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Econ 4346

Econ 4346. Test #1 Topic Review. PARETO OPTIMALITY. An allocation of resources such that: It is impossible to make at least one person better off without making someone else worse off If two people are in a room, and one person has a full allocation of clothes…

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Econ 4346

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  1. Econ 4346 Test #1 Topic Review

  2. PARETO OPTIMALITY • An allocation of resources such that: • It is impossible to make at least one person better off without making someone else worse off • If two people are in a room, and one person has a full allocation of clothes… • And the other person a full allocation of food, then… • Trade will occur to a point where both people • Benefit from the interaction • Cannot improve any further without harming the other • Pareto Optimality serves as the basis for the Production Possibilities Frontier • Review video on blog http://tc6617.wordpress.com/2010/10/13/econ-4346-basic-principles-part-1/

  3. (non) Pareto optimality EXAMPLE A RECTANGLE REPRESENTS ECONOMIC CONSTRAINTS B Two Economic players A and B. Non-Pareto Optimal, since there is room for both to improve

  4. pRODUCTION POSSIBILITIES FRONTIER • Displays efficient combinations of output when factors of production (labor, land, and capital) are used to full potential • Bowed shape represents increasing costs • In order to increase production of one good (A), production of the other (B) must be given up • Sounds like Pareto Optimality, perhaps? • Review Mankiw pp25-28 • Review blog: http://tc6617.wordpress.com/2010/10/13/econ-4346-basic-principles-part-1/

  5. Production Possibilities frontier • Country can produce two goods: • Grain and Wine • Bowed curve is the frontier. • Any point on the curve is • Pareto Optimal • Point ‘b’ is infeasible • Point ‘a’ is non-Pareto Optimal or • ineffecient

  6. Demand curve • Why is it downward sloping? • Because of the Law of Demand • The quantity demanded of a good falls when the price rises

  7. Supply Curve • Why does it slope upward? • Because of the Law of Supply • The quantity supplied of a good rises when the price of the good rises

  8. Equilibrium • A situation in which the market price has reached the level at which quantity supplied equals quantity demanded

  9. Equilibrium of supply and demand S P Equilibrium D Q

  10. Solving for equilbrium • Expedia did the following study (fictional) on its market for package tours • Demand schedule • Qd = 28,000 – 300P • Supply schedule • Qs = 23,000 + 200P • CALCULATE EQUILIBRIUM PRICE AND QUANTITY

  11. Solving for equilibrium P • Qs = 23,000 + 200P $10 • Qd = 28,000 – 300P 25,000 Q Set Qs = Qd 23,000 + 200P = 28000 – 300P Solve for P 500P = 5,000 P = 10 Plug in value for P in one of equations (we’ll use Qd) 28,000-300(10) = Qd = 25,000

  12. PRICE CEILING • Occurs when government puts legal limit on how high the price of a product can be • Why? • Government thinks that price ceilings protect consumers • If government didn’t impose a price ceiling, the product wouldn’t be obtainable to the “average consumer” • Therefore unfair

  13. Price ceiling P S CEILING SHORTAGE D Q Price ceiling below equilibrium. Shortage occurs because demand exceeds supply

  14. Elasticity of demand • See figure 1, Mankiw, page 93 • Perfectly inelastic: Ed = 0 • Inelastic: Ed < 1 • Unit Elastic: Ed = 1 • Elastic: Ed > 1 • Perfectly Elastic: Ed = infinity

  15. Elasticity of supply • See figure 5, Mankiw page 101 • Perfectly Inelastic: Es = 0 • Inelastic: Es < 1 • Unit Elastic: Es = 1 • Elastic: Es > 1 • Perfectly Elastic: Es = infinity

  16. Shifts in supply and demand curves • Thoroughly review pages 67 – 82 in Mankiw

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