ec 131 - principles of microeconomics · by inacio bo - [email protected] grades and etc • problem sets...

by Inacio Bo - [email protected]

EC 131 - PRINCIPLES OF MICROECONOMICS

Woods SchoolSummer 2013

Tuesday, June 25, 13

mailto:[email protected]



ORGANIZATION





ME





YOU!





TEXTBOOK





GRADES AND ETC

• Grade

•Midterm Exam (July 11th) - 35%

• Final Exam (August 1st) - 50%

• Problem Sets (Aplia) - 15%

• Extra credit activities - Extra points

•No make-up exams





GRADES AND ETC

• Problem Sets

•One or two per week

• 1 - all problems submitted, at least 50% of the points

• 0.5 - all problems submitted, less than 50% of the points

• 0 - not all problems submitted





APLIA

• Instructions in the Syllabus

• Problems? Email or office-hours

•Deadlines are strictly enforced. Solve problems before them!





CONTACT AND OFFICE HOURS

• Read emails!

•Office Hours

• Tuesdays: 5:00 PM - 6:00 PM

• Thursdays: 1:00 PM - 2:00 PM

• [email protected]

• http://www2.bc.edu/inacio-bo/ (Slides available after class)






http://www2.bc.edu/inacio-bo/

http://www2.bc.edu/inacio-bo/


WHAT IS ECONOMICS?





“Social science which studies how society manages and allocates its scarce resources”





•How it does•Positive Economics•How it should•Normative Economics





• How markets work? How do they allocate resources?

•When do they fail? What can we do about it? What are the consequences when we do something about it?

MAIN QUESTION





CREATE BOSTON’S RESTAURANTS FROM SCRATCH

• Find land to plant produce and grow livestock

•Different kinds of vegetables need different kinds of land and climate

• Train and hire farmers

• Transportation





TRANSPORTATION

•Different kinds of trucks for different kinds of trucks

• Plan which vegetables, meat and spices go to each type of restaurant

• Choices must be consistent with timing, delivery of trucks, allowed times for truck traffic in different parts of the city

• Right amount of food to be delivered at each restaurant

•More than necessary: lose food

• Less than necessary: lose clients





MORE PLANNING

• Consider changes in demand for different times and conditions

•More ice-cream during summer

• Chinese food during spring festival

•No lunch for arabs during ramadan

• Kosher restaurants need different suppliers





WHO IS PLANNING?

•Nobody!

•Nobody plans, each one just takes care of their own interest but things seem to work out fine

• Free markets are surprisingly efficient in allocating goods and services to and from individuals





ECONOMICS

Economic History Econometrics Economic

Theory

Study economic

phenomena in the past

Application of math and statistics to economic data

Mathematical models of

economic subjects

Microeconomics

Macroeconomics





MICRO/MACROHousehold and

firms

Interactions between

households and firms

Markets

Interest rates

Inflation

Unemployment

Micro

Macro





MICROECONOMICS

• How consumers react to price changes

• How firms decide which price to change

•What is the most efficient way to reduce smoking or air pollution

• How individuals use information in their decisions





THINKING LIKE AN ECONOMIST





•Doesn’t mean becoming an evil individualist!

• It’s a more methodic and precise way to see the world around us

• It can help you see unexpected points of view on common subjects





• A consequence of the fact that resources are scarce

• “There’s no free lunch”

• To get things we like, we usually have to give up something we like.

• Students allocating their time

• The more I study economics, the less I can study psychology

• The more I study economics AND psychology, the less I can watch TV

TRADEOFFS





COSTS

• The cost of something is what you give up to get it

•What’s the cost of college?

• Tuition for money

• Books money

• Room money

•Dining plan

• Really?





COSTS

• If you quit school you still need a room to stay

• You would spend money in a room anyway

• You would still spend money on food

• Real cost of college housing: college housing - alternative housing





COSTS

•More importantly: your time!

