Transcript Tutorial EC 210 Introductory Economics

Tutorial
EC 210 Introductory Economics
Session I
July 4, 2008
Trade off VS Opportunity cost
• Trade off  is an
exchange in one
thing for return in
another
• Opportunity cost  is
the value of the nexthighest-valued
alternative
•  is the cost of
passing up next best
choice when making
a decision
http://www.reffonomics.com/TRB/chapter1/opportunitycost.swf
Example
• Let’s say you are going out this Friday night.
You have many choices of what you can do
and cannot do.
– Go out with your friend
– Stay home and watch TV
– Go on a date
– Read economics textbook (HAHA
– Go camping with your parents
impossible, I know)
All of these choices, except for the one you choose, are
then your choices of possible trade-off
Example
– Go out with your friend
Any one of these
choices (marked
– Stay home and watch TV
– Go on a date  your choice with blue color)
then could be a
– Read economics textbook
trade off (singular)
– Go camping with your parents
• In economics we are concerned with
which one is the trade off and what is it
opportunity cost
• What will be your second choice on the
blue list?
Example
• Let’s say your second choice is to go out
with your friends. If this is so then this is
the trade off of going on a date.
• This trade off has a cost.
• What is the cost?
• In economics we call the cost of the trade
off an opportunity cost
Example
• In this case, the opportunity cost of going
on a date could be the excitement and
friendship you are missing going out with
your friends.
• Is that all?
• The money you are going to spend on
your date could have been spent on
something else
True cost of going on a date = excitement & friendship given up + whatever you
could have used the money for that you spent
Opportunity Cost
• Use the concept of opportunity cost to
explain the following.
a. More people choose to get graduate
degrees when the job market is poor.
b. More people choose to do their own
home repairs when the economy is slow.
c. There are more parks in suburban
areas than in urban areas.
d. Fewer students enroll in classes that
meet before 10:00 A.M.
More people choose to get graduate degrees
when the job market is poor.
• The worse the job market, the lower the
opportunity cost of getting a graduate
degree. One of the opportunity costs of
going to graduate school is not being able
to work. But if the job market is bad, the
salary you can expect to earn is low or you
might be unemployed—so the opportunity
cost of going to school is also low.
More people choose to do their own home
repairs when the economy is slow.
• When the economy is slow, the
opportunity cost of people’s time is also
lower: the salary they could earn by
working longer hours is lower than when
the economy is booming. As a result, the
opportunity cost of spending time doing
your own repairs is lower—so more people
will decide to do their own repairs.
There are more parks in suburban areas than
in urban areas.
• The opportunity cost of parkland is lower
in suburban areas. The price per square
foot of land is much higher in urban than in
suburban areas. By creating parkland, you
therefore give up the opportunity to make
much more money in cities than in the
suburbs.
Fewer students enroll in classes that meet
before 10:00 A.M.
• Before 10:00 A.M. the opportunity cost of
time for many students is very high—it
means giving up an extra hour’s sleep.
That extra hour is much more valuable
before 10:00 A.M. than later in the day.
Economic model-PPF
• Atlantis is a small,
isolated island in the
South Atlantic.
• The inhabitants grow
potatoes and catch
fresh fish.
• a. Draw a production
possibility frontier with
potatoes on the
horizontal axis and fish
on the vertical axis
illustrating these
options, showing
points A–F.
Economic model-PPF
b. Can Atlantis produce 500 pounds of fish and 800 pounds
of potatoes? Explain. Where would this point lie relative
to the production possibility frontier?
c. What is the opportunity cost of increasing the annual
output of potatoes from 600 to 800 pounds?
d. What is the opportunity cost of increasing the annual
output of potatoes from 200 to 400 pounds?
e. Can you explain why the answers to parts c and d are
not the same? What does this imply about the slope of
the production possibility frontier?
Economic model-PPF
b. Can Atlantis produce 500
pounds of fish and 800 pounds
of potatoes? Explain. Where
would this point lie relative to
the production possibility
frontier?
