Can you tell me what these mean? Definitions: Opportunity Costs, Resources are scarce, trade-off, incentive, specialization, equilibrium, interaction of choices, efficiency.

BU 204 MACROECONOMICS CHAPTER 2 Economic Models: Trade-Offs and Trade

What you will learn in this chapter: Why models? Simplified representations of reality play a crucial role in economics. Three simple but important models: Production possibility frontier Comparative advantage Circular-flow diagram The difference between positive economics and normative economics. When economists agree and why they sometimes disagree.

Models in Economics: A model is a simplified representation of a real situation that is used to better understand real-life situations. The production possibility frontier (PPF) illustrates the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given production of the other.

Tom’s Trade-offs: The Production Possibility Frontier

Figure 2-2 Increasing Opportunity Cost Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Economic Growth 7 Economic growth results in an outward shift of the PPF because production possibilities are expanded. The economy can now produce more of everything. Production is initially at point A (20 fish and 25 coconuts),  it can move to point E (25 fish and 30 coconuts).

Production Possibility Frontier Improve understanding of trade offs Illustrates efficiency Shows opportunity costs See economic growth With Trade a country can consume outside its PPF

PPF Efficiency 1. Point A to B show increase in number of computers and decrease in food produced. 2. Resource are taken from food to produce computers. 3. All points on curve show maximum productive efficiency 4. Points inside curve are feasible but inefficient 5. Points outside of curve are infeasible

Production Possibility Curve Opportunity Costs and Trade-offs

Comparative Advantage Model An individual has “ comparative advantage ” in producing a good if the opportunity cost is lower than it would be for someone else An individual has “ absolute advantage ” if he/she can produce more than someone else can Comparative advantage not absolute advantage is the basis for gains in trade

Figure 2-4 Production Possibilities for Two Castaways Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Figure 2-5 Comparative Advantage and Gains From Trade Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Table 2-2 Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Circular Flow Diagram Model that shows transactions by flows around a circle Household defined as a person or group who share their income A firm is an organization that produces good or service Market for Goods-where firms sell Factor Markets-where firms buy resources

Figure 2-7 The Circular-Flow Diagram Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Figure 2-8 Growth in the U.S. Economy from 1962 to 1988 Krugman and Wells: Microeconomics Copyright © 2005 by Worth Publishers

Economics Positive economics: How economy really works Normative economics: How the economy should work. For fun: (Positive? or Negative?) -More than 60% of women are in labor force -Rent control laws should be implemented because thy help achieve fairness -Society should take measures to end gun violence -People who smoke pass on increased medical costs to society

Quick Review 1-Why are models used in economics? 2-Technological improvement will shift curve in which direction? 3-If an economy is producing at level of output that is on the PPF curve, it is using resources efficiently? Non-efficiently? Is it using all it resources? 4-An economy has the lowest opportunity cost for producing a particular good when it has an absolute or comparative advantage?

More Review 5-What are some types of factors of production? 6- Which graphical model shows us how households buy goods and services and sell factors of production. 7-Trade is beneficial to an economy because more goods and services can be obtained at a lower _______________.

Graphing Important to Know: X- horizontal axis (quantity) Y-vertical axis (Price) Horizontal Intercept: x=0 Vertical Intercept : y=0

Homework 1. Graph, and question related to graph, should similar to (next slide) 3. Absolute vs. comparative advantage 10. Economic models 11. Positive vs. Normative economics.

Homework #3 Peter Pundit, an economic reporter states that the EU is increasing productivity in all industries. He claims that this productivity advances in output will soon exceed U.S. and as a result U.S. will not longer benefit from trade with EU. a. Do you think Peter is correct? What is the source of his mistake? b. If the EU and the U.S. Continue to trade, what will characterize the goods that EU exports to U.S., and the good U.S. exports to EU?

Sample PPF (# 1)

The End of Chapter 2 Coming attraction: Chapter 3: Supply and Demand Thank you attending!