• If not in college you could be working, earning $$$$$. For most students, this is the largest cost.

•Opportunity cost: what you give up to get that item.

•Opportunity cost for Tim Cook to go backpacking in Europe for one month

• Cost of backpacking in europe when you’re a student and when you’re an adult?





ECONOMIC MODELS





ECONOMIC MODELS

• Real-life economic interactions are very complex

• The bus driver may let his friend enter without paying

• A person may buy a gift to another because of friendship, love or second intentions

• People may go to college more because of the parties than because of a higher future income

• Impossible to take all effects into consideration and have something useful





SIMPLIFYING ASSUMPTIONS

•We can make simplified versions of what we’re trying to study

•When asking how long it would take for a marble ball to fall from a building, disregard air resistance

• Air effect is insignificant for our question

• If it is a piece of paper, air resistance is significant and that simplification isn’t adequate anymore





ECONOMIC MODELS

• A tool to learn something about the world, where by using some simplifying assumptions (what’s “truly important”) we are able to give better answers to some questions





OUR FIRST MODEL: PPF





ASSUMPTIONS

• Entire economy produces only two goods

• Pizzas

• Burritos

• Let economy have 10,000 workers and labor is all you need to produce them (Inputs)

• In one day, a worker produces 2 pizzas or 10 burritos (Technology)





• If all resources (workers) are devoted only to make pizzas, what does the economy produce?

• If all resources (workers) are devoted only to make burritos, what does the economy produce?

1 worker 1day

1 worker 1day

2 Pizzas

10 Burritos

2 x 10,000 = 20,000 pizzas and 0 burritos

10 x 10,000 = 100,000 burritos and 0 pizzas





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Feasible combinations: inside and including PPF





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Not Feasible combinations: outside PPF





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Points inside PPF are inefficient: it is possibleto increase production of one good without

decreasing the production of the other





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Points at the PPF are efficient: increases in the production of one good must come with the

reduction of the other.Efficient production induces a tradeoff.





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Points at the PPF are efficient: increases in the production of one good must come with the

reduction of the other.Efficient production induces a tradeoff.

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Q: What is the cost of producing 2,000 pizzas?

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Q: What is the cost of producing 2,000 pizzas?A: 10,000 burritos

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Q: What is the cost of producing 2,000 pizzas?A: 10,000 burritos

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos

Opportunity cost of 2,000 pizzas is10,000 burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos

Opportunity cost of 2,000 pizzas is10,000 burritos

Opportunity cost of 1 pizza is5 burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

10,000 → 12,000 Pizzas50,000 → 40,000 Burritos

Opportunity cost of 10,000 burritos is2,000 pizzas

Opportunity cost of 1 burrito is1/5 pizza





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

One is the inverse of the other (5 and 1/5).Not a coincidence!

Opportunity costs of two goods in this model are one the inverse of the

other.





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Slope: 20

100=

1

5

Opportunity cost of good in the horizontal axis





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

PPF

12 B

A

Opportunity cost of good in the vertical axis:

1

Slope





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

22

Shift in the PPF: 1,000 more workers





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

22

Shift in the PPF: 1,000 more workers

Opportunity cost doesn’t change!





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

22

Improvement in pizza technology: each worker can now produce 5 pizzas per day





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

Pizz

as (

P)

22

Improvement in pizza technology: each worker can now produce 5 pizzas per day

New Opportunity Costs:

Burrito =50

100=

1

2

Pizza =100

50= 2





•Economy we just studied had a linear PPF

•You can switch between pizzas and burritos at a constant rate

•Opportunity cost is constant along the PPF





•Think about alternative economy: iPhones and Burritos

•The input is still the same: labor

•Some workers are better at making iPhones (engineers) and others are better at making Burritos (cooks)





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

“Bowed-out” PPF





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Everyone works making iPhones: 20 iPhones

Everyone works making burritos: 100 Burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Take the best cooks that are making iPhonesand put them to make Burritos

