C1-1 Baby Economics Some Tools and Terms…. C1-2 OVERVIEW Refresh some of the topics learned in introductory economics courses Identify Specific tools

C1-1

Baby Economics

Some Tools and Terms…Some Tools and Terms…

C1-2

OVERVIEWOVERVIEW

Refresh some of the topics learned in introductory economics courses

Identify Specific tools required to examine Issues in International Economics (specifically trade)

Refresh some of the topics learned in introductory economics courses

Identify Specific tools required to examine Issues in International Economics (specifically trade)

C1-3

2.1) Important Terms and Tools

•Demand and Supply•Positive and Normative Analysis

•Economic Model•Relative (Real) and Nominal Prices

•Production Possibilities Frontier (Curve)•Indifference Curve (IC)

•Autarky (“ No Trade”)

C1-4

•Consumer and Producer Surplus•Welfare

2.1) Important Terms and Tools

C1-5

WELFARE

International Economics affects the wellbeing of residents of any country.

International Economics affects the wellbeing of residents of any country.

C1-6

WELFARE

Cross border exchange of goods and service, and financial assets are welfare improving because Provide access to goods and services

that can’t be produced at home Provide access to factors that are not

available at home Serve as a forum for transfer of

technology

Cross border exchange of goods and service, and financial assets are welfare improving because Provide access to goods and services

that can’t be produced at home Provide access to factors that are not

available at home Serve as a forum for transfer of

technology

C1-7

WELFARE

when a country involves in international trade, there are always some losers and some winners within a country.

when a country involves in international trade, there are always some losers and some winners within a country.

C1-8

WELFARE

Because

International trade may affect the producers’ benefits (Producers’ Surplus) and consumers’ benefits (Consumers’ Surplus) differently ….

Because

International trade may affect the producers’ benefits (Producers’ Surplus) and consumers’ benefits (Consumers’ Surplus) differently ….

C1-9

WELFARE

For Instance, While consumers may gain from

reduced prices, access to new products/services and quality, some producers may lose their profits and even driven out of markets…loss of jobs

Producers may also benefit from expanded opportunities (access to resources, transfer of a technology, ….)

For Instance, While consumers may gain from

reduced prices, access to new products/services and quality, some producers may lose their profits and even driven out of markets…loss of jobs

Producers may also benefit from expanded opportunities (access to resources, transfer of a technology, ….)

C1-10

Changes inConsumer

Surplus

+Changes in

ProducerSurplus

Gains (+ Changes) > Losses (- Changes)

IMPROVINGWELFARE

C1-11

Demand, Supply and Autarky Price

Copyright©2003 Southwestern/Thomson Learning

Price

Quantity

EquilibriumQuantity

Equilibrium Price

Supply

Demand

If a country engages in no international trade….Autarky price

P

Q

C1-12

Autarky: Why?

The nation is closed to international trade (Political reasons….)

The country is self sufficient… Net changes in its welfare when it

involves in international trade is ZERO Thus decides to produce all what it

consumes/ consumes all what it produces..

The nation is closed to international trade (Political reasons….)

The country is self sufficient… Net changes in its welfare when it

involves in international trade is ZERO Thus decides to produce all what it

consumes/ consumes all what it produces..

C1-13

EXPORTEXPORT


Price

0

Supply

Demand

Surplus

Quantity

P0

P1

Qd Qs

C1-14

IMPORT


Price

0 Quantity

Supply

Demand

Quantitysupplied

Quantitydemanded

P0

Shortage

P1

C1-15

Production Possibilities Frontier

A graph that shows alternative combination of two products that can be produced from the available resources and technology

A graph that shows alternative combination of two products that can be produced from the available resources and technology

The Production Possibilities Frontier (PPF)

Beer

Wine

70

40

A

B

C

0

Usually PPF has a Bowed Out shape

Beer

Wine

70

40

A

B

C

C1-18

Production Possibilities Frontier

Illustrates Several Concepts Attainable/Unattainable

Production levels Efficient and Slack Production

Levels Tradeoffs/Opportunity Cost Economic Growth

Illustrates Several Concepts Attainable/Unattainable

Production levels Efficient and Slack Production

Levels Tradeoffs/Opportunity Cost Economic Growth

C1-19

The Constant-Opportunity Cost Production Possibilities Frontier (PPF)

The Constant-Opportunity Cost Production Possibilities Frontier (PPF)

E

C

Wine0

70

40

Beer

A

302010

55

40

25

B

D

Output levels outside PPF are unattainable given the current technology and resources

C1-20

Fig.1.3. The Production Possibilities Frontier (PPF)Fig.1.3. The Production Possibilities Frontier (PPF)

E

C

Wine0

70

40

Beer

A

302010

55

40

25

BE

Output levels within PPF indicate the presence of unused (unemployed/slack) resources and thus are inefficient

C1-21

Fig.1.3. The Production Possibilities Frontier (PPF)Fig.1.3. The Production Possibilities Frontier (PPF)

E

C

Wine0

70

40

Beer

A

302010

55

40

25

B

A movement from A to B on PPF shows the opportunity Cost of producing 10 more units Wine= 15 units of Beer

C1-22

Economic GrowthEconomic Growth

20000

3,000

1,000

Beer

A

An Outward shift in PPF indicates Economic Growth

Wine

C1-23

2.2. Basic Assumptions …

1. Economic Agents Exhibit Rational Behavior Are goal oriented Choose to use the available resources

in such a way that it gives them the maximum possible satisfaction.

