPC-R
PPC-B
The fact that PPC-B is flatter than PPC-R has an important implication.
To raise output of X by the amount dX, the required reduction in Y is smaller in Blue than in Red.
dX
dX
See Handout
Robin Naylor, Department of Economics, Warwick
41
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
To raise output of X by the amount dX, the required reduction in Y is smaller in Blue than in Red.
In other words, the Opportunity Cost of the extra X is lower in Blue than in Red.
We say that Blue has a Comparative Advantage in the production of X.
And Red has a Comparative Advantage in producing Y.
dX
dX
Robin Naylor, Department of Economics, Warwick
42
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
Blue has a Comparative Advantage in the production of X.
And Red has a Comparative Advantage in producing Y.
This follows entirely from the relative slopes of the 2 PPCs. The MRT (i.e., the slope of the PPC) is greater in Red than in Blue. Thus, Blue has the Comparative Advantage in X.
Robin Naylor, Department of Economics, Warwick
43
Introduction
Gains from Trade• Consider 2 economies, Red and Blue:
X
Y
PPC-R
PPC-B
As a numerical example, let’s say that to raise output of X by the amount dX, the required reduction in Y is 1 unit in Blue and is 3 units in Red.
dX
dXdY=1
dY=3
See Handout
Robin Naylor, Department of Economics, Warwick
44
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
Suppose that to raise output of X by the amount dX, the required reduction in Y is 1 unit in Blue and is 3 units in Red.
Then this has an implication for Trade and Specialisation.
Suppose initially, Blue is at point ‘a-B’ and Red is at ‘a-R’.
(Why might this be?)
dX
dXdY=1
dY=3
a-B
a-R
Robin Naylor, Department of Economics, Warwick
45
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
Suppose initially, Blue is at point ‘a-B’ and Red is at ‘a-R’.
Why might this be?
a-B
a-R
Robin Naylor, Department of Economics, Warwick
46
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
Suppose initially, Blue is at point ‘a-B’ and Red is at ‘a-R’.
If Blue gives up one unit of Y, it raises output of X by dX.
Suppose that at the same time Red cuts production of X by the same amount, dX: then it can raise output of Y by 3 units.
So what is the total change in ‘World’ production of X?
And of Y?
dX
dXdY=1
dY=3
a-B
a-R
Robin Naylor, Department of Economics, Warwick
47
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
So with an unchanged total production of X and a higher total production of Y, the countries could*:
Trade such that Blue exports dX to Red and, in return, Red exports 2 units of Y to Blue.
What would this look like in terms of each country’s PPC?
a-B
a-R
* They ‘could’ trade in the manner we have suggested. In general, how much they trade of each good will depend on . . . ?
b-R
b-BdY=1
dY=1
See Handout
Robin Naylor, Department of Economics, Warwick
48
IntroductionGains from Trade• Consider 2 economies, Red and Blue:
X
Y
So, the countries could trade such that Blue exports X to Red and, in return, Red exports Y to Blue.
Where does this argument lead?
What can you say about the extent of specialisation in this case?
On what assumptions does this result depend?
What change in assumptions might modify this result?
b-R
b-B
See Handout
Robin Naylor, Department of Economics, Warwick
49
Introduction
Key Concepts
• Scarcity• Wants• Opportunity Cost• Trade-offs• Rationing• Markets• Efficiency• Equity• Constraints• Changes at the margin
See Handout
Robin Naylor, Department of Economics, Warwick
50
Introduction
Key Concepts
• Choices• Preferences• Constraints• PPC• MRS• MRT• Optimisation• Absolute advantage• Comparative advantage• Specialisation• Trade
See Handout
Robin Naylor, Department of Economics, Warwick
51
Introduction
Self-study Questions
• Show and explain a PPC for a country
• What determines the position and shape of the PPC
• Explain the concept of the MRT
• Economists often argue that Choices depend on two key concepts: Preferences and Constraints. Explain this argument.
• Explain the concept of the MRS
• Define ‘trade-offs’ (in terms of both preferences and constraints) and ‘Opportunity Cost’ and explain their meanings in a diagram using the concept of the PPC.
• What is meant by Absolute Advantage?
• What is meant by Comparative Advantage? Explain how the concepts of comparative advantage and of opportunity cost are related.
• Show how trade and specialisation can lead to potential gains for both parties in a trade.
See Handout