19 iPhones and 30 Burritos

Start from situation where all workers areproducing iPhones





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Opportunity cost of 30 Burritos: 1 iPhone

Opportunity cost of 1Burrito: 1/30 iPhoneOpportunity cost of iPhone: 30 Burritos





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Produce 20 more burritos. Some IT guysare allocated to mexican kitchens

11 iPhones and 80 Burritos

Now start from 60 Burritos /16 iPhones





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Opportunity cost of 20 Burritos: 5 iPhones

Opportunity cost of 1Burrito: 1/4 iPhoneOpportunity cost of iPhone: 4 Burritos

↑↓





1200 10 20 30 40 50 60 70 80 90 100 110

50

0

10

20

30

40

Burritos (B)

iPho

nes

(I)

19

16

11

Indeed, slopes change

Steeper (high-value) slopes =

high opp cost for Burritoslow opp cost for iPhones





•Opportunity cost of iPhone is higher when many iPhones are produced (many cooks making iPhones)

•Opportunity cost of iPhone is low when economy is producing few iPhones (we can get the top engineers)





GAINS FROM TRADE





What are the main sources of US imports?





•1 - China: U$ 398 Billion

•2 - Canada: U$ 320 Billion

•3 - Mexico: U$ 262 Billion

Top sources of US imports (2011)





What are the main destination of US exports?





•1 - Canada: U$ 234 Billion

•2 - Mexico: U$ 160 Billion

•3 - China: U$ 97 Billion

Top destinations of US exports (2011)





• Two individuals

• A rancher, who can produce only meat

• A farmer, who can produce only potatoes

•Without trade, rancher eats only meat, farmer eats only potatoes

• They could trade and exchange some meat for potatoes, giving them a less boring meal. Both would be better off.

FIRST TRADE MODEL





•Mario and Luigi work 10h/day

•Mario: 1 pizza in 1:00h or 4 burritos in 1:00h

• Luigi: 3 pizzas in 1:00h or 6 burritos in 1:00h

• Luigi is more productive in both products! Can they still benefit from trade?

A LESS OBVIOUS EXAMPLE





800 10 20 30 40 50 60 70

50

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

46

48

Burritos

Pizz

asLuigi's PPF

Opp costs:Burritos=30/60=1/2

Pizza=2





800 10 20 30 40 50 60 70

50

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

46

48

Burritos

Pizz

asMario's PPF

Opp costs:Burritos=10/40=1/4

Pizza=4





Opp cost of Pizza Opp cost of Burrito

Mario

Luigi

4 Burritos 1/4 Pizza






•Luigi is currently producing 15 pizzas and 30 burritos (chosen based on his preferences)

•15 pizzas, 3 pizzas/h = 15/3 = 5h

•30 burritos, 6 burritos/h = 30/6 = 5h

• (5h,5h)=10h (Feasible and Efficient)





•Mario is currently producing 5 pizzas and 20 burritos (chosen based on his preferences)

•5 pizzas, 1 pizza/h = 5/1 = 5h

•20 burritos, 4 burritos/h = 20/4 = 5h

• (5h,5h)=10h (Feasible and Efficient)





•They could do the following:

•Mario spends all the 10h making burritos (20x4=40) and Luigi spends 2h making Burritos (2x6=12) and 8h making pizzas (8x3=24)





MarioMario LuigiLuigi

Pizzas Burritos Pizzas BurritosWithout trade Prod & Cons

With tradeProduction

With trade TradeWith tradeConsumption

Gains from Trade Increase

5 20 15 30

0 40 24 12

Get 6 Give 19 Give 6 Get 19

6 21 18 31

+1 +1 +3 +1





800 10 20 30 40 50 60 70

50

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

46

48

Burritos

Pizz

asLuigi's PPF

Luigi’s consumption after trade





Mario’s consumption after trade

800 10 20 30 40 50 60 70

50

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

46

48

Burritos

Pizz

asMario's PPF





What happened?