1. Economic Agents Exhibit Rational Behavior Are goal oriented Choose to use the available resources

in such a way that it gives them the maximum possible satisfaction.

C1-24


2. There is No Money Illusion Production and consumption decisions

are not based on changes only in some prices…

2. There is No Money Illusion Production and consumption decisions

are not based on changes only in some prices…

C1-25


2. There is No Money Illusion

Production and consumption decisions are based on changes in Real (relative) NOT Nominal prices.

2. There is No Money Illusion

Production and consumption decisions are based on changes in Real (relative) NOT Nominal prices.

C1-26

3. Often times there are only 2 countries, 2 commodities, and 2 factors (2X2X2) Convenience (2 dimensional graphs,

such as PPF, IC…)

3. Often times there are only 2 countries, 2 commodities, and 2 factors (2X2X2) Convenience (2 dimensional graphs,

such as PPF, IC…)


C1-27

4. Factor endowments & technologies are fixed. The supply of factors and technology

in each country is fixed Allows us to draw PPF and trace the

growth path of a nation

4. Factor endowments & technologies are fixed. The supply of factors and technology

in each country is fixed Allows us to draw PPF and trace the

growth path of a nation


C1-28

Beer

Wine

PPF (Production)

PPF

C1-29

PPFPPF

0

Beer

Wine

6

4

A

E

B

C

D

1 2 3

5

3

ΔB=1

ΔB=2

ΔB=3

A bowed out shape of the PPF shows an increasing Opportunity Cost

C1-30

PPFPPF

0

Beer

Wine

6

4

C

1 2 3

5

3

12

8

Result from a neutral technical progress

C1-31

PPFPPF

0

Beer

Wine

6

4

C

1 2 3

5

3

12A non-neutral technical progress

C1-32

PPFPPF

0

Beer

Wine

6

4

C

1 2 3

5

3

8

A non-neutral technical progress

C1-33

5. Markets are Perfectly Competitive

Market prices reflect the true social (opportunity) costs of production.

…P=MC; No Intervention; trade unions have no impact on wages…

5. Markets are Perfectly Competitive

Market prices reflect the true social (opportunity) costs of production.

…P=MC; No Intervention; trade unions have no impact on wages…


C1-34

6. Factors are perfectly mobile within industries Guarantees that resources earn the

same payments in every production sector…

Can move to sectors where returns are higher…price equalization..

6. Factors are perfectly mobile within industries Guarantees that resources earn the

same payments in every production sector…

Can move to sectors where returns are higher…price equalization..


C1-35

6. Preferences can be represented by indifference curves (IC)

6. Preferences can be represented by indifference curves (IC)


C1-36

Definition and Properties of ICs

C1-37

Indifference curves are graphs that reflect the consumption preferences of individuals

Locus of bundles of goods that yield the same level of satisfaction

Indifference curves are graphs that reflect the consumption preferences of individuals

Locus of bundles of goods that yield the same level of satisfaction

Definition

C1-38

Beer

Wine

Different combination of two goods that give a consumer the same (equal) level of satisfaction

IC (Consumption)

A

C

E

2

24

6 10

14

4

C1-39

Beer

Wine

Bundles of Beer and Wine ( A, C, or E) gives a consumer equal (the same) level of satisfaction (utility)

IC (Consumption)

A

C

E

2

24

6 10

14

4

C1-40

Beer

Wine

Budget Line (Price Line): A line that shows the different combination of two goods that a consumer can buy given his budget

IC (Consumption)

A

B

24

10

4

C1-41

Beer

Wine

The Tangency between IC and budget line shows utility max point

IC (Consumption)

A

B

24

10

4

C1-42

Properties

1. Are Down ward slopping(Trade-offs)

C1-43

Beer

Wine

Properties

A

C

E

2

24

6 10

14

4

1. Are Down ward slopping(Trade-offs)Indicate that both goods are

“truly” goods to the consumer….If one bundle (E) has less of one good (Beer),it must have more of another good (A) to be equally pleasing as the other bundle (E).

C1-44

Properties

2. Convex to the Origin (Bowed In)

C1-45

Beer

Wine

A

C

E

2

24

6 10

14

4

2. Convex to the Origin…(Variety)

Indicate that consumers are willing to give up less and less quantities of one good (Beer) for increased consumption of another good (Wine)

C1-46

Properties

3.Infinitely many ICs…(Ranking)

C1-47

Beer

Wine

Consumers can describe their feelings regarding any conceivable consumption bundles…

A

C

E

2

24

6 10

14

4

3. Infinitely many ICs…

An indifference curve on the upper and right hand side of another indifference curve shows higher level of satisfaction..

C1-48

Beer

Wine

Higher utility with the same budget

IC (Consumption)

A

B

24

10

4

C

C1-49

Properties

4. Two Indifference curves never Intersect(Consistency)

C1-50

Beer

Wine

A

C

E

2

24

6

14

4

4. Two ICs never intersect…

Violates the rationality Assumption

C1-51

Why PPF and IC?

C1-52

Beer

Wine

Production and Consumption (Using PPF and IC)

IC(1)

PPF

A

B

IC(2)

C

D

Documents

C1-1 Baby Economics Some Tools and Terms…. C1-2 OVERVIEW Refresh some of the topics learned in introductory economics courses Identify Specific tools