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Econ 4346 Test #1 Topic Review

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PARETO OPTIMALITY An allocation of resources such that:An allocation of resources such that: It is impossible to make at least one person better off without making someone else worse offIt 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…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…And the other person a full allocation of food, then… Trade will occur to a point where both peopleTrade will occur to a point where both people Benefit from the interactionBenefit from the interaction Cannot improve any further without harming the otherCannot improve any further without harming the other Pareto Optimality serves as the basis for the Production Possibilities FrontierPareto Optimality serves as the basis for the Production Possibilities Frontier Review video on blog http://tc6617.wordpress.com/2010/10/13/econ-4346-basic- principles-part-1/Review video on blog http://tc6617.wordpress.com/2010/10/13/econ-4346-basic- principles-part-1/

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(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

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pRODUCTION POSSIBILITIES FRONTIER Displays efficient combinations of output when factors of production (labor, land, and capital) are used to full potentialDisplays efficient combinations of output when factors of production (labor, land, and capital) are used to full potential Bowed shape represents increasing costsBowed shape represents increasing costs In order to increase production of one good (A), production of the other (B) must be given upIn order to increase production of one good (A), production of the other (B) must be given up Sounds like Pareto Optimality, perhaps?Sounds like Pareto Optimality, perhaps? Review Mankiw pp25-28Review Mankiw pp25-28 Review blog: http://tc6617.wordpress.com/2010/10/13/econ-4346- basic-principles-part-1/Review blog: http://tc6617.wordpress.com/2010/10/13/econ-4346- basic-principles-part-1/

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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

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Demand curve Why is it downward sloping?Why is it downward sloping? Because of the Law of DemandBecause of the Law of Demand The quantity demanded of a good falls when the price risesThe quantity demanded of a good falls when the price rises

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Supply Curve Why does it slope upward?Why does it slope upward? Because of the Law of SupplyBecause of the Law of Supply The quantity supplied of a good rises when the price of the good risesThe quantity supplied of a good rises when the price of the good rises

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Equilibrium A situation in which the market price has reached the level at which quantity supplied equals quantity demandedA situation in which the market price has reached the level at which quantity supplied equals quantity demanded

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Equilibrium of supply and demand P Q D S Equilibrium

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Solving for equilbrium Expedia did the following study (fictional) on its market for package toursExpedia did the following study (fictional) on its market for package tours Demand scheduleDemand schedule Qd = 28,000 – 300PQd = 28,000 – 300P Supply scheduleSupply schedule Qs = 23,000 + 200PQs = 23,000 + 200P CALCULATE EQUILIBRIUM PRICE AND QUANTITYCALCULATE EQUILIBRIUM PRICE AND QUANTITY

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Solving for equilibrium P Q Qd = 28,000 – 300P Qs = 23,000 + 200P 1.Set Qs = Qd 2.23,000 + 200P = 28000 – 300P 3.Solve for P 4.500P = 5,000 5.P = 10 6.Plug in value for P in one of equations (well use Qd) 7.28,000-300(10) = Qd = 25,000 $10 25,000

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PRICE CEILING Occurs when government puts legal limit on how high the price of a product can beOccurs when government puts legal limit on how high the price of a product can be Why?Why? Government thinks that price ceilings protect consumersGovernment thinks that price ceilings protect consumers If government didnt impose a price ceiling, the product wouldnt be obtainable to the average consumerIf government didnt impose a price ceiling, the product wouldnt be obtainable to the average consumer Therefore unfairTherefore unfair

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Price ceiling P Q CEILING S D SHORTAGE Price ceiling below equilibrium. Shortage occurs because demand exceeds supply

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Elasticity of demand See figure 1, Mankiw, page 93See figure 1, Mankiw, page 93 Perfectly inelastic: Ed = 0Perfectly inelastic: Ed = 0 Inelastic: Ed < 1Inelastic: Ed < 1 Unit Elastic: Ed = 1Unit Elastic: Ed = 1 Elastic: Ed > 1Elastic: Ed > 1 Perfectly Elastic: Ed = infinityPerfectly Elastic: Ed = infinity

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Elasticity of supply See figure 5, Mankiw page 101See figure 5, Mankiw page 101 Perfectly Inelastic: Es = 0Perfectly Inelastic: Es = 0 Inelastic: Es < 1Inelastic: Es < 1 Unit Elastic: Es = 1Unit Elastic: Es = 1 Elastic: Es > 1Elastic: Es > 1 Perfectly Elastic: Es = infinityPerfectly Elastic: Es = infinity

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Shifts in supply and demand curves Thoroughly review pages 67 – 82 in MankiwThoroughly review pages 67 – 82 in Mankiw

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