AP

1.3 – Comparative Advantage & Trade

Trade and Specialization • Adam Smith in Wealth of Nations, written in 1776, writes about the benefits of specialization. ○ One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a particular business, to whiten the pins is another; it is even a trade by itself to put them into paper; and the important business of making a pin is, in this mannar, divided into about eighteen distinct operations… Those ten persons, therefore, could make among them upwards of 48,000 pins in a day. But if they had all wrought separtely and independently… they certainly could not each of them have made twenty, perhaps not one pin in a day. • Modern example: I, Pencil: The Movie Market Economy vs. Command Economy • In a market economy, production and consumption decisions are the result of decentralized decisions by individuals and firms. • In a command economy, industry is publicly owned and the government makes decisions on the allocation of goods and services. • Most economies are mixed. Specialization and trade are what makes countries prosper. Absolute Advantage • A coutry or individual is simply better than another country or individual in producing a particular product. Comparative Advantage • A country or individual has a LOWER opportunity cost than another country or individual in producing a particular product. • Examples 1 • Examples 2 • Examples 3 Comparative Advantage & PPF Graph • Flatter slope will have comparative advantage in the x-axis good. • Steeper slope will have comparative advantage in the y-axis good.

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1.4 – Utility Maximization

Utility vs. Marginal Utility • Utility ○ arbitrary measure of benefit one receives from an activity (measured in utils) • Marginal Utility ○ change in total utility generated by consuming one additional unit of that good or service ○ Air, for example, is necessary for survival but tends to have little value in terms of marginal utility. ○ Diamonds, on the other hand, provides lots of marginal utility for many consumer. Marginal Utility Per Dollar • The marginal utility per dollar spent on a good considers budge constrains • Formula: ○ 〖MU〗_good/P_good • We are constrained by a budget. • The role of scarcity comes into play when making consumer choices. • Example: ○ We prefer a vacation to Hawaii over a movie, but we must consider the cost of each decision. ○ If Hawaii's marginal utility is 500 but costs $500, and a movie's marginal utility is 50 but costs $10, what do we choose? ○ Marginal Utility Per Dollar for Hawaii: 〖MU〗_good/P_good =500/500=1 ○ Marginal Utility Per Dollar for movie: 〖MU〗_good/P_good =50/10=5 ○ Since 5 1, choose movie Diminishing Marginal Utility • As a person increases consumption, there is a decline in the marginal utility from consuming each additional unit of that product. • You get less

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2.1 – Price & Quantity

Supply and Demand • Supply and demand model ○ a model of how a competitive market functions • The demand curve • The supply curve • The determinants of demand and supply • The equilibrium price and quantity Demand Schedule and Demand Curve • The law of demand ○ A higher price leads to a lower quantity demaned ○ A lower price leads to a higher quantity demanded • Demand schedule vs. demand curve ○ A demand schedule is a table that shows the quantity demanded at each price. ○ A demand curve is a graph that shows the quantity demanded at each price • Demand vs. quantity demanded ○ demand the relationship between a range of prices and the quantities demanded at those prices, as illustrated by a demand curve or a demand schedule. quantity demanded only a certain point on the demand curve or one quantity on the demand schedule ○ Demand refers to the curve, and quantity demanded refers to a specific point on the curve. ○ If price increases, what happens? § No change in demand § Decrease in quantity demanded ○ Graphical Comparison • Demand curve ○ Horizontal axis: Quantity Demanded ○ Vertical axis: Price Shift of the Demand Curve • Changes in the price of related goods ○ Substitutes (positive correlation) § fall in the price of one goods makes consumers less willing to buy the other good ○ Complements (negative correlation) § fall in the price of one of the goods makes consumers more willing to buy the other good ○ How to remember § Kids are positive when having a substitute teacher § We lived in a cynical world. If someone gives you a complement, the true intention might be negative. • Changes in income ○ Normal goods § rise in income increases demand § ie. computers, Disneyland, steak ○ Inferior goods § rise in income decreases demand § ie. macaroni & cheese, top ramen ○ Normal goods vs. inferior goods • Changes in tastes ○ Why do people want what they want? ○ Changes due to fad, beliefs, cultural shifts are all clumped together under preferences. • Changes in expectations ○ If you expect more income in the future, demand for certain goods (ie. car or refrigerator) might increase ○ If expectation of a future price drop of items exist, then the demand for these items drop today, almost like a self-fulfilling prophecy. • Graph • Summary Supply Schedule and Supply Curve • The law of supply ○ A higher price leads to a higher quantity supplied. ○ A lower price leads to a lower quantity supplied. • Supply schedule vs. supply curve ○ A supply schedule is a table that shows the quantity supplied at each price. ○ A supply curve is a graph that shows the quantity supplied at each price. • Supply vs. quantity supplied ○ supply the relationship between a range of prices and the quantities supplied at those prices, as illustrated by a supply curve or a supply schedule. quantity supplied only a certain point on the supply curve or one quantity on the supply schedule ○ Supply refers to the curve, and quantity supplied refers to a specific point on the curve. ○ If price increase, what happens to supply? § Nothing § This is a change in quantity supplied not supply Shifts of the Supply Curve • Changes in input prices ○ Input is a good used to produce another good ○ ie. cheese in a cheese pizza • Change in technology ○ All the ways in which people can turn more inputs into useful goods ○ For example, an improved strain of corn resistant to disease increase supply of corn. • Change in expectations ○ If expectations of a future price increase of items exist, then supplier will tend to hoard the item in order to make more profit in the future. • Related goods ○ If the price of other things I can produce goes up, then my supply of grapes, once again, would go down. • Graph • Summary Supply, Demand, and Equilibrium • Equilibrium price ○ price that clears the market • Equilibrium quantity ○ quantity of good bought and sold at market-clearing price • Equilibrium ○ where the supply and demand curves intersect • Graph Surplus & Shortage • Surplus ○ when quantity supplied exceeds quantity demanded ○ Q_s Q_D ○ Surplus=Q_S−Q_D • Shortage ○ when quantity demanded exceeds quantity supplied ○ Q_D Q_s ○ Shortage=Q_D−Q_S • Graph

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2.2 – Supply & Demand

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2.4 – Price Elasticity of Demand

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