Econ 4346Econ 4346Test #1Test #1

Topic ReviewTopic Review

PARETO OPTIMALITYPARETO OPTIMALITY

• An allocation of resources such that:An allocation of resources such that:• It is impossible to make at least one person better It is impossible to make at least one person better

off without making someone else worse offoff without making someone else worse off

• If two people are in a room, and one person has a If two people are in a room, and one person has a full allocation of clothes…full allocation of clothes…• And the other person a full allocation of food, then…And the other person a full allocation of food, then…

• Trade will occur to a point where both peopleTrade will occur to a point where both people• Benefit from the interactionBenefit from the interaction• Cannot improve any further without harming the otherCannot improve any further without harming the other

• Pareto Optimality serves as the basis for the Pareto Optimality serves as the basis for the Production Possibilities FrontierProduction Possibilities Frontier

• Review video on blog Review video on blog http://tc6617.wordpress.com/2010/10/13/econ-4346-http://tc6617.wordpress.com/2010/10/13/econ-4346-basic-principles-part-1/basic-principles-part-1/

(non) Pareto optimality (non) Pareto optimality EXAMPLEEXAMPLE

RECTANGLE REPRESENTSECONOMIC CONSTRAINTS

A

B

Two Economic players A and B. Non-Pareto Optimal, since there is room for both to improve

pRODUCTION pRODUCTION POSSIBILITIES POSSIBILITIES

FRONTIERFRONTIER• Displays efficient combinations of output Displays efficient combinations of output

when factors of production (labor, land, and when factors of production (labor, land, and capital) are used to full potentialcapital) are used to full potential

• Bowed shape represents increasing costsBowed shape represents increasing costs• In order to increase production of one good (A), In order to increase production of one good (A),

production of the other (B) must be given upproduction of the other (B) must be given up• Sounds like Pareto Optimality, perhaps?Sounds like Pareto Optimality, perhaps?

• Review Mankiw pp25-28Review Mankiw pp25-28• Review blog: Review blog:

http://tc6617.wordpress.com/2010/10/13/econ-http://tc6617.wordpress.com/2010/10/13/econ-4346-basic-principles-part-1/4346-basic-principles-part-1/

Production Possibilities Production Possibilities frontierfrontier

•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

Demand curveDemand curve

•Why is it downward Why is it downward sloping?sloping?•Because of the Law of Because of the Law of

DemandDemand•The The quantity demandedquantity demanded of of

a good falls when the price a good falls when the price risesrises

Supply CurveSupply Curve

•Why does it slope upward?Why does it slope upward?• Because of the Law of SupplyBecause of the Law of Supply

•The quantity supplied of a good The quantity supplied of a good rises when the price of the rises when the price of the good risesgood rises

EquilibriumEquilibrium

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

Equilibrium of supply Equilibrium of supply and demandand demand

P

Q

D

S

Equilibrium

Solving for equilbriumSolving for equilbrium

• Expedia did the following study (fictional) on Expedia did the following study (fictional) on its market for package toursits market for package tours• Demand scheduleDemand schedule

• Qd = 28,000 – 300PQd = 28,000 – 300P

• Supply scheduleSupply schedule• Qs = 23,000 + 200PQs = 23,000 + 200P

• CALCULATE EQUILIBRIUM PRICE AND QUANTITYCALCULATE EQUILIBRIUM PRICE AND QUANTITY

Solving for equilibriumSolving for equilibrium

P

Q

Qd = 28,000 – 300P

Qs = 23,000 + 200P

1. Set Qs = Qd2. 23,000 + 200P = 28000 – 300P3. Solve for P4. 500P = 5,0005. P = 106. Plug in value for P in one of equations (we’ll use Qd)7. 28,000-300(10) = Qd = 25,000

$10

25,000

PRICE CEILINGPRICE CEILING

• Occurs when government puts legal limit on Occurs when government puts legal limit on how high the price of a product can behow high the price of a product can be

• Why?Why?

• Government thinks that price ceilings protect Government thinks that price ceilings protect consumersconsumers• If government didn’t impose a price ceiling, the If government didn’t impose a price ceiling, the

product wouldn’t be obtainable to the “average product wouldn’t be obtainable to the “average consumer”consumer”• Therefore unfairTherefore unfair

Price ceilingPrice ceiling

P

Q

CEILING

S

D

SHORTAGE

Price ceiling below equilibrium. Shortage occurs because demand exceeds supply

Elasticity of demandElasticity of demand

• See figure 1, Mankiw, page 93See figure 1, Mankiw, page 93

• Perfectly inelastic: Ed = 0Perfectly inelastic: Ed = 0

• Inelastic: Ed < 1Inelastic: Ed < 1

• Unit Elastic: Ed = 1Unit Elastic: Ed = 1

• Elastic: Ed > 1Elastic: Ed > 1

• Perfectly Elastic: Ed = infinityPerfectly Elastic: Ed = infinity

Elasticity of supplyElasticity of supply

• See figure 5, Mankiw page 101See figure 5, Mankiw page 101

• Perfectly Inelastic: Es = 0Perfectly Inelastic: Es = 0

• Inelastic: Es < 1Inelastic: Es < 1

• Unit Elastic: Es = 1Unit Elastic: Es = 1

• Elastic: Es > 1Elastic: Es > 1

• Perfectly Elastic: Es = infinityPerfectly Elastic: Es = infinity

Shifts in supply and Shifts in supply and demand curvesdemand curves

• Thoroughly review pages 67 – 82 in MankiwThoroughly review pages 67 – 82 in Mankiw