Principles of Macroeconomics Module 1.1. Scarcity, Limited Resources and Opportunity Costs

Principles of Macroeconomics Module 1.1 Scarcity, Limited Resources and Opportunity Costs

What is Economics? Economics is the study of how people and society allocate scarce resources Scarce resources: For people: Time, Money ect. For firms: Factors of Production à Land, Labor and Capital Since we don t have an infinite amount of resources what do we do with what we have?

Tradeoffs in Decisions People face tradeoffs in decisions because of scarce resources Cannot do everything, buy everything, make everything Need to choose how to allocate our time, our money, our resources When you make one choice you give up the other option

Opportunity Costs Opportunity Cost: What you give up to get something Example: How many times can you hit the snooze button? Benefit Opportunity Cost Hit it once More Sleep Feel rushed in the morning Hit it twice More Sleep Feel rushed Skip breakfast Hit it three times More Sleep Feel rushed Skip breakfast Skip the gym Hit it four times More Sleep Feel rushed Skip breakfast Skip the gym Late for work

Opportunity Cost Opportunity Costs are subjective to the individual and change depending on circumstances What if it was Saturday morning and you hit the snooze button? Benefits of more sleep may outweigh any costs if you don t have to wake up! What if you work in the afternoon? You do not have the same constraints as someone who needs to go to work in the morning!

Opportunity Costs Opportunity Costs drive the decisions we make every day We face them all the time We weigh the costs and benefits of each decisions consciously or subconsciously and make a choice Test yourself: What was a recent decision you made? What did you give up when you made that choice? What was the opportunity cost for you?

Principles of Macroeconomics Module 1.2 Opportunity Costs and Production Possibilities Frontier 7

Production Possibilities Frontier Production possibilities frontier (PPF) represents the opportunity costs an economy faces in the production of two goods. All economies have scarce resources -- need to decide how to allocate those resources to producegoods. If you produce more of one good need to produce less of the other (with no change in available resources) 8

Understanding the PPF Curve Good Y Economy only produces two goods Snapshot in time of production Limited resources can be used in the production of both goods Good X 9

PPF Example Consider an economy that produces two goods: Leather jackets and leather boots. A B C D E Boots 0 20 40 60 80 Jackets 100 90 70 40 0 Draw the PPF curve for this economy As we move from one point to the next calculate the change in the number of boots produced and the number of jackets produced. What does this tell you about how opportunity costs change? 10

PPF Example A B C D E Boots 0 20 40 60 80 Jackets 100 90 70 40 0 Δ Boots + 20 + 20 + 20 + 20 Δ Jackets - 10-20 - 30-40 As we move along the PPF curve: Opportunity Cost changes O.C. RISES as give up more of the good that is SCARCE O.C. is LOWER when the good is in relative ABUNDANCE 11

PPF Example Suppose now that there is a shortage in rubber. - What happens in the boot industry? - What happens in the jacket industry? 12

PPF Exercise With a shortage in rubber, this affects the production of boots relatively more than the production of jackets Bias shift of PPF If there is a change in resources need to consider the impact this has on both industries equal or bias? 13

Key Takeaway All economic agents face tradeoffs when making decisions Whatever they choose comes with an opportunity cost what they could otherwise do with their time, money, resources Apply this concept to understand how an economy makes choices between the production of goods in the PPF 14

Principles of Macroeconomics Module 1.3 Comparative advantage, specialization, and trade 15

How can we satisfy our needs/wants? 1. Economic Self-sufficiency: Produce all of the goods we need/want to consume ourselves 2. Specialization and Trade: Produce one good that we have a Comparative Advantage in and trade with others for what we need GAINS FROM TRADE: We can CONSUME MORE while working the same amount. 16

Trade Exercise Time to Produce One Unit Amount Produced in One Day (8hrs of work) Bread Sweaters Bread Sweaters Seamstress 60 minutes = 1 loaf 120 minutes = 1 sweater Baker 20 minutes = 1 loaf 60 minutes = 1 sweater How much bread and sweaters can each agent produce in one day of work? 17

Trade Exercise Time to Produce One Unit Amount Produced in One Day (8hrs of work) Bread Sweaters Bread Sweaters Seamstress 60 minutes 1 loaf 120 minutes 1 sweater (60/60)*8hrs = 8 loaves (60/120)* 8hrs = 4 sweaters Baker 20 minutes 1 loaf 60 minutes 1 sweater (60/30)*8hrs = 24 loaves (60/60)*8hrs= 8 sweaters Who is better at producing bread? Who is better at producing sweaters? If they split their time evenly between producing both goods, how much can they consume (no trade)? 18

Economic Self-Sufficiency 19

Trade Exercise Based on opportunity cost: Seamstress has a lower opportunity cost in making sweaters For the seamstress, if she produces one more sweater, she gives up baking 2 loaves of bread in that time Baker has a lower opportunity cost in baking bread For the baker if he produces one more loaf of bread, he gives up making 3 sweaters in that time Amount Produced in One Day Opportunity Cost Bread Sweaters Bread Sweaters Seamstress 8 loaves 4 sweaters ½ Sweater 2 Breads Baker 24 loaves 8 sweaters 1/3 Sweater 3 Breads Opportunity Cost determines specialization 20

