ECON200

Principles of Microeconomics

Lecture 1- Unit 1: Foundation Concepts

Instructor: Dr. O. Davis

 Welcome and Introductions
Welcome Everyone
I am Dr. Odetha Davis, your course facilitator.

Please note that this will be your favorite course of

the semester. As long as you read and make an
effort to learn the material, we will get along
perfect!

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 Learning Objectives
At the end of this unit, students should be able to:
 Differentiate between microeconomics and macroeconomics

 Explain why the study of microeconomics is important

 Demonstrate the importance of specializing according to one’s

comparative advantage

 Define opportunity cost

 Demonstrate opportunity cost with a production possibility

curve

 Use graphs to display economic scenarios

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 Diagnostic Case Study
• Is it possible to have everything you want or do you have
enough resource to obtain all the products and services
that you need? Very few people can say yes to this, for the
rest of us there are choices that must be made as we
decide what to purchase. Many factors influence our
choices.
1. Identify some factors that influence our choice of
purchases.
2.Identify a resource that is not scarce and one that is
extremely scarce.
3.How do solve the problem of scarce resources when you
want to make a purchase and don’t have enough money?

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 What Economics Is All About

• Economics: the study of how society allocates its

scarce resources across many competing uses, for
e.g.

• how people decide what to buy, how much to

work, save, and spend;
• how firms decide how much to produce, how
many workers to hire;
• how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs.
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 Three Related Principles

• There are three related principles in economics:

• Scarcity: this is the fact that we have limited resources

to satisfy unlimited wants.

• Choice: since we do not have unlimited resources, then

it means that we must choose which wants will be
satisfied at any given time.

• Opportunity Cost: this is the next best alternative that

is sacrificed when we make each choice. Or
• the value of what you give up in order to have your
choice.
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 Microeconomics & Macroeconomics

• There are two branches of economics:

• Microeconomics: the study of how households and firms

make decisions and how these two groups interact in
markets.

• Macroeconomics: the study of economy-wide events,

such as inflation, unemployment and economic growth.

• A lot of the microeconomic theory forms the foundation

for the study of macroeconomics.

• For this course, we will focus on microeconomics.

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 Methods of Economic Analysis

• There are two methods of economic analysis:

• Positive Statements: are claims that describe the world as it is. For
example:

• Rising gas prices result in more sales of fuel-efficient vehicles.

• Normative Statements: are claims that prescribe how the world

should be. For example:

• Parents should monitor the TV programmes that their children watch.

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Methods of Economic Analysis (Cont’d)

• Positive statements can be confirmed or refuted, as

they are objective and based on facts.

• Normative statements cannot be confirmed or

refuted, as they are subjective and based on
opinions.

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 Marginal Cost-Benefit Analysis

• Marginal cost (MC): the extra cost that you face by

obtaining one more unit of an item, or by doing a little bit
more of an activity.
• Marginal benefit (MB): the extra benefit that you gain by
obtaining one more unit of an item, or by doing a little bit
more of an activity.

• If MB > MC, then you choose to get more of that item, or

to do more of that activity;
• If MB < MC, then you choose not to get more of that item,
or you choose to not do more of that activity;
• If MB=MC, then you are indifferent between either
getting more of that item (or doing more of that activity),
or not.
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 The Production Possibilities Frontier

The Production Possibilities Frontier (PPF): is a

graph that shows the combinations of two goods that
the economy can possibly produce given the
available resources and the available technology.

Example:

• Two goods: computers and rice

• One resource: labour (measured in hours)

• Economy has 50,000 labour hours per month

available for production.
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 PPF Example
• Producing one computer requires 100 hours labour.
• Producing one ton of rice requires 10 hours labour.

Employment of
Production
labour hours
Computers Rice Computers Rice
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000
E 0 50,000 0 5,000
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 PPF Example

Rice
Production (tons)
Point
on Com- 6,000
graph puters Rice E
5,000
4,000 D
A 500 0
B 400 1,000 3,000 C
C 250 2,500 2,000
1,000
B
D 100 4,000
0
A
E 0 5,000
0 100 200 300 400 500 600
Computers

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 Activity 1: Using the PPF

A. On the graph, find the point that represents

(100 computers, 3000 tons of rice), label it F.
Would it be possible for the economy to
produce this combination of the two goods?
Why or why not?

