PrinciplesofMacroeconomicsModule1.1
Scarcity,LimitedResourcesandOpportunityCosts
WhatisEconomics?
• Economicsisthestudyofhowpeopleandsocietyallocatescarceresources
• Scarceresources:• Forpeople:Time,Moneyect.• Forfirms:FactorsofProductionà Land,LaborandCapital
• Sincewedon’thaveaninfiniteamountofresources– whatdowedowithwhatwehave?
TradeoffsinDecisions
• Peoplefacetradeoffsindecisionsbecauseofscarceresources• Cannotdoeverything,buyeverything,makeeverything• Needtochoosehowtoallocateourtime,ourmoney,ourresources
• Whenyoumakeonechoice– yougiveuptheotheroption
OpportunityCosts
• OpportunityCost:Whatyougiveuptogetsomething• Example:Howmanytimescanyouhitthesnoozebutton?
Benefit Opportunity Cost
Hititonce MoreSleep Feelrushed inthemorning
Hitittwice MoreSleep Feel rushedSkipbreakfast
Hititthreetimes MoreSleep Feel rushedSkipbreakfastSkipthegym
Hititfourtimes MoreSleep Feel rushedSkipbreakfastSkipthegymLateforwork
OpportunityCost
• OpportunityCostsaresubjectivetotheindividualandchangedependingoncircumstances
• WhatifitwasSaturdaymorningandyouhitthesnoozebutton?
• Benefitsofmoresleepmayoutweighanycostsifyoudon’thavetowakeup!
• Whatifyouworkintheafternoon?
• Youdonothavethesameconstraintsassomeonewhoneedstogotoworkinthemorning!
OpportunityCosts
• OpportunityCostsdrivethedecisionswemakeeveryday• Wefacethemallthetime• Weweighthecostsandbenefitsofeachdecisionsconsciouslyorsubconsciouslyandmakeachoice
• Testyourself:Whatwasarecentdecisionyoumade?Whatdidyougiveupwhenyoumadethatchoice?Whatwastheopportunitycostforyou?
PrinciplesofMacroeconomicsModule1.2
OpportunityCostsandProductionPossibilitiesFrontier
7
ProductionPossibilitiesFrontierProductionpossibilitiesfrontier(PPF)representstheopportunitycostsaneconomyfacesintheproductionoftwogoods.
Alleconomieshavescarceresources-- needtodecidehowtoallocatethoseresourcestoproducegoods.
Ifyouproducemoreofonegood– needtoproducelessoftheother(withnochangeinavailableresources)
8
UnderstandingthePPFCurve
• Economyonlyproducestwogoods
• Snapshotintimeofproduction
• Limitedresourcescanbeusedintheproductionofbothgoods
9
GoodX
GoodY
PPFExampleConsideraneconomythatproducestwogoods:Leatherjacketsandleatherboots.
• DrawthePPFcurveforthiseconomy
• Aswemovefromonepointtothenext– calculatethechangeinthenumberofbootsproducedandthenumberofjacketsproduced.
• Whatdoesthistellyouabouthowopportunitycostschange?
A B C D EBoots 0 20 40 60 80
Jackets 100 90 70 40 0
10
PPFExampleA B C D E
Boots 0 20 40 60 80
Jackets 100 90 70 40 0
ΔBoots +20 +20 +20 +20
ΔJackets - 10 - 20 - 30 - 40
AswemovealongthePPFcurve:OpportunityCostchanges
• O.C.RISES asgiveupmoreofthegoodthatisSCARCE
• O.C.isLOWERwhenthegoodisinrelativeABUNDANCE
11
PPFExample
Supposenowthatthereisashortageinrubber.- Whathappensinthebootindustry?- Whathappensinthejacketindustry?
12
PPFExerciseWithashortageinrubber,thisaffectstheproductionofbootsrelativelymorethantheproductionofjackets
BiasshiftofPPF
Ifthereisachangeinresources– needtoconsidertheimpactthishasonbothindustries– equalorbias?
13
KeyTakeaway
• Alleconomicagentsfacetradeoffswhenmakingdecisions
• Whatevertheychoosecomeswithanopportunitycost– whattheycouldotherwisedowiththeirtime,money,resources
• ApplythisconcepttounderstandhowaneconomymakeschoicesbetweentheproductionofgoodsinthePPF
14
PrinciplesofMacroeconomicsModule1.3
Comparativeadvantage,specialization,andtrade
15
Howcanwesatisfyourneeds/wants?
