1. AP Macroeconomics Module 1: Economics Basics D. McKee, 09.16.2012
Source: Economics, Krugman and Wells, Worth Publishing, 2006.

2. Models in Economics
Why models? Simplified representations of reality—play a crucial role in economics
Two simple but important models:
production possibility frontier
circular-flow diagram

3. Why Models?
A model is a simplified representation of a real situation that is used to better understand real-life situations.
Create a real but simplified economy
Simulate an economy on a computer
The “other things equal” assumption means that all other relevant factors remain unchanged.

4. Trade-offs: The Production Possibility Frontier
The production possibility frontier (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.
The PPF improves our understanding of trade-offs by considering a simplified economy that produces only two goods by showing this trade-off graphically.

5. The Production Possibility Frontier
Quantity of coconuts 30 D
Feasible and
efficient
in production
Not feasible A 15
Feasible but
not efficient B 9 C
Production possibility frontier
PPF 20 28 40
Quantity of fish

6. Increasing Opportunity Cost

7. Economic Growth

8. Production Possibilities for Two Castaways

9. Production Possibilities for Two Castaways

10. Tom and Hank’s Opportunity Costs

11. Specialize and Trade
Both castaways are better off when they each specialize in what they are good at and trade.
It’s a good idea for Tom to catch the fish for both of them, because his opportunity cost of a fish in terms of coconuts not gathered is only 3/4 of a coconut, versus 2 coconuts for Hank.
Correspondingly, it’s a good idea for Hank to gather coconuts for the both of them.

12. Comparative Advantage and Gains from Trade

13. How the Castaways Gain from Trade

14. Comparative vs. Absolute Advantage
An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people.
An individual has an absolute advantage in an activity if he or she can do it better than other people. Having an absolute advantage is not the same thing as having a comparative advantage.

15. Tom vs. Hank – Absolute vs. Comparative
Tom has an absolute advantage in both activities: he can produce more output with a given amount of input (in this case, his time) than Hank.
But we’ve just seen that Tom can indeed benefit from a deal with Hank because comparative, not absolute, advantage is the basis for mutual gain.
So Hank, despite his absolute disadvantage, even in coconuts, has a comparative advantage in coconut gathering.
Meanwhile Tom, who can use his time better by catching fish, has a comparative disadvantage in coconut-gathering.

16. Supply and Demand A competitive market:
Many buyers and sellers
Same good or service
The supply and demand model is a model of how a competitive market works.
Five key elements:
Demand curve
Supply curve
Demand and supply curve shifts
Market equilibrium
Changes in the market equilibrium

17. Demand Schedule

18. Demand Curve

19. An Increase in Demand
An increase in the population and other factors generate an increase in demand – a rise in the quantity demanded at any given price.
This is represented by the two demand schedules - one showing demand in 2002, before the rise in population, the other showing demand in 2006, after the rise in population.

20. An Increase in Demand

21. Movement Along the Demand Curve

22. Shifts of the Demand Curve

23. What Causes a Demand Curve to Shift?
Changes in the Prices of Related Goods
Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good.
Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good.

24. What Causes a Demand Curve to Shift?
Changes in Income
Normal Goods: When a rise in income increases the demand for a good - the normal case - we say that the good is a normal good.
Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.
Changes in Tastes
Changes in Expectations

25. Individual Demand Curve and the Market Demand Curve

26. Supply Schedule

27. Supply Curve

28. An Increase in Supply

29. An Increase in Supply

30. Movement Along the Supply Curve

31. Shifts of the Supply Curve

32. What Causes a Supply Curve to Shift?
Changes in input prices
An input is a good that is used to produce another good.
Changes in the prices of related goods and services
Changes in technology
Changes in expectations
Changes in the number of producers

33. Individual Supply Curve and the Market Supply Curve

34. Supply, Demand and Equilibrium
Equilibrium in a competitive market: when the quantity demanded of a good equals the quantity supplied of that good.
The price at which this takes place is the equilibrium price (a.k.a. market-clearing price):
Every buyer finds a seller and vice versa.
The quantity of the good bought and sold at that price is the equilibrium quantity.

35. Market Equilibrium

36. Surplus

37. Shortage

38. Equilibrium and Shifts of the Demand Curve

39. Equilibrium and Shifts of the Supply Curve

40. Technology Shifts of the Supply Curve

41. Simultaneous Shifts of Supply and Demand

42. Simultaneous Shifts of Supply and Demand

43. Simultaneous Shifts of Supply and Demand

44. SUMMARY: Module 1

45. SUMMARY: Module 1

46. SUMMARY: Module 1 A change in input prices
A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists talk of increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price.
There are five main factors that shift the supply curve:
A change in input prices
A change in the prices of related goods and services
A change in technology
A change in expectations
A change in the number of producers
The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market.

47. SUMMARY: Module 1
The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up.
An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.
Shifts of the demand curve and the supply curve can happen simultaneously.