Answer: No, Atlantis cannot
produce 500 pounds of fish
and 800 pounds of potatoes. If
it produces 500 pounds of fish,
the most potatoes it can
produce is 600 pounds. This
point would lie outside the
production possibility frontier,
at point G on the diagram.
Economic model-PPF
C. What is the opportunity
cost of increasing the
annual output of potatoes
from 600 to 800 pounds?
Answer: The opportunity
cost of increasing output
from 600 to 800 pounds
of potatoes is 200
pounds of fish.
Economic model-PPF
d. What is the opportunity
cost of increasing the
annual output of potatoes
from 200 to 400 pounds?
Answer: The opportunity
cost of increasing output
from 200 to 400 pounds
of potatoes is 50 pounds
of fish.
Opportunity costs are not equal along
the PPF!!
Economic model-PPF
e. Can you explain why the answers to parts c and d are not the same?
What does this imply about the slope of the production possibility
frontier?
• The answers to parts c and d imply that the more
potatoes Atlantis produces, the higher the opportunity
cost becomes.
• For instance, as you grow more and more potatoes, you
have to use less and less suitable land to do so. As a
result, you have to divert increasingly more resources
away from fishing as you grow more potatoes, meaning
that you can produce increasingly less fish.
• This implies, of course, that the production possibility
frontier becomes steeper the farther you move along it to
the right; that is, the production possibility frontier is
bowed out.
Supply & Demand
• Three steps analysis
– Affect supply or demand
– Direction of curve shift
– New equilibrium price and equilibrium quantity
A C T I V E L E A R N I N G 2:
Changes in supply and demand
Use the three-step method to analyze
the effects of each event on the
equilibrium price and quantity of music
downloads.
Event A: A fall in the price of CDs
Event B: Sellers of music downloads
negotiate a reduction in the
royalties they must pay for each
song they sell.
Event C: Events A and B both occur.
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A C T I V E L E A R N I N G 2:
A. fall in price of CDs
P
The market for
music downloads
S1
STEPS
1. D curve shifts
P1
2. D shifts left
P2
3. P and Q both
fall.
D2
Q2 Q1
D1
Q
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A C T I V E L E A R N I N G 2:
B. fall in cost of royalties
P
STEPS
1. S curve shifts
(royalties are part
of sellers’ costs)
The market for
music downloads
S1
S2
P1
P2
2. S shifts right
D1
3. P falls,
Q rises.
Q1 Q2
Q
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A C T I V E L E A R N I N G 2:
C. fall in price of CDs
AND fall in cost of royalties
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.
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Supply & Demand
In a supply and demand diagram, draw the shift in demand
for hamburgers in your hometown due to the following
events. In each case show the effect on equilibrium price
and quantity.
a. The price of KFC increases.
b. All hamburger sellers raise the price of their french fries.
c. Income falls in town. Assume that hamburgers are a
normal good for most people.
d. Income falls in town. Assume that hamburgers are an
inferior good for most people.
e. Hot dog stands cut the price of hot dogs.
Supply & Demand
a. A rise in the price of a substitute (KFC) causes the
demand for hamburgers to increase. This represents a
rightward shift of the demand curve from D1 to D2 and
results in a rise in the equilibrium price and quantity as
the equilibrium changes from E1 to E2.
Supply & Demand
b. A rise in the price of a complement (french fries) causes
the demand for hamburgers to decrease. This
represents a leftward shift of the demand curve from D1
to D2 and results in a fall in the equilibrium price and
quantity as the equilibrium changes from E1 to E2.
Supply & Demand
c. A fall in income causes the demand for a normal good
(hamburgers) to decrease. This represents a leftward
shift of the demand curve from D1 to D2 and results in a
fall in the equilibrium price and quantity as the
equilibrium changes from E1 to E2.
Supply & Demand
d. A fall in income causes the demand for an inferior good
(hamburgers) to increase. This represents a rightward
shift of the demand curve from D1 to D2 and results in a
rise in the equilibrium price and quantity as the
equilibrium changes from E1 to E2.
