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Economics 101: Introductory Microeconomics
Fall 2011
PPF, Opportunity cost, Comparative vs Absolute Advantages
Production Possibility Frontier shows the maximum quantities of two goods that can be produced in an
economy. It shows the trade-offs that we face when we decide which good to allocate more resources.
Opportunity cost is the options we must give up when we decide to produce one good over another or
choosing one option over other options.
Y
a
PPF B
PPF A
b
c
X
In the above scenario, both countries can produce the same amount of Y so neither have absolute
advantage in the production of Y. Country B can produce more X, so country B has the absolute
advantage in the production of X. On the other hand, comparative advantages look at opportunity cost.
If country A wants to produce a units of product Y, it has to give up b units of product X. Thus the
opportunity cost of producing 1 unit of Y for country A is b/a; and also for country B is c/a. The
opportunity cost of producing 1 unit of X for country A is a/b; and for country B is a/c. Since it cost
country A less to produce the same amount of Y, country A has the comparative advantage product Y.
Country B has the comparative advantage in the production of product X. Each country will specialize
in the production of the product which it has the comparative advantage. If the two countries trade, then
the price range for 1 unit of Y is equal to the range between the two opportunities costs for 1 unit of Y.
In this case, the price range is b/a and c/a.
Example 1: Opportunity Cost
Suppose the UW Lacrosse Club plays a game of lacrosse for 2 hours every Thursday night. The fee a
player must pay in order to participate in each game is $10. Troy is thinking about playing this
Thursday. Troy is also considering other alternative uses of his time is selling pizza and earning $8 per
hour.
What is the opportunity cost of playing Lacrosse this Thursday night?
a. $8
b. $10
c. $16
d. $26
Example 2: PPF, Opportunity Cost, and Comparative Advantage
China and the US both produce manufacturing goods and financial service. Suppose that in one month,
China can produce 12 units of manufacturing goods and 0 unit of financial service, or 0 unit of
manufacturing goods and 6 unit of financial service, or any combination lying on the line between these
two points. During the same amount of time, US can produce 15 units of manufacturing goods and 0 units
of financial services, or 0 unit of manufacturing goods and 15 units of financial service, or any
combination lying on the line between these two points.
(1) Draw the PPFs for both China and US (Put manufacturing goods on the horizontal axis).
(2) Find in the above graph the points that are feasible but inefficient for China, the points that are both
feasible and efficient for China, and the points that are not feasible for China. Do the same things for
US.
(3) Which country has the absolute advantage in producing manufacturing goods? Which country has
the absolute advantage in producing financial service?
(4) What is the opportunity cost for China to produce one more unit of manufacturing goods? What
about US?
(5) What is the opportunity cost for China to produce one more unit of financial service? What about US?
(6) Which country has the comparative advantage in producing manufacturing goods? Which country
has the comparative advantage in producing financial service?
(7) If the two countries are allowed to trade with each other, which country will specialize in producing
manufacturing goods? Which country will specialize in producing financial service?
(8) If the two countries are going to trade with each other, which is the price range (in terms of units of
manufacturing goods) acceptable for both China and the US for one unit of financial service?
Production Possibility Frontier (PPF)
Example 3
Use the graph below to answer the following questions about an economy that produces two goods: guns
and butter. The line on the graph represents PPF of the economy.
a. At which points production is efficient?
Which points are feasible? Which points are
not feasible?
b. Assume this economy initially produces 7
units of butter. If instead they decide to produce
9 units of butter, what is the opportunity cost?
What happens to the opportunity cost of butter
as the economy moves from point B to point
D?
Economics 101: Introductory Microeconomics Fall 2011
Week 1 Discussion Section Handout Solutions
Example 1
Answer: $26
Example 2
(1) Line CN shows the PPF for China and line US shows the PPF for the US.
China
Financial
service
Financial
service S
15
US
N
6
O
C
12
Manufacturing
O
U
15
Manufacturing
(2) Points in the right triangle OCN but not on line CN are feasible but inefficient for China.
Points on line CN are both feasible and efficient for China. Points to the right and up of line
CN is infeasible for China. Points in the right triangle OUS but not on line US are feasible
but inefficient for the US. Points on line US are both feasible and efficient for the US. Points
to the right and up of line US is infeasible for the US.
(3) The US has the absolute advantage in producing both manufacturing goods and financial
service, because it can produce more than China in the same amount of time.
(4) The opportunity cost of producing one more unit of manufacturing goods is 1/2 unit of
financial service for China, and it is 1 for the US.
(5) The opportunity cost of producing one more unit of financial service is 2 uni ts of
manufacturing goods for China, and it is 1 for the US.
(6) China has the comparative advantage of producing manufacturing goods, and US has the
comparative advantage of producing financial service.
(7) China will specialize in producing manufacturing goods, and US will specialize in producing
financial service.
(8) 1-2 units of manufacturing goods. [China will be the buyer of financial service. The highest
price he would pay for one unit of financial service is 2 units of manufacturing goods, its
opportunity cost of producing one unit of financial service itself. If the price of one unit of
financial service is higher than this, China would choose to produce financial service itself
rather than trade with the US. So 2 units of manufacturing goods is the highest price of one
unit of financial service for a potential trade between the two countries. The US is the seller
of financial service. The lowest price it would ask for one unit of financial service is 1 unit of
manufacturing goods, its opportunity cost of producing one unit of financial service. If the
price of financial service is lower than this, the US will make a negative profit by producing
and selling financial service. So 1 unit of manufacturing goods is the lowest price of one unit
of financial service for a potential trade.
Example 3
a. Point B and D are efficient; point A, B, and D are feasible; point C is infeasible.
b. The opportunity cost of increasing butter production from 7 units to 9 units is 6 units of guns. ( ↑ 2
butter = ↓ 6 guns). This is a movement from point B to point D. Notice that butter production increases by
2 units from 7 to 9, while gun production decreases by 6 units from 10 to 4.
c. It will increase.
Example 4
a. (graph) b. A: 1, B: -3/2
c. A: y = x + 10, B: y = -1.5x + 27.5 d. (7, 17)
Example 5
a. (graph) b. 3
c. Positively related d. (graph)
e. -1 f. 2
g. y=6+3x. (graph)