B. Next, find the point that represents (300

computers, 3500 tons of rice), label it G.
Would it be possible for the economy to
produce this combination of the two goods?
Why or why not?
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 Activity 1: Using the PPF (Answers)
 Point F: Rice
100 computers, (tons)
3000 tons rice 6,000
5,000
 Point F requires
40,000 hours 4,000
of labour 3,000
((100X100)+ F
(3000X10)). 2,000
Possible but 1,000
not efficient: could
get more 0
0 100 200 300 400 500 600
of either good
w/o sacrificing any Computers
of the other. 15
 Activity 1: Using the PPF (Answers)
Rice
 Point G: (tons)
300 computers, 6,000
3500 tons rice
5,000
 Point G requires
4,000
65,000 hours G
of labour 3,000
((300X100)+ 2,000
(3500X10)).
1,000
Not possible
because 0
0 100 200 300 400 500 600
economy
only has Computers
50,000 hours. 16
 The PPF: What We Know So Far

Points on the PPF (like A – E) are:

• Possible and
• Efficient: all resources are fully utilized

Points under the PPF (like F) are:

• Possible, but
• Not efficient: some resources are underutilized (e.g.,
workers unemployed, factories idle)

Points above the PPF (like G) are:

• Not possible, because we do not have enough
resources to produce at those levels of output.
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 The PPF & Opportunity Cost

Opportunity cost (OC) is what is sacrificed in order for you

to have your choice.
In terms of physical items, the OC of an item is what must be
given up (or sacrificed) in order for you to obtain that item.

Moving along a PPF involves shifting resources (e.g., labour)

from the production of one good to the other.

Society faces a tradeoff: Getting more of one good requires

sacrificing some of the other.

The slope of the PPF tells you the opportunity cost of one
good in terms of the other.
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 The PPF & Opportunity Cost
Rice The slope of a line
(tons)
equals the
6,000 –1000 “rise over the run”, or
slope = = –10
100 the vertical change
5,000
divided by the
4,000
horizontal change.
3,000
Here, the opportunity
2,000
cost (OC) of a
1,000 computer is
0 10 tons of rice.
0 100 200 300 400 500 600
Similarly the OC of 1
Computers ton of rice is 1/10 of a
computer.
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Activity 2: The PPF & Opportunity Cost

•In which country is the opportunity cost of cloth lower?

FRANCE ENGLAND
Wine Wine
600 600

500 500

400 400

300 300

200 200

100 100

0 0
0 100 200 300 400 0 100 200 300 400
Cloth Cloth
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 Activity 2: The PPF & Opportunity Cost

Answer: The absolute value of the slope of the PPF gives the
OC of whatever good is measured on the x-axis.
France
Slope of PPF = -600/300 = -2
In absolute value terms: OC of 1 unit of cloth = 2 units of wine

England
Slope of PPF = -200/300 = -2/3 = -0.67
In absolute value terms: OC of 1 unit of cloth = 0.67 unit of
wine

England has the lower opportunity cost for cloth, as they

only sacrifice 0.67 of a unit of wine.
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 Economic Growth & the PPF

With additional Rice

(tons) Economic
resources or an
6,000 growth shifts
improvement in
the PPF
technology, 5,000
outward.
the economy can
4,000
produce
more computers, 3,000
2,000
more rice,
1,000
or any combination in 0
between. 0 100 200 300 400 500 600
Computers

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 The Shape of the PPF

The PPF could be a straight line or bow-shaped.

It all depends on what happens to opportunity cost

(OC) as economy shifts resources from one industry
to the other.

• If OC remains constant, PPF is a straight line.

(In the previous example, OC of a computer was
always 10 tons of rice).

• If OC of a good rises as more of the good is

produced, then the PPF is bow-shaped….
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 Why the PPF Might Be Bow-Shaped

As the economy shifts

Sodas
resources
from sodas to
treadmills:
• PPF becomes
steeper;
• OC of treadmills
increases.