Supply & Demand
e. A fall in the price of a substitute (hot dogs) causes
demand for hamburgers to decrease. This is represented
by a leftward shift of the demand curve from D1 to D2
and results in a fall in the equilibrium price and quantity
as the equilibrium changes from E1 to E2.
Supply & Demand
The market for many goods changes in predictable ways according to
the time of year, in response to events such as holidays, vacation
times, seasonal changes in production, and so on. Using supply and
demand, explain the change in price in each of the following cases.
Note that supply and demand may shift simultaneously.
a. Lobster prices usually fall during the summer peak harvest season,
despite the fact that people like to eat lobster during the summer
months more than during any other time of year.
b. The price of a Christmas tree is lower after Christmas than before
and fewer trees are sold.
c. The price of a round-trip ticket to Paris on Air France falls by more
than $200 after the end of school vacation in September. This
happens despite the fact that generally worsening weather
increases the cost of operating flights to Paris, and Air France
therefore reduces the number of flights to Paris at any given price.
Supply & Demand
a. There is a rightward shift of the demand curve from D1 to D2 during
the summer months, as consumers prefer to eat more lobster
during the summer than during other times of the year. Other things
equal, this leads to a rise in the price of lobster. Simultaneously,
lobster fishermen produce more lobster during the summer peak
harvest time, when it is cheaper to harvest lobster, representing a
rightward shift of the supply curve of lobster from S1 to S2. Other
things equal, this leads to a fall in the price of lobster. Given the
simultaneous rightward shifts of both the demand and supply
curves, the equilibrium changes from E1 to E2. The fall in price
indicates that the rightward shift of the supply curve exceeds the
rightward shift of the demand curve.
Supply & Demand
b. There is a leftward shift of the demand curve for
Christmas trees after Christmas from D1 to D2, as fewer
consumers want Christmas trees at any given price. The
supply curve does not shift; the reduction in the quantity
of trees supplied is a movement along the supply curve.
This leads to a fall in the equilibrium price and quantity,
as the equilibrium changes from E1 to E2.
Supply & Demand
c. There is a leftward shift of the demand curve for tickets to Paris in
September, after the end of school vacation, from D1 to D2. Other
things equal, this leads to a fall in the price of tickets. At the same
time, as the cost of operating flights increases, Air France decreases
the number of flights, shifting the supply curve leftward from S1 to
S2. Other things equal, this leads to a rise in price. Given the
simultaneous leftward shifts of both the demand and supply curves,
the equilibrium changes from E1 to E2. The fall in price indicates
that the leftward shift of the demand curve exceeds the leftward shift
of the supply curve.
A C T I V E L E A R N I N G 1:
Effects of a tax
Suppose govt
imposes a tax
on buyers of
$30 per room.
Find new
Q, PB, PS,
and incidence
of tax.
P
140
130
The market for
hotel rooms
S
120
110
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
A C T I V E L E A R N I N G 1:
Answers
P
140
The market for
hotel rooms
130
Q = 80
120
PB = 110
PB = $110
100
PS = $80
90
PS = 80
Incidence
buyers: $10
sellers: $20
S
Tax
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
A C T I V E L E A R N I N G 2:
Elasticity and changes in equilibrium
• The supply of beachfront property is
inelastic. The supply of new cars is
elastic.
• Suppose population growth causes
demand for both goods to double
(at each price, Qd doubles).
• For which product will P change the most?
• For which product will Q change the most?
A C T I V E L E A R N I N G 2:
Answers
When supply
is inelastic,
an increase in
demand has a
bigger impact
on price than
on quantity.
Beachfront property
(inelastic supply):
P
D1 D2
S
B
P2
P1
A
Q 1 Q2
Q
A C T I V E L E A R N I N G 2:
Answers
When supply
is elastic,
an increase in
demand has a
bigger impact
on quantity
than on price.
New cars
(elastic supply):
P
D1 D2
S
P2
P1
B
A
Q1
Q2
Q