MSU EC 201 - Chap2 (24 pages)

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Chap2



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Chap2

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24
School:
Michigan State University
Course:
Ec 201 - Introduction to Microeconomics
Introduction to Microeconomics Documents
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Krugman and Wells Chapter 2 Steven J Haider EC201 Spring 2015 Models Models are simplified representations of reality They can help us focus on important parts of a problem A model useful for one purpose may not be useful for another Example a map The map would be useless if it were not simplified This map is good for getting to Kalamazoo but bad for getting to Stockbridge p2 Models Economic models tend to be mathematical We can make precise statements about the model We can use models to help us think about real life situations Key word is can it depends on whether the model includes the important pieces Models can help us focus on one piece of a problem at a time all else equal or ceteris paribus Two common pitfalls to using economic models Mistaking the model for reality the model may not apply Dismissing all models as being wrong of course the assumptions are wrong but that doesn t mean the model is useless p3 Production Possibility Frontier PPF Our first model Set up Boeing can produce Dreamliners and smaller jets each year Some example production levels PPF provides the trade off p4 Production Possibility Frontier PPF Concepts Feasible vs infeasible quantities Efficiency Technology Opportunity cost See next slide p5 Opportunity cost Opportunity cost what must be given up for something else Consider moving from A to B A 15 DL 20 SJ B 9 DL 28 SJ Thus to move from A to B one gives up 6 DL for 8 SJ From A to B the opportunity cost for 8 SJ is 6 DL p6 Opportunity cost We often talk about OC in terms of 1 unit A 15 DL 20 SJ B 9 DL 28 SJ Or 6 DL 8 SJ 1 SJ 6 8 or 3 4 DL 1 DL 8 6 or 4 3 SJ Between A B The OC of 1 SJ is 3 4 DL from A to B The OC of 1 DL is 4 3 SJ from B to A p7 Opportunity cost From B to A 6 DL 8 SJ 1 DL 8 6 or 4 3 SJ From A to 0 30 15 DL 20 SJ 1 DL 20 15 or 4 3 SJ From 40 0 to B 9 DL 12 SJ 1 DL 12 9 or 4 3 SJ OC for 1 DL is always the same p8 Why is OC constant PPF is a straight line OC is just the slope Y X negative The slope is constant Generally we think OC increases Bowed out Fig 2 2 First 20 SJ costs 5 DL second 20 SJ costs 25 DL Why Some resources may be better suited to SJ than others size of factory p9 Economic growth Economic growth shift out of the PPF Potential causes of economic growth Increases in factors of production e g pop growth Technological growth e g more automation p10 The PPF The PPF is a very simplified model just two goods but it has allowed us to precisely define and consider efficiency opportunity cost and economic growth p11 Gains from specialization trade Suppose there were two countries US and Brazil each of which produce two goods large jets LJ and small jets SJ Can they gain from specializing and then trading If one was particularly skilled in LJ and the other in SJ it would seem the answer is clearly yes Powerful insight there are gains even if one of the two countries is more highly skilled in both In economic jargon absolute advantage doesn t determine whether trade is beneficial What matters comparative advantage We will work through an example first p12 Gains example The technology Fig 2 4 The US is better at producing LJ and SJ than Brazil In other words the US has an absolute advantage in producing both Note assumed consumption levels without trade both are efficient US at 16 18 and Brazil at 6 8 p13 Gains example Suppose they specialize and then trade the result Without trade both consume what they produce With trade I propose levels of production that are consistent with PPF see previous slide Total consumption always equals total production i e the total consumption is feasible given production Both are consuming bundles outside their PPF more SJ and LJ p14 Gains example Both are consuming bundles outside their PPF more fish and more coconuts US gains 2 LJ and 4 SJ Brazil gains 2 LJ and 4 SJ With specialization both US and Brazil achieved a level of consumption that was infeasible outside the PPF without trade p15 Gains example How does this work First verify that opportunity costs below match Fig 2 4 The US has a comparative advantage in producing LJ because there is a lower opportunity cost 4 3 3 The US gives up 4 3 small jets for each large jet but Brazil gives up 3 Brazil has a comparative advantage in producing SJ because there is a lower opportunity cost 1 3 3 4 Brazil gives up 1 3 large jet for each small jet but the US gives up 3 4 p16 Gains example NOTE don t make this harder than it needs to be Does the US look relatively better than Brazil in SJ or LJ That s the product we have the comparative advantage in And Brazil must have the comparative advantage in the other product p17 Gains example How does this work continued In the trade laid out below the US gave up 10 large jets for 20 small jets The US is willing to do this we get 2 SJ for each LJ we give up but if we produced on our own we would only get 4 3 SJ for each LJ we give up Brazil is willing to do this they get 1 LJ for every 2 SJ they give up but if they produced on their own they would need to give up 3 SJ for each LJ p18 Gains example Some things to note The US has an absolute advantage in both goods We can produce more SJ and more LJ than Brazil US and Brazil both gain from trading with each other We both consume something that was previously infeasible Both specialized in the production of the good for which they have a comparative advantage US had lower OC in LJ production so we specialized in LJ production As long as the US and Brazil are different each has a comparative advantage in something The proposed outcome both completely specialize and a trading price of 1 LJ for 2 SJ is not the only one where both benefit it is just an example It s a highly simplified model two goods and two countries the bare minimum if we want to talk about specialization and trade p19 Gains lessons for int l trade Economists generally look favorably on int l trade It s just an application of comparative advantage and specialization US can gain from trading with developed countries who may have similar or superior technology and undeveloped countries NOTE this means that trade is good on net not that …


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