1. Tutorial EC 210 Introductory Economics
Session I
July 4, 2008

2. Trade off VS Opportunity cost
Trade off  is an exchange in one thing for return in another
Opportunity cost  is the value of the next-highest-valued alternative
 is the cost of passing up next best choice when making a decision

3. Example
Let’s say you are going out this Friday night. You have many choices of what you can do and cannot do.
Go out with your friend
Stay home and watch TV
Go on a date
Read economics textbook (HAHA impossible, I know)
Go camping with your parents
All of these choices, except for the one you choose, are then your choices of possible trade-off

4. Example
Go out with your friend
Stay home and watch TV
Go on a date  your choice
Read economics textbook
Go camping with your parents
In economics we are concerned with which one is the trade off and what is it opportunity cost
What will be your second choice on the blue list?
Any one of these choices (marked with blue color) then could be a trade off (singular)

5. Example
Let’s say your second choice is to go out with your friends. If this is so then this is the trade off of going on a date.
This trade off has a cost.
What is the cost?
In economics we call the cost of the trade off an opportunity cost

6. Example
In this case, the opportunity cost of going on a date could be the excitement and friendship you are missing going out with your friends.
Is that all?
The money you are going to spend on your date could have been spent on something else
True cost of going on a date = excitement & friendship given up + whatever you could have used the money for that you spent

7. Opportunity Cost
Use the concept of opportunity cost to explain the following.
a. More people choose to get graduate degrees when the job market is poor.
b. More people choose to do their own home repairs when the economy is slow.
c. There are more parks in suburban areas than in urban areas.
d. Fewer students enroll in classes that meet before 10:00 A.M.

8. More people choose to get graduate degrees when the job market is poor.
The worse the job market, the lower the opportunity cost of getting a graduate degree. One of the opportunity costs of going to graduate school is not being able to work. But if the job market is bad, the salary you can expect to earn is low or you might be unemployed—so the opportunity cost of going to school is also low.

9. More people choose to do their own home repairs when the economy is slow.
When the economy is slow, the opportunity cost of people’s time is also lower: the salary they could earn by working longer hours is lower than when the economy is booming. As a result, the opportunity cost of spending time doing your own repairs is lower—so more people will decide to do their own repairs.

10. There are more parks in suburban areas than in urban areas.
The opportunity cost of parkland is lower in suburban areas. The price per square foot of land is much higher in urban than in suburban areas. By creating parkland, you therefore give up the opportunity to make much more money in cities than in the suburbs.

11. Fewer students enroll in classes that meet before 10:00 A.M.
Before 10:00 A.M. the opportunity cost of time for many students is very high—it means giving up an extra hour’s sleep. That extra hour is much more valuable before 10:00 A.M. than later in the day.

12. Economic model-PPF
Atlantis is a small, isolated island in the South Atlantic.
The inhabitants grow potatoes and catch fresh fish.
a. Draw a production possibility frontier with potatoes on the horizontal axis and fish on the vertical axis illustrating these options, showing points A–F.

13. Economic model-PPF
b. Can Atlantis produce 500 pounds of fish and 800 pounds of potatoes? Explain. Where would this point lie relative to the production possibility frontier?
c. What is the opportunity cost of increasing the annual output of potatoes from 600 to 800 pounds?
d. What is the opportunity cost of increasing the annual output of potatoes from 200 to 400 pounds?
e. Can you explain why the answers to parts c and d are not the same? What does this imply about the slope of the production possibility frontier?

14. Economic model-PPF
b. Can Atlantis produce 500 pounds of fish and 800 pounds of potatoes? Explain. Where would this point lie relative to the production possibility frontier?
Answer: No, Atlantis cannot produce 500 pounds of fish and 800 pounds of potatoes. If it produces 500 pounds of fish, the most potatoes it can produce is 600 pounds. This point would lie outside the production possibility frontier, at point G on the diagram.

