Previous LectureEconomy Wide InteractionsChapter 2Lecture 2Previous Lecture - Individual Choice- Opportunity Cost- Scarcity- Marginal Decisions- Making trade-offsCurrent Lecture:- Markets Move Toward Equilibrium- an economic situation is in equilibrium when no individual would be better off doing something different; any time there is a change, the economy will move to a new equilibrium.- Resources Should Be Used As Efficiently As Possible to Achieve Society’s Goals- An economy is efficient if takes all opportunities to make some people better off without making other people worse off. Equitymeans that everyone gets his/her fair share.- Efficiency vs. Equity- Example- Handicapped-designated parking spaces in a busy parking lot.- There is a conflict between: Equity- making life “fairer” for handicapped people, and efficiency-making sure that all opportunities to make people better off have been fully exploited by not letting parking spaces go unused.- Often people have different views with regard to “what is fair”- Markets Usually Lead to Efficiency- The incentives built into a market economy already ensure that resources are usually used efficiently; opportunities to make people better off are not wasted.- Exception exists when there is a market failure, that is, the individual pursuit of self-interest found in markets makes society worse off. Thus the market outcome is inefficient.- When Markets Do Not Achieve Efficiency, Government Intervention Can Improve Society’s Welfare- The question is why do markets fail?- Individual actions have side effects not taken into account by the market. These are called externalities.- One party prevents mutually beneficial trades from occurring in the attempt to capture agreater share of resources of itself (monopoly)- Some goods cannot be efficiently managed by markets. ECON 2106 1st EditionEconomy Wide InteractionsPrinciples that underlie economy-wide interactions:1) One person’s spending is another person’s income2) Overall spending sometimes gets out of line with the economy’s productive capacity3) Government policies can change spendingChapter 2Objectives:- Why Models-simplified representation of reality- Two simple and important models: Production Possibility Frontier and Comparative Advantage- Circular-flow diagram-schematic representation of the economy- The difference between positive and normative economics- When economist agree and when they disagree- Models in Economics- a model is a simplified representation of a real situation that is used to better understand real-life situations. The “other things equal” assumption means that all other relevant factors remain unchanged.- Trade Offs: The Production Possibility Frontier (PPF): The 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.- It improves our understanding of trade-offs by considering a simplified economy that produces only two goods by showing this trade-off