Trade Exercise What happens if the baker and seamstress want to trade? Suppose the agents agree that: Baker will spend 5 hours on bread, 3 hours on sweaters Seamstress will spend 8 hours on sweaters How much do they produce? How much will they consume? Will they gain from the trade? 21

Trade Exercise AMOUNT PRODUCED Bread Sweaters Seamstress 0 (60/120)* 8hrs = 4 sweaters Baker (60/20)*5hrs = 15 loaves (60/60)*3hrs = 3 sweaters What if they agree to trade 2 sweaters for 5 loaves of bread? How much will they consume? 22

Trade Exercise AMOUNT CONSUMED Bread Seamstress 0 bread + 5 bread = 5 bread Baker 15 bread - 5 bread = 10 bread Sweaters 4 sweaters 2 sweaters = 2 sweaters 3 sweaters + 2 sweaters = 5 sweaters Has the seamstress gained from this trade? Has the baker gained from this trade? 23

With Trade 15 Produce 10 Consume Consume Produce 3 5 24

Comparative Advantage Agent with the lower opportunity cost in producing the good will have a comparative advantage in its production Opportunity Costs Bread Sweaters Seamstress 1 more bread = ½ sweater 1 more sweater = 2 bread COMPARATIVE ADVANTAGE Baker 1 more bread = 1/3 sweater COMPARATIVE ADVANTAGE 1 more sweater = 3 bread No single agent can have a comparative advantage in both goods. As long as the opportunity costs between two agents differ both can gain from trade. 25

Key Takeaway Trade and specialization make everyone better off because consume more without working more Trade can be beneficial even when one economic agent is much better at producing both goods To determine which goods an economic agent will produce need to understand comparative advantage (or) opportunity cost in producing each good 26

Supply and Demand Model Principles of Macroeconomics Module 1.4 (A)

What are competitive markets? Competitive Markets: Bring together the decentralized decisions of buyers and sellers Decentralized Decisions of Buyers: Drive them to try to get the lowest possible price for the goods they want Decentralized Decisions of Sellers: Drive them to try to get the highest possible price for the goods they are selling When these decisions come together competitive markets yield: Best possible price for the product Produced at the lowest possible cost Most efficient allocation of resources

What are competitive markets? Fundamental Assumptions of Supply + Demand Model: 1. Operating under Perfect Competition Lots of buyers and sellers Goods sold are identical No cost to entering or leaving the market 2. Equal access to information 3. Externalities do not exist No single economic agent can unilaterally exert any price control

What is Demand? Demand comes from the buyer of a good/service Each buyer is trying to get the lowest price possible for the good/service that they want Quantity Demanded: Amount of the good buyers want to buy at each price point

What is Demand? Demand Schedule: gives the quantity demanded at each price Price Quantity Demanded $5 13 $6 12 $7 10

What is Demand? From the demand schedule, we can determine the demand curve Price $7 $6 $5 10 12 13 Demand Q demanded Demand Curve: Relationship between price of the good and amount people want to buy of the good (quantity demanded) Law of Demand: As price of a good declines, people want to buy more of it

Changes in Demand Movement along the demand curve: Price of the good has changed but there is no change in the willingness of buyers to buy the good Price changes move to a new point on the demand curve (from A to B) Price $7 A $5 B Demand 10 13 Q demanded

Changes in Demand Shift in the demand curve: Some factor has changed that directly impacts buyers willingness to buy the good Demand curve shifts at each price point there is now a new quantity demanded Price $7 A B D.1 D.2 10 15 Q demanded

Factors that Shift Demand 1. Change in Income Normal Goods Sally just received a raise at work. She now buys Starbuck s lattes on her way to work. Price of lattes $4.50 A B 0 1 Q demanded Inferior Goods After receiving her raise, Sally no longer buys coffee at the gas station on her way to work. D.1 D.2

Factors that Shift Demand 2. Change in Price of Related Goods Compliments: Goods that are consumed together If the price of hot dogs increases, people will demand (or buy) less hot dog buns Price of Good A increases: Demand for Good B decreases Price of Good A decreases: Demand for Good B increases Price of Hot Dog Buns $1.50 B A 5 6 D.1 D.2 Q demanded

Factors that Shift Demand 2. Change in Price of Related Goods Substitutes: Goods that can be consumed in the place of another good If the price of hot dogs increases, people will demand (or buy) more hamburgers Price of Good A increases: Demand for Good B increases Price of Good A decreases: Demand for Good B decreases Price of Hamburgers $4.00 A B 7 8 Q demanded

Factors that Shift Demand 3. Change in Tastes and Preferences As it gets colder out in the winter months, people prefer to buy sweaters and jackets. Demand for sweaters increases. 4. Change in Number of Buyers As laptops become more popular and easy to use, more people buy them. Demand for laptops increases. 5. Change in Future Expectations Future Price of the Good: If people expect discounted prices due to retailers holiday sales, they will wait to buy the goods Future Income: If a college student secures a job that he will start in a few months, he will feel more confident buying an expensive suit today.