Treadmills

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 Why the PPF Might Be Bow-Shaped

At A, OC of
At point A,

Sodas
A treadmills is low.
most workers are
producing soda,
even those who
are better suited
to building treadmills.

So, we do not have to

give up much soda
to get more treadmills.
Treadmills

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 Why the PPF Might Be Bow-Shaped

At B, most workers are

Sodas
At B, OC of
producing treadmills. treadmills
The few left in soda is high.
production are the best
soda-makers. B
Producing more
treadmills would require
shifting some of the best
soda-makers away from
soda production,
causing a big drop in Treadmills
soda output.
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 Why the PPF Might Be Bow-Shaped

So, PPF is bow-shaped when different workers have

different skills, and different opportunity costs of
producing one good in terms of the other.

The PPF would also be bow-shaped when there is

some other resource, or mix of resources with varying
opportunity costs.

(E.g., different types of land suited for different uses).

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 The PPF: A Summary

• The PPF shows all combinations of two goods that an

economy can possibly produce, given its resources
and technology.

• The PPF illustrates the concepts of tradeoff and

opportunity cost, efficiency and inefficiency,
unemployment, and economic growth.

• A linear PPF indicates constant opportunity cost,

while a bow-shaped PPF illustrates the concept of
increasing opportunity cost as well as the existence of
specialized resources.
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 Absolute & Comparative Advantage
• We will now discuss the concepts of absolute and
comparative advantage. We will use:

•Tool: The PPF

•Concept: Opportunity Cost

•Absolute Advantage: is the ability to produce a good using

fewer inputs than another producer. Or:

the ability to produce more of a good than another producer.

•Comparative Advantage: is the ability to produce a good at

a lower opportunity cost than another producer.
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 Activity 3: Mutually Beneficial Trade
Argentina and Brazil each have 10,000 hours of labour per
month.

• In Argentina, producing one pound of coffee requires 2

hours, and producing one bottle of wine requires 4 hours;

• In Brazil, producing one pound of coffee requires 1 hour,

and producing one bottle of wine requires 5 hours.

A. Draw the PPFs of Argentina and Brazil.

B. Who has the absolute advantage in each good?
C. Who has the comparative advantage in each good?
D. Derive a possible scenario for gains from trade to be
realized. 30
Activity 3: Mutually Beneficial Trade (Cont’d)
Before we draw the PPFs, we need to know the maximum
production values in each country. These maximum values will
give us the x- and y- intercepts of the each country’s PPF.

Argentina
Maximum coffee production = 10,000 hrs / 2 hrs = 5000 lbs
Maximum wine production = 10,000 hrs / 4 hrs = 2500 bottles

Brazil
Maximum coffee production = 10,000 hrs / 1 hr = 10,000 lbs
Maximum wine production = 10,000 hrs / 5 hrs = 2000 bottles

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Activity 3: Mutually Beneficial Trade (Cont’d)

Argentina’s PPF Brazil’s PPF

Coffee
Coffee

10000

5000

2000
2500 Wine Wine

Slope of PPF
Slope of PPF
= -10000/2000
= -5000/2500
= -5
= -2

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 Activity 3: Mutually Beneficial Trade (Cont’d)
Absolute Advantage

Let’s look at the total production values in a table:

Country Coffee Production Wine Production

Argentina 5000 lbs 2500 bottles

Brazil 10,000 lbs 2000 bottles

It is clear that Argentina has the absolute advantage in wine

production as it produces 2500 bottles compared to Brazil’s
2000 bottles.
Brazil has the absolute advantage in producing coffee, as it
can produce 10,000 pounds of coffee compared to Argentina’s
5000 pounds. 33
Activity 3: Mutually Beneficial Trade (Cont’d)
Comparative Advantage
In order to determine which country has the comparative advantage,
then we need to calculate the opportunity cost (OC) of producing
each good in each country:

Argentina
OC of making 1 lb of coffee = Wine production/Coffee production =
2500/5000 = 0.5 bottle of wine
OC of making 1 bottle of wine = Coffee production/Wine production
= 5000/2500 = 2 lbs of coffee

