Micro and Macro Models Agec 217
Dec 17, 2015
Micro and Macro Models
• Terms (almost all not involving money)– Opportunity Cost– Absolute Advantage– Comparative Advantage– Specialization– Production Possibility Frontier– Imports– Exports– Circular Flow Diagram
Opportunity Cost
• Opportunity Cost: The next best
alternative you give up in order to obtain or
produce an item
Opportunity Cost
Opportunity cost for each of three identical jobs with identical benefits, but with employers paying different salaries:
– Employer A: $70,000– Employer B: $50,000– Employer C: $30,000
Absolute and Comparative Advantage
• Two individuals, Kate and Charlie, are stranded on a desert island and subsist on a diet of bananas and coconuts.
Absolute and Comparative Advantage
• Production per HourBananas
• Kate: 40 per hour• Charlie: 20 per hour
Coconuts• Kate: 20 per hour• Charlie: 4 per hour
Absolute and Comparative Advantage
• Absolute Advantage: The person, firm, or
nation with a higher level of productivity
compared to that of another.
Absolute and Comparative Advantage
• Kate has the absolute advantage
producing both bananas and coconuts
Absolute and Comparative Advantage
• Who has the comparative advantage?
• Comparative Advantage: the person, firm,
or nation with the lower opportunity cost
vs. that of another.
Absolute and Comparative Advantage
Calculating opportunity cost (the next best
alternative)
– Opportunity cost of producing bananas = the
number of coconuts produced in a unit of time
divided by the number of bananas produced
in the same unit of time.
Absolute and Comparative Advantage
• Opportunity CostBananas
• Kate: ½ coconut• Charlie: 1/5 coconut
Coconuts• Kate: 2 bananas• Charlie: 5 bananas
Absolute and Comparative Advantage
• Let’s assume that each is eating only their own production in the following manner:
– Kate: 20 bananas and 10 coconuts– Charlie: 10 bananas and 2 coconuts
• Are there any shifts in production or trades that could be taken advantage of?
Absolute and Comparative Advantage
• Specialization: focusing production more heavily on a good for which you have a comparative advantage, with the expectation of trading for other goods for which you do not have a comparative advantage
Absolute and Comparative Advantage
• Let’s assume that they produce:– Kate: 12 bananas and 14 coconuts– Charlie: 20 bananas and 0 coconuts
• Is this a valid direction?
• Are the numbers valid?
Absolute and Comparative Advantage
• If Charlie trades 9 bananas to Kate for 3 coconuts, they will have– Kate: 21 bananas and 11 coconuts– Charlie: 11 bananas and 3 coconuts
• Compared to before:– Kate: 20 bananas and 10 coconuts– Charlie: 10 bananas and 2 coconuts
Absolute and Comparative Advantage
• The comparative advantage allows
people, firms, or nations to specialize and
trade
Production Possibility Frontier• A graph of all potential production
combinations in an economy (compare to the flat PPF for an individual)
Production Possibility Frontier
Efficient Points: points on the curve
Inefficient Points: points below the curve
Impossible Points: points above the curve
- Often Called the Production Possibility Curve (PPC)
Imports and Exports
• Imports: goods or services produced
abroad and sold in ones own country
• Exports: goods or services produced in
ones own country and sold abroad
Circular Flow Diagram (Mankiw)
Copyright © 2004 South-Western
Spending
Goods andservicesbought
Revenue
Goodsand servicessold
Labor, land,and capital
Income
= Flow of inputs and outputs
= Flow of dollars
Factors ofproduction
Wages, rent,and profit
FIRMS•Produce and sellgoods and services
•Hire and use factorsof production
•Buy and consumegoods and services
•Own and sell factorsof production
HOUSEHOLDS
•Households sell•Firms buy
MARKETSFOR
FACTORS OF PRODUCTION
•Firms sell•Households buy
MARKETSFOR
GOODS AND SERVICES
Circular Flow Diagram
• Enhanced diagram: Wikipedia
– http://upload.wikimedia.org/wikipedia/en/e/ee/Circular_flow_of_income.JPG