Opp cost of Pizza

Opp cost of Burrito

Mario

Luigi



Pizzas/h Burritos/h

Mario

Luigi

1 4

3 6

Luigi has absolute advantage over Mario in

the production of both goods

Absolute advantage: ability to produce more with the same inputs

Mario has comparative advantage over Luigi in the production of Burritos

Comparative advantage: ability to produce a good at a lower opportunity

cost





What happened?

Opp cost of Pizza

Opp cost of Burrito

Mario

Luigi



Mario has comparative advantage over Luigi in the production of Burritos

Since opportunity costs are inverses, one always has comparative advantage on one good! (Unless they have the same opportunity cost)

Luigi has comparative advantage over Mario in

the production of Pizzas





• Each one specialized on the good on which they have comparative advantage and then traded.

• Think about it: to obtain one more burrito, Luigi has to give up on 1/2 pizza.

• Mario can say “I can make that Burrito. Give me 1/3 of a pizza”.

• Mario can then reduce production of Pizza by 1/3. This allows him to increase production of Burritos by 4/3 (4 Burritos per pizza).

• Result: Luigi got his burrito for cheaper than 1/2 pizza and Mario had a “profit” of 1/3 burrito.





• It is possible for one person to have absolute advantage in both goods

• It is impossible for a person to have comparative advantage in both goods

• When does nobody have comparative advantage over the other? Only if both have the same opportunity costs

• Gains from specialization comes from comparative advantage, not absolute advantage.

• If opportunity costs differ, both can gain from specialization and trade.





•Which trades will make both better off?

• Let’s look back at the trade between Mario and Luigi

PRICE OF TRADE










5 20 15 30

0 40 24 12


6 21 18 31

+1 +1 +3 +1

Mario gave 19 Burritos and got 6 pizzasEach pizza cost 19/6=3.17 burritos

Luigi gave 6 pizzas and got 19 BurritosEach burrito cost 6/19=0.31 pizza










5 20 15 30

0 40 24 12


6 21 18 31

+1 +1 +3 +1

Each pizza cost 19/6=3.17 burritos

Each burrito cost 6/19=0.31 pizza

Opp cost of Pizza

Opp cost of Burrito

Mario

Luigi







Pizza between 2 and 4 burritos

Burrito between 1/4 and 1/2 pizza

Opp cost of Pizza

Opp cost of Burrito

Mario

Luigi



Any trade made at a price between bothopportunity costs is beneficial.





INTERNATIONAL TRADE

• Just as people can benefit from specialization and trade, so can different countries

• That’s why the US sells and buys so much from the same countries: trading is a game in which both can be made better off

• Comparative advantage theory says that if each good is produced at the country with comparative advantage in that good every country can then benefit from trade

• Trade among nations has more complex issues, since some individuals can be made worse off though the country as a whole is better off.

• Example: if country specializes in Burritos, pizza makers may lose their jobs.





INTERNATIONAL TRADE

• Imports: goods produced abroad and sold domestically

• Exports: goods produced domestically and sold abroad





BOWED-OUT PPF AND TRADE

• Can two countries with the same exact PPF be better-off by trade?

• Yes if they are bowed-out PPFs!





1000 10 20 30 40 50 60 70 80 90

100

0

10

20

30

40

50

60

70

80

90

Burritos

Pizzas

A

B

X





1000 10 20 30 40 50 60 70 80 90

100

0

10

20

30

40

50

60

70

80

90

Burritos

Pizz

as

A

B

X

A'

B'

A's Exports

A's ImportsB's Imports

B's Exports





FOR NEXT CLASS

• Catch-up readings: Chapters 2 and 3

•Next lecture readings: Chapter 4

• Problem set is available and due next Tuesday




ec 131 - principles of microeconomics · by inacio bo - [email protected] grades and etc • problem sets...

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