Micro and Macro Models Agec 217

Micro and Macro Models Terms (almost all not involving money) –Opportunity Cost –Absolute Advantage –Comparative Advantage –Specialization –Production Possibility Frontier –Imports –Exports –Circular Flow Diagram

Opportunity Cost Opportunity Cost: The next best alternative you give up in order to obtain or produce an item

Opportunity Cost What would you be doing if you were not in class today?

Opportunity Cost Opportunity cost for each of three identical jobs with identical benefits, but with employers paying different salaries: –Employer A: $70,000 –Employer B: $50,000 –Employer C: $30,000

Absolute and Comparative Advantage Two individuals, Kate and Charlie, are stranded on a desert island and subsist on a diet of bananas and coconuts.

Absolute and Comparative Advantage Production per Hour Bananas Kate: 40 per hour Charlie: 20 per hour Coconuts Kate: 20 per hour Charlie: 4 per hour

Absolute and Comparative Advantage Absolute Advantage: The person, firm, or nation with a higher level of productivity compared to that of another.

Absolute and Comparative Advantage Kate has the absolute advantage producing both bananas and coconuts

Absolute and Comparative Advantage Who has the comparative advantage? Comparative Advantage: the person, firm, or nation with the lower opportunity cost vs. that of another.

Absolute and Comparative Advantage Calculating opportunity cost (the next best alternative) –Opportunity cost of producing bananas = the number of coconuts produced in a unit of time divided by the number of bananas produced in the same unit of time.

Absolute and Comparative Advantage Opportunity Cost Bananas Kate: ½ coconut Charlie: 1/5 coconut Coconuts Kate: 2 bananas Charlie: 5 bananas

Absolute and Comparative Advantage Let’s assume that each is eating only their own production in the following manner: –Kate: 20 bananas and 10 coconuts –Charlie: 10 bananas and 2 coconuts Are there any shifts in production or trades that could be taken advantage of?

Absolute and Comparative Advantage Specialization: focusing production more heavily on a good for which you have a comparative advantage, with the expectation of trading for other goods for which you do not have a comparative advantage

Absolute and Comparative Advantage Let’s assume that they produce: –Kate: 12 bananas and 14 coconuts –Charlie: 20 bananas and 0 coconuts Is this a valid direction? Are the numbers valid?

Absolute and Comparative Advantage If Charlie trades 9 bananas to Kate for 3 coconuts, they will have –Kate: 21 bananas and 11 coconuts –Charlie: 11 bananas and 3 coconuts Compared to before: –Kate: 20 bananas and 10 coconuts –Charlie: 10 bananas and 2 coconuts

Absolute and Comparative Advantage The comparative advantage allows people, firms, or nations to specialize and trade

Production Possibility Frontier A graph of all potential production combinations in an economy (compare to the flat PPF for an individual)

Production Possibility Frontier Efficient Points: points on the curve Inefficient Points: points below the curve Impossible Points: points above the curve - Often Called the Production Possibility Curve (PPC)

Imports and Exports Imports: goods or services produced abroad and sold in ones own country Exports: goods or services produced in ones own country and sold abroad

Circular Flow Diagram (Mankiw) Copyright © 2004 South-Western Spending Goods and services bought Revenue Goods and services sold Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Firms sell Households buy MARKETS FOR GOODS AND SERVICES

Circular Flow Diagram Enhanced diagram: Wikipedia – Circular_flow_of_income.JPGhttp://upload.wikimedia.org/wikipedia/en/e/ee/ Circular_flow_of_income.JPG

Circular Flow Diagram: Enhanced

Experiment Tomorrow EconPort –