Production Possibility Frontier, Opportunity Cost | ECON 101, Assignments of Microeconomics

Download Production Possibility Frontier, Opportunity Cost | ECON 101 and more Assignments Microeconomics in PDF only on Docsity! Econ 101 Spring 2009: TA Handout Week1 TA: Mai Seki Office Hours: Tue. 12:30-1:30pm Office: SOC SCI 6439 E-mail: seki@wisc.edu https://mywebspace.wisc.edu/seki/web/teaching.htm 1 Production Possibility Frontier (PPF) The Production Possibility Frontier (PPF) illustrates the trade-offs facing an economy that produces two goods. It shows the maximum quantity of one good that can be produced given the quantity of the other good produced. 2 Opportunity Cost Opportunity cost: what you must give up in order to get a good or service. i) If you have a graph, (take x-axis=quantity of good A on the graph then X=x- intercept and Y =y-intercept ) OR if you have information like ’Mai makes X units of good A and Y units of good B per hour’, then the opportunity cost of good A is Y/X (O.P. of good B is X/Y ). (In order to produce X units of good A, a person needs to give up producing Y units of good B. This is equivalent to give up producing Y/X units of good B in order to make 1 unit of good A.) ii) If you have information like, ’Mai makes 1 unit of good A with x hours of work and 1 unite of good B with y hours’, then the opprotunity cost of good A is x/y (O.P. of good B is y/x). (In order to make 1 unit of good A, a person uses x hours. With this x hours, he can make x/y units of good B. Then x/y is the opportunity cost of good A in terms of good B.) 3 Absolute vs Comparative Advantage An economy enjoys an absolute advantage in the production of a good if that good can be produced with fewer resources (inputs) than in other economies. An economy enjoys a comparative advantage in the production of a good if that good can be produced at a lower opportunity cost than in other economies. 1 4 Competitive Market Demand-Supply analysis is a basic tool of microeconomics. In a market, supply and demand curves tell us how much will be produced by firms and how much will be demanded by consumers as a function of price. The key feature of a competitive market is that no single agent can affect the market price (price taker). This means that individual does not have “market power”. Conditions for a competitive market • Many buyers and sellers (implies no barrier to entry). • Goods traded in the market are homogeneous (has similar quality and characteristics/attributes). • Perfect information about the good and the market mechanism 5 Demand • The quantity demanded is the amount of a good that consumers want to buy at a given price, holding constant the other factors that influence purchases. • A demand curve shows the quantity demanded at each possible price, again holding constant other factors that influence purchases. The demand curve is a relationship between the quantity demanded and the price. Thus, the demand function is QD = f(P ). The law of demand: For almost every conceivable product, consumers demand more when the price is lower. The law of demand implies that demand curves slope downward. 2 7.1 Not in equilibrium If the price is initially lower than the equilibrium price, there will be excess demand (Shortage). If the price is initially above the equilibrium price, there will be excess supply (Surplus). To summarize, – Shortage =QDemand−QSupply →incentive for buyers to offer a higher price – Surplus = QSupply −QDemand → incentive for sellers to offer a lower price 7.2 Equilibrium effects of shifts in demand and supply curves We have already known that there are several factors that shift the demand or supply curves. Now we look at the equilibrium effects of shifts in demand and supply curves. 5 8 Elasticities Elasticity measures the sensitivity of one variable to another. To be more precise, elasticities measure the percentage change in one variable in re- sponse to a given percentage change in another variable. All elasticities take the following form: PercentagechangeinA PercentagechangeinB = ∆A/A ∆B/B – The Price Elasticity of Demand measures the responsiveness of quantity demanded to a change in price. εDP = Percentagechangeinquantity Percentagechangeinprice = ∆Q/Q ∆P/P = ∆Q ∆P P Q – The Income Elasticity of Demand is the percentage change in quantity demanded divided by the percentage change in income. ξ = Percentagechangeinquantity Percentagechangeinincome = ∆Q/Q ∆Y/Y = ∆Q ∆Y Y Q Income elasticities may be positive (normal goods) or negative (inferior goods). 6