economics 1 2011-12

Economics 1 (EC107) 2011-12: Micro (Term 1)

Robin Naylor, Department of Economics, Warwick

1

Economics 12011-12

(Lecture 1)

Welcome!


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


3

Economics 1

Organisation

• Lecture timetable

• Seminar arrangements

• Personal Essays

• Examination and Assessment


4

Economics 1

• Term 1 Microeconomics

• Term 2 Macroeconomics


5

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


6

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


7

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:


8

Introduction


Tractors

Tanks

0 Tr Max

Ta Max The Production Possibility Curve

The Production Possibility Set

See Handout


9

Introduction


Tractors

Tanks

0 Tr Max

Ta MaxOn what does the position of the Production Possibility Curve depend?


10

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

What can you say about point ‘a’?


11

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

‘a’ is not ‘technically’ efficient. A ‘Pareto’ improvement can be made.


12

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

What can you say about point ‘b’?. b


13

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

There can be no Pareto Improvement from ‘b’. It is Pareto Efficient.

. b


14

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

What can you say about point ‘c’?. b

. c


15

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

How could we get to point ‘c’?. b

. c


16

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

If we are at ‘a’, how can we have more Tractors?. b

See Handout


17

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

If we are at ‘b’, how can we have more Tractors?. b

See Handout


18

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

If we are at ‘b’, how can we have more Tractors?. b

. d


19

Introduction


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


20

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

The slope of the PPC is called the Marginal Rate of Transformation (MRT).

Why?. b

. d


21

Introduction


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


22

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a


. b

. d

So the MRT is increasing in the case of the concave PPC. Why?


23

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a


. b

. d

So the PPC and the MRT describe the Trade-off we have to make between the 2 goods.


24

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a


. b

. d

So the PPC and the MRT describe the Opportunity Cost of the extra Tr.


25

Introduction


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


26

Introduction


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


27

Introduction


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


28

Introduction


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


29

Introduction


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


30

Introduction (Lecture 2)


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


31

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

Why might the PPC be convex, as shown?

IC


32

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

A set or family of Indifference Curves

IC1

IC2

IC3

See Handout


33

Introduction


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


34

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

. b

. d

On which IC would society like most to be?

See Handout


35

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

. b

. d


At what point is this?


36

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

. b

. d


At what point is this?

. e


37

Introduction


Tractors

Tanks

0 Tr Max

Ta Max

. a

. b

. d

At ‘e’, MRS = MRT.

Discuss.

. e


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


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


40

Introduction


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


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


42


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.


43

Introduction


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


44


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


45


X

Y


Why might this be?

a-B

a-R


46


X

Y


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


47


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


48


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


49

Introduction

Key Concepts

• Scarcity• Wants• Opportunity Cost• Trade-offs• Rationing• Markets• Efficiency• Equity• Constraints• Changes at the margin

See Handout


50

Introduction

Key Concepts

• Choices• Preferences• Constraints• PPC• MRS• MRT• Optimisation• Absolute advantage• Comparative advantage• Specialisation• Trade

See Handout


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

economics 1 2011-12

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