econ micro

Distinguish between comparative advantage and absolute advantage.

A person has a comparative advantage in producing a good when he or she has the lowest opportunity cost of producing it. Comparative advantage is based on the output forgone. A person has an absolute advantage in production when he or she uses the least amount of time or resources to produce one unit of that particular good or service. Absolute advantage is a measure of productivity in using inputs.

Over what range of prices does a shortage arise? What happens to the price when there is a shortage?

A shortage arises at market prices below the equilibrium price. A shortage causes the price to rise, decreasing quantity demanded and increasing quantity supplied until the equilibrium price is attained.

Over what range of prices does a surplus arise? What happens to the price when there is a surplus?

A surplus arises at market prices above the equilibrium price. A surplus causes the price to fall, decreasing quantity supplied and increasing quantity demanded until the equilibrium price is attained.

What is the source of the gains from trade?

As long as people have different opportunity costs of producing goods or services, total output is higher with specialization and trade than if each individual produced goods and services under self-sufficiency. This increase in output is the gains from trade.

Why is the price at which the quantity demanded equals the quantity supplied the equilibrium price?

At the equilibrium price, the quantity demanded by consumers equals the quantity supplied by producers. At this price, the plans of producers and consumers are coordinated and there is no influence on the price to move away from equilibrium.

Why does Brazil face a tradeoff on its PPF?

Brazil faces a tradeoff on its PPF because Brazil's resources and technology are limited. For Brazil to produce more of one good, it must shift factors of production away from the other good. Therefore to increase production of one good requires decreasing production of the other, which reflects a tradeoff.

Does Brazil face an increasing opportunity cost of ethanol? What feature of Brazil's PPF illustrates increasing opportunity cost?

Brazil faces an increasing opportunity cost of ethanol production. For instance, when increasing ethanol production from 0 barrels per day to 22 barrels the opportunity cost of a barrel of ethanol is 1/22 of a ton of food while increasing ethanol production another 18 barrels per day (to a total of 40 barrels per day) has an opportunity cost of 1/18 of a ton of food per barrel of ethanol. The PPF's bowed outward shape reflects the increasing opportunity cost.

List all the influences on selling plans, and for each influence, say whether it changes supply.

Changes in the price of the good change the quantity supplied. They do not change the supply of the good. Influences that change the supply of a good include: • Prices of factor of production. A rise (fall) in the price of a factor of production increases firms' costs of production and decreases (increases) the supply of the good. • Prices of related goods produced. If the price of a substitute in production rises (falls), firms decrease (increase) their sales of the original good and the supply for the original good decreases (increases). A rise (fall) in the price of a complement in production increases (decreases) production of the original good, causing the supply of the original good to increase (decrease). • The expected future price of the good. A rise (fall) in the expected future price of the good decreases (increases) the amount suppliers sell today. This change in expectations decreases (increases) the supply in the current period. • The number of sellers. An increase (decrease) in the number of sellers in a market increases the quantity of the good available at every price, and increases (decreases) the supply. • Technology. An advance in technology increases the supply. • The state of nature. A good (bad) state of nature, such as good (bad) weather for agricultural products, increases (decreases) the supply.

How does economic growth influence the production possibilities frontier?

Economic growth shifts the PPF outward. Persistent outward shifts in the production possibility frontier—economic growth—are caused by the accumulation of resources, such as more capital equipment or by the development of new technology.

What does the demand curve tell us about the price that consumers are willing to pay?

For any fixed quantity of a good available, the vertical distance of the demand curve from the x-axis shows the maximum price that consumers are willing to pay for that quantity of the good. The price on the demand curve at this quantity indicates the marginal benefit to consumers of the last unit consumed at that quantity.

What does the supply curve tell us about the producer's minimum supply price?

For any quantity, the vertical distance between the supply curve and the x-axis shows the minimum price that suppliers must receive to produce that quantity of output. As a result, the price is the marginal cost of the last unit produced at this level of output.

What are the gains from specialization and trade?

From society's standpoint, the total output of goods and services available for consumption is greater with specialization and trade. From an individual's perspective, each person who specializes enjoys being able to consume a larger bundle of goods and services after trading with others who have also specialized, than would otherwise be possible under self-sufficiency. These increases are the gains from specialization and trade for society and for individuals.

