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Econ 4346
Test #1
Topic Review
PARETO OPTIMALITY
• An allocation of resources such that:
• It is impossible to make at least one person better off without
making someone else worse off
• If two people are in a room, and one person has a full
allocation of clothes…
• And the other person a full allocation of food, then…
• Trade will occur to a point where both people
• Benefit from the interaction
• Cannot improve any further without harming the other
• Pareto Optimality serves as the basis for the Production
Possibilities Frontier
• Review video on blog
http://tc6617.wordpress.com/2010/10/13/econ-4346-basicprinciples-part-1/
(non) Pareto optimality
EXAMPLE
RECTANGLE REPRESENTS
ECONOMIC CONSTRAINTS
A
B
Two Economic players A and B. Non-Pareto Optimal, since there is room for both to improve
pRODUCTION
POSSIBILITIES FRONTIER
• Displays efficient combinations of output when factors
of production (labor, land, and capital) are used to full
potential
• Bowed shape represents increasing costs
• In order to increase production of one good (A),
production of the other (B) must be given up
• Sounds like Pareto Optimality, perhaps?
• Review Mankiw pp25-28
• Review blog:
http://tc6617.wordpress.com/2010/10/13/econ-4346basic-principles-part-1/
Production
Possibilities frontier
•Country can produce two goods:
Grain and Wine
•Bowed curve is the frontier.
Any point on the curve is
Pareto Optimal
•Point ‘b’ is infeasible
•Point ‘a’ is non-Pareto Optimal or
ineffecient
Demand curve
• Why is it downward sloping?
• Because of the Law of Demand
• The quantity demanded of a good
falls when the price rises
Supply Curve
• Why does it slope upward?
• Because of the Law of Supply
• The quantity supplied of a good rises
when the price of the good rises
Equilibrium
• A situation in which the market price has
reached the level at which quantity
supplied equals quantity demanded
Equilibrium of supply
and demand
P
S
Equilibrium
D
Q
Solving for
equilbrium
• Expedia did the following study (fictional) on its
market for package tours
• Demand schedule
• Qd = 28,000 – 300P
• Supply schedule
• Qs = 23,000 + 200P
• CALCULATE EQUILIBRIUM PRICE AND QUANTITY
Solving for
equilibrium
P
Qs = 23,000 + 200P
$10
Qd = 28,000 – 300P
25,000
1.
2.
3.
4.
5.
6.
7.
Q
Set Qs = Qd
23,000 + 200P = 28000 – 300P
Solve for P
500P = 5,000
P = 10
Plug in value for P in one of equations (we’ll use Qd)
28,000-300(10) = Qd = 25,000
PRICE CEILING
• Occurs when government puts legal limit on how high
the price of a product can be
• Why?
• Government thinks that price ceilings protect
consumers
• If government didn’t impose a price ceiling, the product
wouldn’t be obtainable to the “average consumer”
• Therefore unfair
Price ceiling
P
S
CEILING
SHORTAGE
D
Q
Price ceiling below equilibrium. Shortage occurs because demand exceeds supply
Elasticity of demand
• See figure 1, Mankiw, page 93
• Perfectly inelastic: Ed = 0
• Inelastic: Ed < 1
• Unit Elastic: Ed = 1
• Elastic: Ed > 1
• Perfectly Elastic: Ed = infinity
Elasticity of supply
• See figure 5, Mankiw page 101
• Perfectly Inelastic: Es = 0
• Inelastic: Es < 1
• Unit Elastic: Es = 1
• Elastic: Es > 1
• Perfectly Elastic: Es = infinity
Shifts in supply and
demand curves
• Thoroughly review pages 67 – 82 in Mankiw