15. Economic model-PPF
C. What is the opportunity cost of increasing the annual output of potatoes from 600 to 800 pounds?
Answer: The opportunity cost of increasing output from 600 to 800 pounds of potatoes is 200 pounds of fish.

16. Economic model-PPF
d. What is the opportunity cost of increasing the annual output of potatoes from 200 to 400 pounds?
Answer: The opportunity cost of increasing output from 200 to 400 pounds of potatoes is 50 pounds of fish.
Opportunity costs are not equal along the PPF!!

17. Economic model-PPF
e. Can you explain why the answers to parts c and d are not the same? What does this imply about the slope of the production possibility frontier?
The answers to parts c and d imply that the more potatoes Atlantis produces, the higher the opportunity cost becomes.
For instance, as you grow more and more potatoes, you have to use less and less suitable land to do so. As a result, you have to divert increasingly more resources away from fishing as you grow more potatoes, meaning that you can produce increasingly less fish.
This implies, of course, that the production possibility frontier becomes steeper the farther you move along it to the right; that is, the production possibility frontier is bowed out.

18. Supply & Demand Three steps analysis Affect supply or demand
Direction of curve shift
New equilibrium price and equilibrium quantity

19. A C T I V E L E A R N I N G 2: Changes in supply and demand
Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
Event A: A fall in the price of CDs
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
Event C: Events A and B both occur.
In case it’s not clear: The royalties that sellers must pay the artists are part of the sellers’ “costs of production.” Typically, this royalty is a fixed amount each time one of the artist’s songs is downloaded. Event B is a reduction in this cost. 19

20. A C T I V E L E A R N I N G 2: A. fall in price of CDs
The market for music downloads P Q S1
STEPS D1 D2
1. D curve shifts P1 Q1
2. D shifts left P2 Q2
3. P and Q both fall.
This is an extension of Active Learning exercise 1C, where we saw that a fall in the price of compact discs would cause a fall in demand for music downloads, because the two goods are substitutes. 20

21. A C T I V E L E A R N I N G 2: B. fall in cost of royalties
The market for music downloads P Q S1 S2
STEPS D1
1. S curve shifts P1 Q1
(royalties are part of sellers’ costs) Q2 P2
2. S shifts right
NOTE: Don’t worry that the text on this slide looks garbled in “Normal view” (i.e. edit mode). It works fine in “Slide Show” (i.e. presentation mode).
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. This event causes a fall in “costs of production” for sellers of music downloads. Hence, the S curve shifts to the right.
3. P falls, Q rises. 21

22. A C T I V E L E A R N I N G 2: C. fall in price of CDs AND fall in cost of royalties
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.
It’s not necessary to draw a graph here. The answers to steps 1 and 2 should be clear from parts A and B. The answer to step 3 is a combination of the results from A and B. 22

23. Supply & Demand
In a supply and demand diagram, draw the shift in demand for hamburgers in your hometown due to the following events. In each case show the effect on equilibrium price and quantity.
a. The price of KFC increases.
b. All hamburger sellers raise the price of their french fries.
c. Income falls in town. Assume that hamburgers are a normal good for most people.
d. Income falls in town. Assume that hamburgers are an inferior good for most people.
e. Hot dog stands cut the price of hot dogs.

24. Supply & Demand
a. A rise in the price of a substitute (KFC) causes the demand for hamburgers to increase. This represents a rightward shift of the demand curve from D1 to D2 and results in a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2.

25. Supply & Demand
b. A rise in the price of a complement (french fries) causes the demand for hamburgers to decrease. This represents a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2.

26. Supply & Demand
c. A fall in income causes the demand for a normal good (hamburgers) to decrease. This represents a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2.

27. Supply & Demand
d. A fall in income causes the demand for an inferior good (hamburgers) to increase. This represents a rightward shift of the demand curve from D1 to D2 and results in a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2.

28. Supply & Demand
e. A fall in the price of a substitute (hot dogs) causes demand for hamburgers to decrease. This is represented by a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2.