Why does demand not change when the price of a good changes with no change in the other influences on buying plans?

If the price of a good falls and nothing else changes, then the quantity of the good demanded increases and there is a movement down along the demand curve, but the demand for the good remains unchanged and the demand curve does not shift.

What happens to the quantity of cell phones supplied and the supply of cell phones if the price of a cell phone falls?

If the price of cell phones falls and nothing else changes, then the quantity of cell phones supplied will decrease and there is a movement down along the supply curve for cell phones. The supply of cell phones, however, remains unchanged and the supply curve does not shift.

List all the influences on buying plans that change demand, and for each influence, say whether it increases or decreases demand.

Influences that change the demand for a good include: • The prices of related goods. A rise (fall) in the price of a substitute increases (decreases) the demand for the first good. A rise (fall) in the price of a complement decreases (increases) the demand for the first good. • The expected future price of the good. A rise (fall) in the expected future price of a good increases (decreases) the demand in the current period. • Income. An increase (decrease) in income increases (decreases) the demand for a normal good. An increase in income decreases (increases) the demand for an inferior good. • Expected future income and credit. An increase (decrease) in expected future income or credit increases (decreases) the demand. • The population. An increase (decrease) in population increases (decreases) the demand. • People's preferences. If people's preferences for a good rise (fall), the demand increases (decreases).

How does the production possibilities frontier show that every choice involves a tradeoff?

Movements along the PPF frontier illustrate that producing more of one good requires producing less of other good. This observation reflects the result that a tradeoff must be made when producing output efficiently.

Why do people specialize and trade?

People can compare consumption possibilities from producing all goods and services through self-sufficiency against specializing in producing only those goods and services that reflect their comparative advantage and trading their output with others who do the same. People can then see that the consumption possibilities from specialization and trade are greater than under self-sufficiency. Therefore it is in people's own self-interest to specialize. It was Adam Smith who first pointed out in the Wealth of Nations how individuals voluntarily engage in this socially beneficial and cooperative activity through the pursuit of their own self-interest, rather than for society's best interests.

Does economic growth overcome scarcity?

Scarcity reflects the inability to satisfy all our wants. Regardless of the amount of economic growth, scarcity will remain present because it will never be possible to satisfy all our wants. For instance it will never be possible to satisfy all the wants of the several thousand people who all would like to ski the best slopes on Vail with only their family and a few best friends present. So economic growth allows more wants to be satisfied but it does not eliminate scarcity.

Why does the PPF bow outward and what does that imply about the relationship between opportunity cost and the quantity produced?

Some resources are better suited to produce one type of good or service, like pizza. Other resources are better suited to produce other goods or services, like DVDs. If society allocates resources wisely, it will use each resource to produce the kind of output for which it is best suited. Consider a PPF with pizza measured on the x-axis and DVDs measured on the y-axis. A small increase in pizza output when pizza production is relatively low requires only a small increase in the use of those resources still good at making pizza and not good at making DVDs. This yields a small decrease in DVD production for a large increase in pizza production, creating a relatively low opportunity cost reflected in the gentle slope of the PPF over this range of output. However, the same small increase in pizza output when pizza production is relatively large will require society to devote to pizza production those resources that are less suited to making pizza and more suited to making DVDs. This reallocation of resources yields a relatively small increase in pizza output for a large decrease in DVD output, creating a relatively high opportunity cost reflected in the steep slope of the PPF over this range of output. The opportunity cost of pizza production increases with the quantity of pizza produced as the slope of the PPF becomes ever steeper. This effect creates the bowed out effect (the concavity of the PPF function) and means that as more of a good is produced, the opportunity cost of producing additional units increases.

In one hour, Sue can produce 40 caps or 4 jackets and Tessa can produce 80 caps or 4 jackets. Calculate Sue's opportunity cost of producing a cap. Calculate Tessa's opportunity cost of producing a cap. Who has a comparative advantage in producing caps? If Sue and Tessa specialize in producing the good in which they have a comparative advantage, and they trade 1 jacket for 15 caps, who gains from the specialization and trade?