Brazil
OC of making 1 lb of coffee = Wine production/Coffee production =
2000/10000 = 0.2 bottle of wine
OC of making 1 bottle of wine = Coffee production/Wine production
= 10000/2000 = 5 lbs of coffee
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 Activity 3: Mutually Beneficial Trade (Cont’d)
Comparative Advantage (Cont’d)
Let’s consider these opportunity cost (OC) calculations in a table:

Country Coffee OC Wine OC

Argentina 0.5 bottle of wine 2 pounds of coffee

Brazil 0.2 bottle of wine 5 pounds of coffee

Argentina has the comparative advantage in wine

production, as it sacrifices only 2 pounds of coffee (compared
to Brazil’s 5 pounds of coffee).
Brazil has the comparative advantage in coffee production,
as it sacrifices only 0.2 of a bottle of wine which is less than
Argentina’s 0.5 of a bottle of wine. 35
Activity 3: Mutually Beneficial Trade (Cont’d)

• We consider comparative advantage to decide who (a person

or a country) should specialize in producing what product.

•Since Argentina has the comparative advantage in wine

production, then Argentina should focus on producing wine.

•Brazil has the comparative advantage in coffee production, so

Brazil should focus on producing coffee.

•Let’s consider the situation of an autarky – when a country

engages in no trade and produces all goods for itself; vs.
•Trade- each country specializes according to its comparative
advantage and exchanges goods between themselves.

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 Activity 3: Mutually Beneficial Trade (Cont’d)
Autarky: In this case Argentina will use half of its 10,000
labour hours to produce wine and the other half to produce
coffee. Brazil will do the same. Each country will produce
and consume all that it produces (see the values in red).
The PPFs now look like:

Argentina’s PPF Brazil’s PPF

Coffee
Coffee

10000
5000

5000
2500

2500 Wine 2000 Wine

1250 1000

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Activity 3: Mutually Beneficial Trade (Cont’d)
Trade
•If both countries are to trade, then they must be able to
satisfy their autarky consumption requirements. Otherwise,
there’s no incentive to engage in trade.

•A possible trade agreement:

•If Argentina specializes in wine production, then it can

produce the maximum of 2500 bottles, keeping 1300 bottles
at home and trading 1200 bottles of wine to Brazil.

•If Brazil specializes in coffee production, then it can produce

the maximum of 10,000 pounds, keeping 7000 pounds at
home and trading 3000 pounds of coffee to Argentina.
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Activity 3: Mutually Beneficial Trade (Cont’d)
Gains from Trade
This trade agreement enables Argentina and Brazil to
consume at points outside of their PPFs. The difference
between the autarky consumption levels and the trade
consumption levels is called gains from trade.
Argentina’s PPF Brazil’s PPF
Coffee
Coffee

10000
5000 7000 B
3000
A 5000
2500

2500 Wine 2000 Wine

1250 1000

1300 1200

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 Activity 3: Mutually Beneficial Trade (Cont’d)
Coffee Wine
No Trade (Autarky)

Argentina Produce: 2500 1250

Consume: 2500 1250
Brazil Produce: 5000 1000
Consume: 5000 1000
Trade
Argentina Produce: 0 2500
Consume: 3000 1300
Brazil Produce: 10000 0
Consume: 7000 1200

Gains from Trade

Argentina Consumes 500 lbs more 50 bottles more

Brazil Consumes 2000 lbs more 200 bottles more

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 Activity 4: ASSIGNMENT
Andrew can read a page of economics in 10 minutes,
and read a page of sociology in 4 minutes. Benjamin can
read a page of economics in 6 minutes and read a page
of sociology in 3 minutes. They each have 60 minutes.

a. What are the maximum number of pages of

economics and sociology that each person can read?
b. Who has the absolute advantage in reading
economics? Why? Who has the absolute advantage in
reading sociology? Why?
c. Who has the comparative advantage in reading
economics? Why? Who has the comparative
advantage in reading sociology? Why?
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END OF LECTURE NOTES

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