1. Chapter 2 Comparative Advantage: The Basis of Exchange ( Economic Models )

2. Economics: Redefined Economics is the subject that studies how decision-making entities allocate and utilize the limited resources to produce goods and services that best satisfy the various, unlimited, competing human desires.

3. Economics: Macro vs. Micro Macroeconomics: –How does the economic system work? –When and why economic system does not work? –When do people become counterproductive? –Why are there ups and downs in the economy? –Why is the long run mainly a story of ups? => National economy, GDP, inflation, unemployment, international trade, exchange rate, etc.

4. Economics: Macro vs. Micro Microeconomics: –The housing market in Shanghai –The price of Honda Accord in Guangzhou –The production quantity of peaches in Nanhui –The number of people hired producing milk powder at Mengniu –The number of T-shirts I buy at Hang-Ten => Individual decisions and interactions, individual consumer behaviors, individual producer decisions on production and input requirements, single product market, single market structure, etc.

5. Microeconomics Individual decisions about what to do and what not to do. Decisions about production and consumption made by individual firms and consumers (market economy) How individuals ’ pursuit of self interest can lead to good results as a whole (the invisible hand)

6. Also in Microeconomics Society ’ s goal: efficiency and equity Market usually leads to efficiency, but not necessarily equity. There are times for market failures. When market fails, it calls for government interventions. Proper “ incentives ” offered by government interventions may help reach society ’ s goals.

7. Economics: a way of thinking and an analysis tool Economics is not the body of concrete truth, but an engine for the discovery of concrete truth.

8. Economic Analysis Positive analysis : –objective descriptions about what things are (facts) Normative analysis: –value judgments on what thingsshould be (opinions)

9. Positive vs. Normative Positive: objective descriptio ns what things are factsMinimum wage: Shanghai-960 Beijing-800 Shanghai higher Normativ e: value judgments what things should be opinion s Minimum wage causes higher unemployment, therefore it should be eliminated

10. Equilibrium Analysis Equilibrium ： –a situation in which economic forces are balanced and in the absence of external influences the values of economic variables will not change

11. Example: Market equilibrium Market forces: demand and supply Economic Variables: market price and quantity of product exchanged Market equilibrium: a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. buyerssellers –This price is often called the equilibrium price or market clearing price and will tend not to change unless demand or supply change.equilibrium pricemarket clearing

12. Static vs. Dynamic Analysis Static analysis: under what conditions the economic variables will reach equilibrium (ignoring the time factor and the process of getting to equilibrium) equilibrium

14. 2015-8-18 14 Static vs. Dynamic Analysis Comparative static analysis: what happens to the equilibrium and the values of the economic variables if some of the conditions change Equilibrium price under D1 vs. equilibrium price under D2

15. 2015-8-18 15 Static vs. Dynamic Analysis Dynamic analysis: –the process analysis; –the interactive process and relationships among all economic variables Equilibrium price P1 –US companies bankrupt  US income lowers  US consumption of Chinese products lowers  Chinese exports decreases  Chinese income lowers  Chinese comsumption decreases  Chinese companies investments decrease  Chinese domestic D lower  equilibrium price lower

16. 2015-8-18 16 Economic Models A model is a simplified representation of a real situation that is used to better understand real-life situations.

17. 2015-8-18 17 Economic model Using functions to describe the inter relationships among economic variables Word description, mathematics, graphs Abstract: skip some of the non-vital factors and variables (assumptions) Focus on certain relationships only (hypothesis)

18. 2015-8-18 18 A Model Definitions of variables Assumptions Hypothesis Forecast Test True: theory False: 1. adjust hypothesis  >forecast  test 2. Give up

19. 2015-8-18 19 Model Example: PPC The production possibility curve the trade-offs facing an economy that produces only two goods.

20. 2015-8-18 20 PPC Issue to investigate: how many of each product a country can produce Variables: Product A, Product B –Define: Qa: (F) the quantity of fish produced by the economy Qb: (C) the quantity of coconut produced by the economy * Can also be butter vs. gun, bread vs. dresses, etc.

21. 2015-8-18 21 PPC Assumptions: –only two goods produced –only two kinds of resources, each of limited amount –resources are used up with efficiency –there is increasing opportunity costs

22. 2015-8-18 22 PPC Hypothesis: producing more of A would require reduction in production of B (the only way to produce more of A is to produce less of B -- trade off) Forecast: when more of A is produced, production of B decreases (reason: less resources available)

23. 2015-8-18 23 PPC Test: real data Conclusion: true: accept, realistic and helpful theory (if not: why? Assumptions? Data? Methods? Retest?...)

24. The PPC

25. Increasing Opportunity Cost

26. Shift of the PPF: Economic Growth Economic growth results in an outward shift of the PPF because production possibilities are expanded.

27. 2015-8-18 27 PPC: Key Points Intersections with X-axis and Y- axis Points inside, on, outside the curve The bowed-out shape Shift of the curve

28. 2015-8-18 28 Marginal Analysis Trade off situations: How much decisions (as vs. either-or) marginal analysis: comparing marginal benefit to marginal cost Marginal Benefit: additional benefit related to one more unit change Marginal Cost: additional cost related to the same one more unit change

29. Example: Marginal Cost

30. Marginal Benefit

31. Net Gain

32. 2015-8-18 32 Decision rule if MB >= MC, DO IT! if MB < MC, FORGET IT! Total net gain is maximized when marginal net gain = 0 or when MB=MC

33. The Goal: Maximization of Total Net Gain

34. 2015-8-18 34 Math and Graph Variables: Total Net Gain (G) Hours of mowing (H) Assumptions: Hypothesis: G = f (H) (more hours, more gain) Forecast: 1.gain from 4 hours is more than gain from 3 hours 2.gain from 10 hours is more than gain from 9 hours Test: 1. True; 2. False (correct hypothesis then forast and test again)

35. 2015-8-18 35 Graph Plotting: origin, X-axis, Y-axis, Variables: independent, dependent Relationships: positive, negative; linear, nonlinear;

36. 2015-8-18 36 Slopes: Calculation Linear: Change in Y / Change in X = △ Y / △ X Non-linear: –Arc method: connect to points on the arc with a straight line, then calculate the slope of the straight line –Point method:draw a tangent line at a point and calculate the slope of the tangent line

37. 2015-8-18 37 Slopes: Meaning slope > 0, positive relationship (upward sloping) slope = 0, horizontal line slope < 0, negative relationship (downward sloping) slope = infinite, vertical line constant slope: straight line variable slope: curve Maximum and Minimum of a curve: when point slope = 0