Sue forgoes 4 jackets to produce 40 caps, so Sue's opportunity cost of producing one cap is (4 jackets)/(40 caps) or 0.1 jacket per cap. Tessa forgoes 4 jackets to produce 80 caps, so Tessa's opportunity cost of producing one cap is (4 jackets)/(80 caps) or 0.05 jacket per cap. Tessa's opportunity cost of a cap is lower than Sue's opportunity cost, so Tessa has a comparative advantage in producing caps. Tessa specializes in caps and Sue specializes in jackets. Both Sue and Tessa gain from trade. Sue gains because she can obtain caps from Tessa at a cost of (1 jacket)/(15 caps), which is 0.067 jacket per cap, a cost that is lower than what it would cost her to produce caps herself. Tessa also gains from trade because she trades caps for jackets for 0.067 jacket per cap, which is higher than her cost of producing a cap.

How does the production possibilities frontier illustrate production efficiency?

The combinations of outputs that lie on the PPF illustrate the concept of production efficiency. These points are the maximum production points possible and are attained only by producing the goods and services at the lowest possible cost. Any point inside the frontier reflects production where one or both outputs may be increased without decreasing the other output level. Clearly, such points cannot be production efficient.

What is the equilibrium price of a good or service?

The equilibrium price is the price at which the quantity demanded by the buyers is equal to the quantity supplied by the sellers.

Why is the equilibrium price the best deal available for both buyers and sellers?

The equilibrium price reflects that the highest price consumers are willing to pay for that amount of the good or service and is just equal to the minimum price that suppliers require for delivering it. Demanders would prefer to pay a lower price, but suppliers are unwilling to supply that quantity at a lower price. Suppliers would prefer a higher price, but demanders are unwilling to pay a higher price for that quantity. Hence neither demanders not suppliers can do business at a better price.

What is the law of demand and how do we illustrate it?

The law of demand states: "Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded." The law of demand is illustrated by a downward-sloping demand curve drawn with the quantity demanded on the horizontal axis and the price on the vertical axis. The slope is negative to show that the higher the price of a good, the smaller is the quantity demanded and the lower the price of a good, the greater is the quantity demanded.

What is the law of supply and how do we illustrate it?

The law of supply states that "other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied." The law of supply is illustrated by an upward-sloping supply curve drawn with the quantity supplied on the horizontal axis and the price on the vertical axis. The slope is positive to show that the higher the price of a good, the greater is the quantity supplied and the lower the price of a good, the smaller is the quantity supplied.

How does the production possibilities frontier illustrate opportunity cost?

The negative slope of the production possibility curve illustrates the concept of opportunity cost. Moving along the production possibility frontier, producing additional units of a good requires that the output of another good must fall. This sacrifice is the opportunity cost of producing more of the first good.

Draw a graph of Brazil's PPF and explain how your graph illustrates scarcity.

The production possibilities frontier indicates scarcity because it shows the limits to what can be produced. In particular, production combinations of ethanol and food crops that lie outside the production possibilities frontier are not attainable.

Define the quantity demanded of a good or service.

The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price.

Define the quantity supplied of a good or service.

The quantity supplied of a good or service is the amount of the good or service that firms plan to sell in a given period of time at a specified price.

Why is opportunity cost a ratio?

The slope of the PPF is a ratio that expresses the quantity of lost production of the good on the y-axis to the increase in the production of the good on the x-axis moving downward along the PPF. The steeper the slope, the greater ratio, and the greater is the opportunity cost of increasing the output of the good measured on the horizontal axis.

What generates economic growth?

The two key factors that generate economic growth are technological change and capital accumulation. Technological change allows an economy to produce more with the same amount of limited resources, Capital accumulation, the growth of capital resources including human capital, means that an economy has increased its available resources for production.

How does the production possibilities frontier illustrate scarcity?

The unattainable combinations of production that lie beyond the PPF illustrate the concept of scarcity. There simply are not enough resources to produce any of these combinations of outputs. Additionally, while moving along the PPF to increase the production of one good requires that the production of another good be reduced, which also illustrates scarcity.

What is the opportunity cost of economic growth?

When a society devotes more of its scarce resources to research and development of new technologies, or devotes additional resources to produce more capital equipment, both decisions lead to increased consumption opportunities in future periods at the cost of less consumption today. The loss of consumption today is the opportunity cost borne by society for creating economic growth.