Lecture IV Notes For Sept 17, 2007; Problems Due Wednesday I. Things that You Should Know About the PPF II. Today's Learning Objective: The Marshallian Cross S &amp; D III. Short Run Supply Curves (Firm &amp; Market), Slope &amp; Shifters IV. Individual and <a href="/keyword/market-demand-curve/" >market demand curve</a> s V. Supply &amp; Demand Interaction in Markets VI. Useful Insights from the Marshalian Cross Diagram I. Things that You Should Know About the PPF A. The PPF shows the tradeoff in production between goods 1. The slope of the PPF is the opportunity cost of the good on the horizontal in terms of the good on the vertical axis. ` B. To form a PPF, you need a production function for two goods, say X = aLX and Y = bLY, and a limit on the amount of inputs available, L =LX +LY. Then substitute X/a for LX and Y/b for LY, so that , L =LX +LY becomes L = X/a + Y/b, and solve for Y to get the equation of the PPF as Y = bL (b/a)X this is a linear PPF C. PPF's divide product space of goods X and Y into three regions (1) Below the PPF points are not technically efficient; (2) above the PPF points are infeasible; (3) on the PPF points are technically efficient. D. Most PPF's are non-linear concave from below. Opportunity cost of the good on the vertical axis increases as you try to produce more of it relative to the other good. E. To choose outputs X and Y to maximize revenue, begin with the revenue equation R = P XX + P YY, where P's are prices assumed constant. Plot iso-revenue lines, Y = R/P Y (P X/P Y)X and find the highest iso-revenue line that touches the PPF (usually a tangent to the PPF). This is the X*, Y* pair that maximizes revenue. 1. X*,Y* is technically efficient on the PPF 2. X*,Y* is allocatively efficient maximizes R 3. An allocatively efficient is technically efficient F. Changing P X or P Y causes the allocatively efficient point to change for non-linear PPFs and this illustrates a supply response of the firm, increase price and ouput of that good rises while output of the other good falls. G. PPF's also demonstrate gains from exchange and trade, absolute advantage, and comparative advantage. 1. If the PPFs of two producers have different slopes, opportunity costs of goods X and Y differ. 2. The producer with the flatter PPF, has the lower opportunity cost of good X (needs to give up less Y per unit X added) this producer has a comparative advantage in X. 3. Greater output is achieved if producers specialize in the good where they have a comparative advantage and trade or exchange goods. II. Today's Learning Objective: The Marshalian Cross S &amp; D A. Alfred Marshal's Principles of Economics (1890) B. Markets tend to an equilibrium price-quantity pair 1.Equilibrium is found at intersection points where downward sloping demand curve cuts supply from above. (Q*, P*) 2. If price is above equilibrium, P'', it tends to fall 3. If price is below equilibrium, P', it tends to rise C. Supply and demand illustrated the Marshallian cross Price Marshallian Cross Supply P'' P* P' Demand Q* Quantity III. Short Run Supply Curves (Firm &amp; Market), Slope &amp; Shifters A. Market versus individual firm supply curves 1. Firms produce more as price rises - we learned this from the PPF diagram 2. If the market consists of many firms, we must add individual supply curves horizontally to get market supply B. Changes in price DO NOT shift supply - you move along the supply curve price changes! C. Factors that DO shift supply curves 1. Changing the number of firms shifts supply 2. Changing input costs 3. Changing &quot;technology&quot; - including rules and laws IV. <a href="/keyword/market-demand-curve/" >market demand curve</a> - Origins, Slope and Shifters A. Market versus individual demand curves 1. Adding individual demand curves horizontally to get <a href="/keyword/market-demand-curve/" >market demand curve</a> s B. Changes in price DO NOT shift demand curves: as price changes you move along the demand curve! C. Factors that DO shift demand curves: 1. Changing taste 2. Changing income 3. Changing prices of substitutes &amp; complements 4. Changing the number of consumers V. Supply &amp; Demand Interaction in Markets - The Marshallian Cross Diagram - from the original &quot;Principles&quot; A. Consider consequences of alternative prices 1. Goldilocks and the 3 price levels... a. Too high (above intersection of S&amp;D)- excess supply b. Too low (below intersection of S&amp;D) excess demand c. Just right (at the intersection of S&amp;D) does not mean 0 inventory B. How to spot excess supply and demand in the &quot;real world&quot; 1. Lines outside the store 2. Order today for delivery in six months 3. &quot;Left over merchandise marked down for &quot;quick sale&quot; 4. Warehouse full of merchandise 5. Advertise openings for 10 employees and either 500 apply or only 5 apply! Does Wal-mart pay its employees too little? Too much? Are teachers &quot;underpaid&quot;? VI. Useful Insights from the Marshalian Cross Diagram A. Farmers have a very good growing season but the price of crops falls. Is this a problem? Is this a solution? B. During a severe winter, fuel oil prices rise in the north. Is this a problem? Is this a solution? C. People really enjoy playing music but the wages of musicians are low. Is this a problem? Is this a solution? D. Price and the &quot;Theory of Value&quot; in Economics 1. Price measures willingness to pay for another unit on the demand curve 2. Price measures opportunity cost of producing another unit on the supply curve.