1. First Picture The Production Possibilities Frontier Tradeoffs in Pictures Quantity of Computers Produced Quantity of Cars Produced 3,000 1,000 2,000 2,200 A 700 60030001,000 B Feasible but Inefficient C D Infeasible Pts Production Possibilities Frontier  Efficient Points

2. Supply Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones Second Picture Supply and Demand 2134567891012110 $3.00 2.50 2.00 1.50 1.00 0.50 Equilibrium

3. Supply and Demand on Parade

4. An Increase in Demand Price of Ice-Cream Cone 2.00 0 7 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 2....resulting in a higher price... $2.50 10 3....and a higher quantity sold. New equilibrium Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

5. S2S2 A Decrease in Supply Price of Ice-Cream Cone 2.00 012347891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream... New equilibrium 2....resulting in a higher price... $2.50 3....and a lower quantity sold.

6. Elastic Demand: Quantity demanded responds dramatically to price  Elasticity is greater than 1 Quantity Price 4 $5 1. A 22% increase in price... Demand 100 50 2....leads to a 67% decrease in quantity.

7. Inelastic Supply: Quantity doesn’t respond much to price  Elasticity is less than 1 Quantity Price 4 $5 1. A 22% increase in price... 110 100 Supply 2....leads to a 10% increase in quantity.

8. Consumer Surplus and Producer Surplus Price Equilibrium price 0Quantity Equilibrium quantity A Supply C B Demand D E Producer surplus Consumer surplus

9. Price 0 Quantity Equilibrium quantity Supply Demand Cost to sellers Value to buyers Cost to sellers Value to buyers is greater than cost to sellers. Value to buyers is less than cost to sellers. Efficiency of Competitive Market Equilibrium … and the Tax Wedge

10. Remember MR = MC and market price is the marginal revenue of a price-taking competitive firm MR = P = MC

11. The Effects of a Tariff Deadweight Loss Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Tariff World price Q1SQ1S Q2SQ2S Q2DQ2D Q1DQ1D Price without tariff Price with tariff Imports without tariff Imports with tariff A B CE G DF Deadweight loss

12. GDP: Real and Nominal Gross Domestic Product (GDP):Gross Domestic Product (GDP): the market value of all final goods and services produced within a country during a year. GDP = C + I + G + Ex – Im = C + I + G + NX = C + I + G + NX Real GDPReal GDP adjusts for inflation Nominal GDP = $GDP = P x Q $ GDP = GDP Deflator x Real GDP Real GDP = Q = $GDP/P = Nominal GDP divided by (deflated by) the GDP Price Deflator

13. Foreign Exchange Rate: Appreciation and Depreciation A currency appreciates when it buys more of a foreign currency.A currency appreciates when it buys more of a foreign currency. –Appreciation makes foreign goods cheaper. –Appreciation  Imports Up and Exports Down. A currency depreciates when it buys less of a foreign currency.A currency depreciates when it buys less of a foreign currency. –Depreciation makes foreign goods more expensive. –Depreciation  Imports Down and Exports Up.

14. Current Account vs. Financial Account The balance of payments must balance Current Account + Financial Account = 0 –If we buy more goods and services from foreigners than they buy from us, we have to borrow the difference  sell them our IOUs. Capital inflows help finance domestic investment and the government’s deficit

15. Interest Rates: Nominal and Real Nominal Interest Rate (i): the interest rate observed in the market. Real Interest Rate (r): the nominal rate adjusted for inflation (  ). Real Interest Rate = Nominal Interest Rate – Inflation Rate r = i -  IILow real interest rates spur business investment spending (the I in C + I + G + NX)

16. Imports and Exports The demand for imports depends on current economic activity, Y IM = IM a + mpi Y “mpi” is the marginal propensity to import Exports are exogenously determined they depend on conditions in foreign economies, not our economy Net exports is NX = EX – (IM a + mpi Y) or NX = NX a – mpi Y Net expects decrease as the economy expands

17. Demand-Side Equilibrium and the Multiplier At equilibrium: Y = C + I + G + NX = AE Increase in Y = Spending Multiplier x {Increase in Autonomous Spending} Multiplier = 1/(mps + mpi)