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Unformatted text preview: Chapter 2 - Gains from trade Specialization allows for increased productivity. We can create more stuff if we all specialize. Model #1 2 people - Lauren and Whitney are stranded on an island. Suppose they can make dresses or shoes. Assumption: only input for making dresses and shoes is time (labor) (not cloth or material). It takes Lauren 1 hr to make a dress and 2 hours to make a pair of shoes. It takes Whitney 30 minutes to make a dress and 1.5 hours to make a pair of shoes. Each person has 12 hours to work. Who has AA in dresses?- Whitney 30 min < 1 hour Who has AA in shoes?- Whitney 1.5 hrs < 2 hrs If Lauren only made dresses how many dresses could she make? 12 hr / 1 hr = 12 dresses Dresses Shoes Lauren 12 12 hr/2hr = 6 Whitney 12hr/30 min = 24 12 hr / 1.5 hr = 8 Absolute Advantage (AA) - The ability to produce a good with fewer resources (time). Production Possibilities frontier (PPF) - the graph of all possible combinations of dresses and shoes Whitney and Lauren can make in 12 hrs. PPF model in notes - PPF always straight line in class, not curved. Example: If they each spend 1/2 of their time on dresses and half their time on shoes, Lauren makes 6 dresses and 3 shoes and Whitney makes 12 dresses and 4 shoes. Total in the economy: 18 dresses and 7 shoes. (Each one working individually). With specialization - more can be made in the economy. Comparative Advantage and Gains from trade Suppose that Whitney and Lauren decided to specialize to increase the total production in the economy. Who should specialize in which good? - Calculate Opportunity Costs Opportunity Cost - the amount of the other good you give up in order to produce one unit of the good. Opportunity Cost of dresses for Lauren - 1/2 shoes - it takes her 1 hr to make a dress. She could have made 1/2 a pair of shoes in that time. Opportunity Cost of shoes for Lauren - 2 dresses. It takes her 2 hours to make a pair of shoes. She could have made 2 dresses in that amount of time. The opportunity costs for the same person, different goods are always inverses. Opportunity cost of dresses for Whitney - 1/3 shoes. Opp Cost of shoes for Whitney - 3 dresses dresses shoes Lauren .5 shoes 2 dresses Whitney 1/3 shoes 3 dresses OP/PPF Economics Page 1 P(brownies) Q(brownies) D1 D2 P(ice cream) = decreases As the price of ice cream decreases, demand for brownies increase Substitute- things you consume instead of the good of interest, increase in the price of a substitute results in the increase of the demand of the good P(brownies) Q(brownies) P(cookies) decrease Complements : goods consumed with the good of interest ex: ice cream with brownie, increase in the price of ice cream will cause decrease in demand for brownies SUPPLY Quantity Supplied: the amount of a good that sellers are willing and able to sell at a given price Shift in Demand:-Income (normal goods, inferior goods)-Taste and Preference (use your intuition)-Price of related goods/substitute goods-Change in # of buyers => logical changes...
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- Spring '08
- Supply And Demand