Economics 1 2013-14

1. Economics 12013-14 (Lecture 1) Welcome! Robin Naylor, Department of Economics, Warwick

2. Economics 1 Accompanying Resources Module Website see various tabs (thumbprint, assessment, feedback) see links to slides and pod/webcasts/transcripts Module Manual (with reading list) Seminar Work and Problem Sets and e-forums Departmental Handbooks and Web-Sites MyEconomics Portal Robin Naylor, Department of Economics, Warwick

3. Economics 1 Organisation (see module manual for details) Lecture timetable Lecture notes/handouts Seminar/e-forum arrangements (from week 3) Personal Essays Examination and Assessment Robin Naylor, Department of Economics, Warwick

4. Economics Readings (Micro) Besanko and Braeutigam, Microeconomics 4th Edition, Wiley, 2011 Estrin, Laidler and Dietrich (ELD), Microeconomics, 2008 + Many other textbooks plus other literature: see Module Manual Robin Naylor, Department of Economics, Warwick

5. Term 1: Micro Topics • Introduction Scarcity and Trade; Markets • Topic 1 Household behaviour • Topic 2 Firm behaviour • Topic 3 Product markets • Topic 4 Factor markets • Topic 5 Market Structure, Efficiency and Failure Robin Naylor, Department of Economics, Warwick

6. Introduction • The fundamental problem of scarcity • Cause: excess of wants over ‘natural’ supply • Consequences: (i) Choices over production (ii) Trade-offs and opportunity costs (iii) Rationing of distribution (Markets etc . . .) Consider a 2-good economy: Robin Naylor, Department of Economics, Warwick

7. Introduction • The fundamental problem of scarcity Defence D-Max The Production Possibility Curve The Production Possibility Set 0 F-Max Food Robin Naylor, Department of Economics, Warwick

8. Introduction • The fundamental problem of scarcity Defence . c D-Max What can you say about points a, b and c? . b . a 0 F-Max Food Robin Naylor, Department of Economics, Warwick

9. Introduction • The fundamental problem of scarcity The MRT is the amount of one good (D) we have to give up in order to have an extra unit of the other good (F). Defence D-Max . b So the MRT is increasing in the case of the concave PPC. Why? . d . a 0 F-Max Food Robin Naylor, Department of Economics, Warwick

10. Introduction • The fundamental problem of scarcity The PPC shows us the trade-off that Society has to make between 2 goods. Note also relationship to Opportunity Cost What about the trade-off that the Society is prepared to make? Defence 0 Food Robin Naylor, Department of Economics, Warwick

11. Introduction The slope of the Indifference Curve shows us how much of one good the society is prepared to give up (‘trade off’) in order to have an extra unit of the other good: This is the Marginal Rate of Substitution (MRS). Why might it be convex? Defence IC 0 Food Robin Naylor, Department of Economics, Warwick

12. Introduction A set or family of Indifference Curves Defence IC3 IC2 IC1 0 Food Robin Naylor, Department of Economics, Warwick

13. Introduction ‘a’ is not technically efficient. ‘b’ is. So is ‘d’. So how can we choose between ‘b’ and ‘d’? They are both ‘technically’ efficient. But they are not both Allocatively Efficient . . . Defence . b . d . a 0 Food Robin Naylor, Department of Economics, Warwick

14. Introduction On which IC would society like most to be? At what point is this? Defence . b . d . a Where MRS = MRT. 0 Food Robin Naylor, Department of Economics, Warwick

15. Introduction Gains from Trade • Consider 2 economies, Red and Blue: Y Who has an absolute advantage in producing X? And Y? PPC-R PPC-B X Robin Naylor, Department of Economics, Warwick

16. Introduction To raise output of X by the amount dX, the required reduction in Y is smaller in Blue than in Red. In other words, the Opportunity Cost of the extra X is lower in Blue than in Red. We say that Blue has a Comparative Advantage in the production of X. And Red has a Comparative Advantage in producing Y. Gains from Trade • Consider 2 economies, Red and Blue: Y dX dX X Robin Naylor, Department of Economics, Warwick

17. Introduction Suppose initially, Blue is at point ‘a-B’ and Red is at ‘a-R’. If Blue gives up one unit of Y, it raises output of X by dX. Suppose thatat the same time Red cuts production of X by the same amount, dX: then it can raise output of Y by 3 units. So what is the total change in ‘World’ production of X? And of Y? Y dY=3 a-R dX a-B dY=1 dX X Robin Naylor, Department of Economics, Warwick

18. Introduction So with an unchanged total production of X and a higher total production of Y, the countries could*: Trade such that Blue exports dX to Red and, in return, Red exports 2 units of Y to Blue. What would this look like in terms of each country’s PPC? Y b-R dY=1 a-R b-B dY=1 a-B X Robin Naylor, Department of Economics, Warwick

19. Introduction Key Concepts • Scarcity • Wants • Opportunity Cost • Trade-offs • Rationing • Markets • Efficiency • Equity • Constraints • Changes at the margin Robin Naylor, Department of Economics, Warwick

20. Introduction Key Concepts • Choices • Preferences • Constraints • PPC • MRS • MRT • Optimisation • Absolute advantage • Comparative advantage • Specialisation • Trade Robin Naylor, Department of Economics, Warwick

21. Introduction Self-study Questions • Show and explain a PPC for a country • What determines the position and shape of the PPC • Explain the concept of the MRT • Economists often argue that Choices depend on two key concepts: Preferences and Constraints. Explain this argument. • Explain the concept of the MRS • Define ‘trade-offs’ (in terms of both preferences and constraints) and ‘Opportunity Cost’ and explain their meanings in a diagram using the concept of the PPC. • What is meant by Absolute Advantage? • What is meant by Comparative Advantage? Explain how the concepts of comparative advantage and of opportunity cost are related. • Show how trade and specialisation can lead to potential gains for both parties in a trade. Robin Naylor, Department of Economics, Warwick