1.EconomicSelf-sufficiency:Produceallofthegoodsweneed/wanttoconsumeourselves
2.SpecializationandTrade: ProduceonegoodthatwehaveaComparativeAdvantageinandtradewithothersforwhatweneed
GAINSFROMTRADE:WecanCONSUMEMOREwhileworkingthesameamount.
16
TradeExerciseTimetoProduceOneUnit Amount ProducedinOneDay
(8hrsofwork)
Bread Sweaters Bread Sweaters
Seamstress 60minutes =1loaf
120minutes =1sweater
Baker 20minutes=1loaf
60minutes=1sweater
Howmuchbreadandsweaterscaneachagentproduceinonedayofwork?
17
TradeExercise
• Whoisbetteratproducingbread?
• Whoisbetteratproducingsweaters?
• Iftheysplittheirtimeevenlybetweenproducingbothgoods,howmuchcantheyconsume(notrade)?
TimetoProduceOneUnit Amount ProducedinOneDay(8hrsofwork)
Bread Sweaters Bread Sweaters
Seamstress 60minutes –1loaf
120minutes –1sweater
(60/60)*8hrs =8loaves
(60/120)* 8hrs=4sweaters
Baker 20minutes–1loaf
60minutes– 1sweater
(60/30)*8hrs=24loaves
(60/60)*8hrs=8sweaters
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EconomicSelf-Sufficiency
19
TradeExerciseBasedonopportunitycost:• Seamstress hasaloweropportunitycostinmakingsweaters• Fortheseamstress,ifsheproducesonemoresweater,shegivesupbaking2loavesofbreadinthattime
• Baker hasaloweropportunitycostinbakingbread• Forthebakerifheproducesonemoreloafofbread,hegivesupmaking3sweatersinthattime
OpportunityCostdeterminesspecialization
Amount ProducedinOneDay OpportunityCostBread Sweaters Bread Sweaters
Seamstress 8loaves 4sweaters ½ Sweater 2Breads
Baker 24loaves 8sweaters 1/3Sweater 3Breads
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TradeExerciseWhathappens ifthebakerandseamstresswanttotrade?
Supposetheagentsagreethat:• Bakerwillspend5hoursonbread,3hoursonsweaters• Seamstresswillspend8hoursonsweaters
Howmuchdotheyproduce?Howmuchwilltheyconsume?Willtheygainfromthetrade?
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TradeExercise
Whatiftheyagreetotrade2sweatersfor5loavesofbread?
Howmuchwilltheyconsume?
AMOUNTPRODUCEDBread Sweaters
Seamstress 0 (60/120)*8hrs=4sweaters
Baker (60/20)*5hrs =15loaves
(60/60)*3hrs=3sweaters
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TradeExercise
Hastheseamstressgainedfromthistrade?Hasthebakergainedfromthistrade?
AMOUNTCONSUMEDBread Sweaters
Seamstress 0 bread+5bread=5bread
4sweaters– 2sweaters=2sweaters
Baker 15bread- 5bread=10bread
3sweaters+2sweaters=5sweaters
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WithTrade
24
15
3
10
5
Produce
Consume
Produce
Consume
ComparativeAdvantageAgentwiththeloweropportunitycostinproducingthegoodwill
haveacomparativeadvantageinitsproduction
OpportunityCostsBread Sweaters
Seamstress 1 morebread=½sweater 1moresweater =2breadCOMPARATIVEADVANTAGE
Baker 1morebread=1/3sweaterCOMPARATIVEADVANTAGE
1moresweater =3bread
• Nosingleagentcanhaveacomparativeadvantageinbothgoods.
• Aslongastheopportunitycostsbetweentwoagentsdiffer– bothcangainfromtrade.
