Economics 1 (EC107) : Micro (Term 1) Robin Naylor, Department of Economics, Warwick 1 Economics (Lecture 1) Welcome!

Robin Naylor, Department of Economics, Warwick 2 Economics 1 Accompanying Resources Module Website – see various tabs (thumbprint, assessment, feedback) – see links to slides and pod/webcasts/transcripts Module Manual – (with reading list) Seminar Work and Problem Sets and e-forums Departmental Handbooks and Web-Sites MyEconomics Portal

Robin Naylor, Department of Economics, Warwick 3 Economics 1 Organisation (see module manual for details) Lecture timetable Lecture notes/handouts Seminar/e-forum arrangements(from week 3) Personal Essays Examination and Assessment

Robin Naylor, Department of Economics, Warwick 4 Economics Readings (Micro) Besanko and Braeutigam, Microeconomics 4 th Edition, Wiley, 2011 Estrin, Laidler and Dietrich (ELD), Microeconomics, Many other textbooks plus other literature: see Module Manual

Robin Naylor, Department of Economics, Warwick 5 Term 1: Micro Topics IntroductionScarcity and Trade; Markets Topic 1Household behaviour Topic 2Firm behaviour Topic 3Product markets Topic 4Factor markets Topic 5Market Structure, Efficiency and Failure

Robin Naylor, Department of Economics, Warwick 6 Introduction The fundamental problem of scarcity –Cause: excess of wants over ‘natural’ supply –Consequences: (i) Choices over production (ii) Trade-offs and opportunity costs (iii) Rationing of distribution (Markets etc...) Consider a 2-good economy:

Robin Naylor, Department of Economics, Warwick 7 Introduction The fundamental problem of scarcity Food Defence 0F-Max D-MaxThe Production Possibility Curve The Production Possibility Set

Robin Naylor, Department of Economics, Warwick 8 Introduction The fundamental problem of scarcity Food Defence 0F-Max D-Max. a What can you say about points a, b and c?. b. c

Robin Naylor, Department of Economics, Warwick 9 Introduction The fundamental problem of scarcity Food Defence 0F-Max D-Max. a The MRT is the amount of one good (D) we have to give up in order to have an extra unit of the other good (F).. b. d So the MRT is increasing in the case of the concave PPC. Why?

Robin Naylor, Department of Economics, Warwick 10 Introduction The fundamental problem of scarcity Food Defence 0 The PPC shows us the trade-off that Society has to make between 2 goods. Note also relationship to Opportunity Cost What about the trade-off that the Society is prepared to make?

Robin Naylor, Department of Economics, Warwick 11 Introduction Food Defence 0 The slope of the Indifference Curve shows us how much of one good the society is prepared to give up (‘trade off’) in order to have an extra unit of the other good: This is the Marginal Rate of Substitution (MRS). Why might it be convex? IC

Robin Naylor, Department of Economics, Warwick 12 Introduction Food Defence 0 A set or family of Indifference Curves IC1 IC2 IC3

Robin Naylor, Department of Economics, Warwick 13 Introduction Food Defence 0. a ‘a’ is not technically efficient. ‘b’ is. So is ‘d’. So how can we choose between ‘b’ and ‘d’? They are both ‘technically’ efficient. But they are not both Allocatively Efficient.... b. d

Robin Naylor, Department of Economics, Warwick 14 Introduction Food Defence 0. a. b. d On which IC would society like most to be? At what point is this? Where MRS = MRT.

Robin Naylor, Department of Economics, Warwick 15 Introduction Gains from Trade Consider 2 economies, Red and Blue: X Y PPC-R PPC-B Who has an absolute advantage in producing X? And Y?

Robin Naylor, Department of Economics, Warwick 16 Introduction Gains from Trade Consider 2 economies, Red and Blue: X Y To raise output of X by the amount dX, the required reduction in Y is smaller in Blue than in Red. In other words, the Opportunity Cost of the extra X is lower in Blue than in Red. We say that Blue has a Comparative Advantage in the production of X. And Red has a Comparative Advantage in producing Y. dX

Robin Naylor, Department of Economics, Warwick 17 Introduction X Y Suppose initially, Blue is at point ‘a- B’ and Red is at ‘a-R’. If Blue gives up one unit of Y, it raises output of X by dX. Suppose that at the same time Red cuts production of X by the same amount, dX: then it can raise output of Y by 3 units. So what is the total change in ‘World’ production of X? And of Y? dX dY=1 dY=3 a-B a-R

Robin Naylor, Department of Economics, Warwick 18 Introduction X Y So with an unchanged total production of X and a higher total production of Y, the countries could*: Trade such that Blue exports dX to Red and, in return, Red exports 2 units of Y to Blue. What would this look like in terms of each country’s PPC? a-B a-R b-R b-B dY=1

Robin Naylor, Department of Economics, Warwick 19 Introduction Key Concepts Scarcity Wants Opportunity Cost Trade-offs Rationing Markets Efficiency Equity Constraints Changes at the margin

Robin Naylor, Department of Economics, Warwick 20 Introduction Key Concepts Choices Preferences Constraints PPC MRS MRT Optimisation Absolute advantage Comparative advantage Specialisation Trade

Robin Naylor, Department of Economics, Warwick 21 Introduction Self-study Questions Show and explain a PPC for a country What determines the position and shape of the PPC Explain the concept of the MRT Economists often argue that Choices depend on two key concepts: Preferences and Constraints. Explain this argument. Explain the concept of the MRS Define ‘trade-offs’ (in terms of both preferences and constraints) and ‘Opportunity Cost’ and explain their meanings in a diagram using the concept of the PPC. What is meant by Absolute Advantage? What is meant by Comparative Advantage? Explain how the concepts of comparative advantage and of opportunity cost are related. Show how trade and specialisation can lead to potential gains for both parties in a trade.