What is Supply? Supply comes from the seller of a good/service Each seller is trying to get the highest price possible for the good/service that they produce Quantity Supplied: Amount of the good sellers are willing to sell at each price point

What is Supply? Supply Schedule: gives the quantity supplied at each price Price Quantity Supplied $5 10 $6 12 $7 13

What is Supply? From the supply schedule, we can determine the supply curve Price Supply $7 $6 $5 10 12 13 Q supplied Supply Curve: Relationship between price of the good and amount firms are willing to sell of the good (quantity supplied) Law of Supply: As price of a good increases, people want to sell more of it

Changes in Supply Movement along the supply curve: Price of the good has changed but there is no change in the cost of production or willingness to sell by the firm Price changes move to a new point on the supply curve (from A to B) Price Supply $7 B $5 A 10 13 Q supplied

Changes in Supply Shift in the supply curve: Some factor has changed that directly impacts sellers willingness to sell/produce the good (or) their cost of production Supply curve shifts at each price point there is now a new quantity supplied Price S.1 S.2 $7 A B 10 15 Q supplied

Factors that Shift Supply 1. Change in Price of Inputs If the price of wood increases, the cost of producing tables would increase. Supply would decrease at each price point. Price of Tables S.2 S.1 $100 B A 100 150 Q supplied

Factors that Shift Supply 2. Change in Production Technology The replacement of workers with robots in car production. Supply increases at each price point. 3. Change in Number of Sellers More sellers means more production at each price point. Supply increases. 4. Change In Future Expectations Future Price of the Good: Expect price to rise in the future produce/sell more then Future Price of Inputs: Expect inputs to be more expensive produce/sell more today

Key Takeaway Demand is determined by the buyers of a good. Buyer always want to get the lowest price they can! Hence, demand is downward sloping Supply is determined by the sellers of the good. Sellers always want to get the highest price they can! Hence, supply is upward sloping Certain factors affect each of the curves and cause them to shift. The shifts come from an underlying change to the willingness to buy or willingness to sell.

Supply, Demand and Market Equilibrium Principles of Macroeconomics Module 1.4 (B)

Market Equilibrium Price Supply P* Q* Demand Quantity

Market Equilibrium Price P P* SURPLUS Supply Qd Qs Demand Quantity

Market Equilibrium Price Supply P* P SHORTAGE Qd Qs Demand Quantity

Test your Understanding Consider the market for oranges. Draw out the supply and demand curves based on the following supply and demand schedule: Price QD QS $5 10 50 $4 20 40 $3 30 30 $2 40 20 $1 50 10 $0 60 0 1. Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? 2. Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate and explain. 3. What happens if the price of apples falls? Illustrate and explain. 4. What if both scenarios happen simultaneously?

Test your Understanding 1. Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? Price Supply $3 A 30 Demand Quantity

Test your Understanding 2. Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate. Price $4 B S.2 S.1 $3 A 25 30 Demand Quantity

Test your Understanding 3. What happens if the price of apples falls? Illustrate and explain. Price S.1 $3 $2 B 25 30 A D.2 D.1 Quantity

Test your Understanding 4. What if both scenarios happen simultaneously? Ambiguous change in equilibrium price Price $3 C B B' A S.2 S.1 D.2 10 30 D.1 Quantity Definite decrease in equilibrium quantity

Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Increases Demand Increases Ambiguous Effect on Price Quantity Increases Price A S.1 B S.2 In the market for sweaters: - Winter is coming and it s going to be a cold one! (Increase in Demand) - Wool becomes cheaper (Increase in Supply) Q.1 Q.2 D.1 D.2 Quantity

Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Decreases Demand Increases Price increases Ambiguous Effect on Quantity Price P.2 P.1 B A S.2 S.1 In the market for coffee: - FDA says coffee can help people stay healthy (Increase in Demand) - A drought in Ecuador destroys the coffee crops (Decrease in Supply) D.2 D.1 Quantity

Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Decreases Demand Decreases Ambiguous Effect on Price Quantity Decreases In the market for snowboards: - Skiing gear is now cheaper than snowboarding gear (Decrease in Demand) - A few major producers of snowboards decide to shift their business focus to other products (Decrease in Supply) Price B Q.2 A Q.1 S.2 S.1 D.1 D.2 Quantity

Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Increases Demand Decreases Price decreases Ambiguous Effect on Quantity In the market for electric cars: - Gas prices fall, people prefer to keep their old cars (Decrease in Demand) - Innovations in production make it cheaper for companies to make electric cars (Increase in Supply) Price P.1 P.2 A S.1 S.2 B D.1 D.2 Quantity

Key Takeaway Market Equilibrium brings together the decentralized decisions of buyers and sellers Because each agent is looking out for their own best interest we get the optimal results in the model Shifts in the S or D curve must come from a change in one of the factors that change either willingness to sell or willingness to buy S-D Graph is critical in helping us find equilibrium and analyze/understand changes in the market.