29. Supply & Demand
The market for many goods changes in predictable ways according to the time of year, in response to events such as holidays, vacation times, seasonal changes in production, and so on. Using supply and demand, explain the change in price in each of the following cases. Note that supply and demand may shift simultaneously.
a. Lobster prices usually fall during the summer peak harvest season, despite the fact that people like to eat lobster during the summer months more than during any other time of year.
b. The price of a Christmas tree is lower after Christmas than before and fewer trees are sold.
c. The price of a round-trip ticket to Paris on Air France falls by more than $200 after the end of school vacation in September. This happens despite the fact that generally worsening weather increases the cost of operating flights to Paris, and Air France therefore reduces the number of flights to Paris at any given price.

30. Supply & Demand
There is a rightward shift of the demand curve from D1 to D2 during the summer months, as consumers prefer to eat more lobster during the summer than during other times of the year. Other things equal, this leads to a rise in the price of lobster. Simultaneously, lobster fishermen produce more lobster during the summer peak harvest time, when it is cheaper to harvest lobster, representing a rightward shift of the supply curve of lobster from S1 to S2. Other things equal, this leads to a fall in the price of lobster. Given the simultaneous rightward shifts of both the demand and supply curves, the equilibrium changes from E1 to E2. The fall in price indicates that the rightward shift of the supply curve exceeds the rightward shift of the demand curve.

31. Supply & Demand
b. There is a leftward shift of the demand curve for Christmas trees after Christmas from D1 to D2, as fewer consumers want Christmas trees at any given price. The supply curve does not shift; the reduction in the quantity of trees supplied is a movement along the supply curve. This leads to a fall in the equilibrium price and quantity, as the equilibrium changes from E1 to E2.

32. Supply & Demand
c. There is a leftward shift of the demand curve for tickets to Paris in September, after the end of school vacation, from D1 to D2. Other things equal, this leads to a fall in the price of tickets. At the same time, as the cost of operating flights increases, Air France decreases the number of flights, shifting the supply curve leftward from S1 to S2. Other things equal, this leads to a rise in price. Given the simultaneous leftward shifts of both the demand and supply curves, the equilibrium changes from E1 to E2. The fall in price indicates that the leftward shift of the demand curve exceeds the leftward shift of the supply curve.

33. A C T I V E L E A R N I N G 1: Effects of a taxQ P S
The market for hotel rooms D
Suppose govt imposes a tax on buyers of $30 per room.
Find new Q, PB, PS, and incidence of tax.

34. A C T I V E L E A R N I N G 1: AnswersQ P S
The market for hotel rooms D
Q = 80
PB =
Tax
PB = $110
PS = $80
PS =
Incidence
buyers: $10
sellers: $20

35. A C T I V E L E A R N I N G 2: Elasticity and changes in equilibrium
The supply of beachfront property is inelastic. The supply of new cars is elastic.
Suppose population growth causes demand for both goods to double (at each price, Qd doubles).
For which product will P change the most?
For which product will Q change the most?
This is one of the “Problems and Applications” at the end of the chapter.

36. A C T I V E L E A R N I N G 2: Answers
Beachfront property (inelastic supply):
When supply is inelastic, an increase in demand has a bigger impact on price than on quantity. P Q S D1 D2 B Q2 P2
In this slide and the next, the initial price and quantity and the two demand curves are the same. The only difference is the elasticity of supply and slope of the supply curve.
[The D curve shifts to the right, but not in a parallel fashion: at each price, quantity demanded is twice as high, so the new D curve will be flatter than the initial one.]
In the text box containing the verbal explanation, “bigger impact” is shorthand for “bigger percentage impact” or “bigger proportional impact.” Q1 P1 A

37. A C T I V E L E A R N I N G 2: Answers
New cars (elastic supply):
When supply is elastic, an increase in demand has a bigger impact on quantity than on price. P Q D1 D2 S Q2 P2 B Q1 P1 A