Ellys PeeplesMicroeconomy Ch. 29/1/11Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues.The Circular- Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firmsTwo types of “actors”: households firmsTwo markets: the market for goods and services the market for “factors of production”Factors of production: the resources the economy uses to produce goods and services including: labor land (natural resources) capital (buildings and machines used in production)p. 25 figure 1The Production Possibilities Frontier (PPF)- a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology  Recall: the Opportunity cost of an item is what must be given up to obtain that item. Moving along a PPF involves shifting resources (labor) from the production of one good to the other Society faces a tradeoff: getting more of one good requires sacrificing some of the other The slope of the PPF tells you’re the opportunity cost of one good in terms of the othero The PPF could be a straight line, or bow-shaped Depends on what happens to opportunity cost as economy shifts resources from one industry to the other- If opp. Cost remains constant, PPF is a straight line- If opp. Cost of a good rises as the economy produces more of the good, PPF is bow-shaped- Resources are not perfectly adaptable PPF is bow-shaped when different workers have different skills, different opportunity costs of producing one good in terms of the other The PPF would also be bow-shaped when there is some other resource, or mix of resources with varying opportunity costs (different types of land)As scientists, economists make positive statements, which attempt to describe the world as it is.As policy advisors, economists make normative statements, which attempt to prescribe how the world should be.It takes less resources to make computes so we move it to cars. Economic growth.A Parable for the Modern Economy- Two goods: meat and potatoes- Two people: rancher and farmer- If rancher produces only meato And farmer produces only potatoes o Both gain from trade- If both rancher and farmer produce both meat and potatoeso They still gain from specialization and trade- Specialization- “You do what you to best”Specialization and tradeo Farmer- specialize in growing potatoeso More time growing potatoeso Less time raising cattleo Rancher- specialize in raising cattleo More time raising cattleo Less time growing potatoeso Tradeo 5 oz of meat for 15 oz of potatoesAbsolute advantage- produce a good using fewer input than another producerOpportunity cost- whatever must be given up to obtain some item, measures the trade-off between the two good that each producer faceso Comparative advantage-o Produce a good-lower opportunity cost than another producero Reflects- relative opportunity costo Principle of comparative advantageo Each good- produced by the individual that has the smaller opportunity cost of producing that good One person can have absolute advantage in both goods cannot have comparative advantage in both goodFor different opportunity costs one person- comparative advantage in one good the other person- comparative advantage in the other good Opportunity cost of one good inverse of the opportunity cost of the other*Gains from specialization and trade based on comparative advantage total production in economy rises o increase in the size of the economic pieo everyone- better off Trade can benefit everyone in societyo Allows people to specialize in activities  Have a comparative advantage The price of tradeo Must lie between the two opportunity costs Principle of comparative advantage explains:o Interdependenceo Gains from tradeShould the US trade with other countries?Imports- Goods produced abroad and sold domesticallyExports- goods produced domestically and sold abroadPrinciple of comparative advantage- each good- produced by the countryo smaller opportunity cost of producing that goodSpecialization and trade- all countries- greater prosperity Quantity demanded of any good is the amount of the good that buyers are willing and able to purchase at a specific price. QD is a point on the demand curve.Demand curve is a set of various quantities demanded at corresponding prices. It isthe curve itselfLaw of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equalDemand schedule: a table that shows the relationship between the price of a good and the quantity demanded The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price. *The demand curve shows how price affect quantity demanded, other things being equal. A change in the price of the good changed QD and results in a movement along the D curve.*These “other things” are non-price determinants of demand (things that determine buyer’s demand for a food, other than the good’s price).- changes in them shift the D curve….Increase in # of buyers increases quantity ……not finishedDemand for a normal good is positively related to income- increase in income causes increase in quantity demanded at each price, shifts D curve to the right(Demand for an Inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)Two goods are substitutes if an increase in the price of one causes an increase in demand for the other. Two good are complements if an increase in the price of one causes a fall in demand for the other.Anything that causes a shift in tastes toward a good will increase demand for that good and shift its curve to the right. Expectations affect consumer’s buying decisions. The Quantity supplied of any good is the amount that sellers are willing and able tosell at a specific price. QS is a point on the supply curve.The Supply curve is a set of various quantities supplied at corresponding prices.Law of supply: the claim that the quantity supplied of a good rises when the price ofthe good rises, other things equal.Supply schedule: a table that shows the relationship between the price of a good and the quantity suppliedThe quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. The supply