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KeyTakeaway• Tradeandspecializationmakeeveryonebetteroffbecause– consumemorewithoutworkingmore
• Tradecanbebeneficialevenwhenoneeconomicagentismuchbetteratproducingbothgoods
• Todeterminewhichgoodsaneconomicagentwillproduce– needtounderstandcomparativeadvantage(or)opportunitycostinproducingeachgood
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Supply and Demand ModelPrinciples of Macroeconomics
Module 1.4 (A)
What are competitive markets?CompetitiveMarkets:
– Bringtogetherthedecentralizeddecisionsofbuyersandsellers– DecentralizedDecisionsofBuyers:
• Drivethemtotrytogetthelowestpossiblepriceforthegoodstheywant
– DecentralizedDecisionsofSellers:• Drivethemtotrytogetthehighestpossiblepriceforthegoodstheyareselling
Whenthesedecisionscometogether– competitivemarketsyield:– Bestpossiblepricefortheproduct– Producedatthelowestpossiblecost– Mostefficientallocationofresources
What are competitive markets?CompetitiveMarkets:
– Bringtogetherthedecentralizeddecisionsofbuyersandsellers– DecentralizedDecisionsofBuyers:
• Drivethemtotrytogetthelowestpossiblepriceforthegoodstheywant
– DecentralizedDecisionsofSellers:• Drivethemtotrytogetthehighestpossiblepriceforthegoodstheyareselling
Whenthesedecisionscometogether– competitivemarketsyield:– Bestpossiblepricefortheproduct– Producedatthelowestpossiblecost– Mostefficientallocationofresources
What are competitive markets?FundamentalAssumptionsofSupply+DemandModel:
1.OperatingunderPerfectCompetition• Lotsofbuyersandsellers• Goodssoldareidentical• Nocosttoenteringorleavingthemarket
2.Equalaccesstoinformation3.Externalitiesdonotexist
Nosingleeconomicagentcanunilaterallyexertanypricecontrol
What are competitive markets?FundamentalAssumptionsofSupply+DemandModel:
1.OperatingunderPerfectCompetition• Lotsofbuyersandsellers• Goodssoldareidentical• Nocosttoenteringorleavingthemarket
2.Equalaccesstoinformation3.Externalitiesdonotexist
Nosingleeconomicagentcanunilaterallyexertanypricecontrol
What are competitive markets?FundamentalAssumptionsofSupply+DemandModel:
1.OperatingunderPerfectCompetition• Lotsofbuyersandsellers• Goodssoldareidentical• Nocosttoenteringorleavingthemarket
2.Equalaccesstoinformation3.Externalitiesdonotexist
Nosingleeconomicagentcanunilaterallyexertanypricecontrol
What is Demand?
• Demandcomesfromthebuyerofagood/service
• Eachbuyeristryingtogetthelowestpricepossibleforthegood/servicethattheywantQuantityDemanded:Amountofthe
goodbuyerswanttobuyateachpricepoint
What is Demand?
DemandSchedule:givesthequantitydemandedateachprice
Price QuantityDemanded
$5 13$6 12$7 10
What is Demand?• Fromthedemandschedule,wecandeterminethedemand
curve
• DemandCurve:Relationshipbetweenpriceofthegoodandamountpeoplewanttobuyofthegood(quantitydemanded)
• LawofDemand:Aspriceofagooddeclines,peoplewanttobuymoreofit
Qdemanded
Price
Demand
$7
$6
$5
101213
Changes in DemandMovementalongthedemandcurve:• Priceofthegoodhaschangedbutthereisnochangeinthe
willingnessofbuyerstobuythegood
• Pricechanges– movetoanewpointonthedemandcurve(fromAtoB)
Qdemanded
Price
Demand
$7
$5
1013
A
B
Changes in DemandShiftinthedemandcurve:• Somefactorhaschangedthatdirectlyimpactsbuyers’
willingnesstobuythegood
• Demandcurveshifts– ateachpricepointthereisnowanewquantitydemanded
Qdemanded
Price
D.1
$7
1015
A B
D.2
Factors that Shift Demand1.ChangeinIncome
• NormalGoodsSallyjustreceivedaraiseatwork.ShenowbuysStarbuck’s
lattesonherwaytowork.
• InferiorGoodsAfterreceivingherraise,Sallynolongerbuyscoffeeatthegas
stationonherwaytowork.
Qdemanded
Priceoflattes
D.1
$4.50
01
A
D.2
B
Factors that Shift Demand2.ChangeinPriceofRelatedGoods
• Compliments:Goodsthatareconsumedtogether• Ifthepriceofhotdogsincreases,peoplewilldemand(orbuy)lesshotdogbuns
• PriceofGoodAincreases:DemandforGoodBdecreases• PriceofGoodAdecreases:DemandforGoodBincreases
Qdemanded
PriceofHotDogBuns
D.1
$1.50
56D.2
AB
Factors that Shift Demand2.ChangeinPriceofRelatedGoods
• Substitutes: Goodsthatcanbeconsumedintheplaceofanothergood
• Ifthepriceofhotdogsincreases,peoplewilldemand(orbuy)morehamburgers
• PriceofGoodAincreases:DemandforGoodBincreases• PriceofGoodAdecreases:DemandforGoodBdecreases
Qdemanded
PriceofHamburgers
$4.00
78
BA
Factors that Shift Demand3.ChangeinTastesandPreferences
Asitgetscolderoutinthewintermonths,peopleprefer tobuysweatersandjackets.Demandforsweaters increases.4.ChangeinNumberofBuyers
Aslaptopsbecomemorepopularandeasytouse,morepeoplebuythem.Demandforlaptopsincreases.5.ChangeinFutureExpectations
FuturePriceoftheGood:Ifpeopleexpectdiscountedpricesduetoretailersholidaysales,theywillwaittobuythegoods
FutureIncome:Ifacollegestudentsecuresajobthathewillstartinafewmonths,hewillfeelmoreconfidentbuyinganexpensivesuittoday.
What is Supply?
• Supply comes from the seller of a good/service
• Each seller is trying to get the highest price possible for the good/service that they produce
• Quantity Supplied: Amount of the good sellers are willing to sell at each price point
What is Supply?
SupplySchedule:givesthequantitysuppliedateachprice
Price QuantitySupplied
$5 10$6 12$7 13
What is Supply?• Fromthesupplyschedule,wecandeterminethesupplycurve
• SupplyCurve:Relationshipbetweenpriceofthegoodandamountfirmsarewillingtosellofthegood(quantitysupplied)
• LawofSupply:Aspriceofagoodincreases,peoplewanttosellmoreofit
Qsupplied
Price Supply
$7
$6
$5
101213
Changes in SupplyMovementalongthesupplycurve:• Priceofthegoodhaschangedbutthereisnochangeinthe
costofproductionorwillingnesstosellbythefirm
• Pricechanges– movetoanewpointonthesupplycurve(fromAtoB)
Qsupplied
PriceSupply
$7
$5
1013
B
A
Changes in SupplyShiftinthesupplycurve:• Somefactorhaschangedthatdirectlyimpactssellers’
willingnesstosell/producethegood(or)theircostofproduction
• Supplycurveshifts– ateachpricepointthereisnowanewquantitysupplied
Qsupplied
Price S.1
$7
1015
A B
S.2
Factors that Shift Supply1. ChangeinPriceofInputs
Ifthepriceofwoodincreases,thecostofproducingtableswouldincrease.Supplywoulddecrease ateachpricepoint.
Qsupplied
S.2
$100
100150
B A
PriceofTables S.1
Factors that Shift Supply2.ChangeinProductionTechnology
Thereplacementofworkerswithrobotsincarproduction.Supplyincreasesateachpricepoint.
3.ChangeinNumberofSellersMoresellersmeansmoreproductionateachpricepoint.Supplyincreases.
4.ChangeInFutureExpectationsFuturePriceoftheGood:Expectpricetoriseinthefuture– produce/sell
morethenFuturePriceofInputs:Expectinputstobemoreexpensive– produce/sell
moretoday
Key Takeaway• Demandisdeterminedbythebuyersofagood.Buyeralwayswanttogetthelowestpricetheycan!Hence,demandisdownwardsloping
• Supplyisdeterminedbythesellersofthegood.Sellersalwayswanttogetthehighestpricetheycan!Hence,supplyisupwardsloping
• Certainfactorsaffecteachofthecurvesandcausethemtoshift.Theshiftscomefromanunderlyingchangetothe“willingnesstobuy”or“willingnesstosell”.
Supply, Demand and Market Equilibrium
Principles of MacroeconomicsModule 1.4 (B)
Market Equilibrium
Supply
Demand
Quantity
Price
P*
Q*
Market Equilibrium
Supply
Demand
Quantity
Price
P*
Qd Qs
P
SURPLUS
Market Equilibrium
Supply
Demand
Quantity
Price
P*
Qd Qs
P
SHORTAGE
Test your UnderstandingConsiderthemarketfororanges.Drawoutthesupplyanddemandcurvesbasedonthefollowingsupplyanddemandschedule:
1. Drawoutthesupplyanddemandcurvesbasedonthisinformation.Whereistheequilibriumpriceandquantity?
2. SupposethereisanexceptionallycoldwinterinFloridawithfrostsruiningmanygroves.Whathappenstothismarket?Illustrateandexplain.
3. Whathappensifthepriceofapplesfalls?Illustrateandexplain.4. Whatifbothscenarioshappensimultaneously?
Price QD QS
$5 10 50
$4 20 40
$3 30 30
$2 40 20
$1 50 10
$0 60 0
Test your Understanding1. Drawoutthesupplyanddemandcurvesbasedonthisinformation.Where isthe
equilibriumpriceandquantity?
Supply
DemandQuantity
Price
$3
30
A
Test your Understanding2.Suppose there isanexceptionallycoldwinter inFloridawithfrosts ruiningmanygroves.Whathappens tothismarket? Illustrate.
S.1
DemandQuantity
Price
$3
30
A
S.2
B$4
25
Test your Understanding3.Whathappensifthepriceofapplesfalls?Illustrateandexplain.
S.1
D.1Quantity
Price
$3
30
A
D.2
B’$2
25
Test your Understanding4.Whatifbothscenarioshappensimultaneously?
S.1
D.1
Quantity
Price
$3
30
A
D.2
B'
10
S.2
B
C
Definitedecreaseinequilibriumquantity
Ambiguouschangeinequilibrium
price
Simultaneous Shifts in Both CurvesSIMULTANEOUS
SHIFTS DemandIncreases
SupplyIncreases
AmbiguousEffectonPrice
QuantityIncreases
S.1
D.1Quantity
Price
Q.1
A
D.2
B
Q.2
S.2
Inthemarketforsweaters:- Winteriscomingandit’sgoingtobeacoldone!(IncreaseinDemand)
- Woolbecomescheaper(IncreaseinSupply)
Simultaneous Shifts in Both Curves
SIMULTANEOUSSHIFTS DemandIncreases
SupplyDecreases
Priceincreases
AmbiguousEffectonQuantity
S.1
D.1Quantity
Price
P.1 AD.2
BP.2
S.2
Inthemarketforcoffee:- FDAsayscoffeecanhelppeoplestayhealthy(IncreaseinDemand)
- AdroughtinEcuadordestroysthecoffeecrops(DecreaseinSupply)
Simultaneous Shifts in Both Curves
SIMULTANEOUSSHIFTS DemandDecreases
SupplyDecreases
AmbiguousEffectonPrice
QuantityDecreases
S.1
D.1
Quantity
Price
Q.1
A
D.2
B
Q.2
S.2
Inthemarketforsnowboards:- Skiinggearisnowcheaperthansnowboardinggear(DecreaseinDemand)
- Afewmajorproducersofsnowboardsdecidetoshifttheirbusinessfocustootherproducts(DecreaseinSupply)
Simultaneous Shifts in Both CurvesSIMULTANEOUS
SHIFTS DemandDecreases
SupplyIncreases
Pricedecreases
AmbiguousEffectonQuantity
S.1
D.1
Quantity
Price
P.1A
D.2
BP.2
S.2
Inthemarketforelectriccars:- Gaspricesfall,peopleprefertokeeptheiroldcars(DecreaseinDemand)
- Innovationsinproductionmakeitcheaperforcompaniestomakeelectriccars(IncreaseinSupply)
Key Takeaway
•MarketEquilibriumbringstogetherthedecentralizeddecisionsofbuyersandsellers• Becauseeachagentislookingoutfortheirownbestinterest– wegettheoptimalresultsinthemodel• ShiftsintheSorDcurvemustcomefromachangeinoneofthefactorsthatchangeeither“willingnesstosell”or“willingnesstobuy”• S-DGraphiscriticalinhelpingusfindequilibriumandanalyze/understandchangesinthemarket.
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