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ECON101 Lecture Notes - Absolute Advantage, Economic Equilibrium, Marginal Cost

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Eva Lau

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Economics 101
1. Scarcity and Choice (Chapter 1 and 2)
a. Wants and scarcity; self-interest, social interest
o Inability to get everything we want, universal, confronts
all living things
o Not an independent problem, relative to human wants
o Choosing alternatives
o Everyday life applications
o Decisions involve cost, benefit is simple, cost is painful
Economics: social science that studies the choices that
individuals, governments and entire societies make as they
cope with scarcity and the incentives that influence and
reconcile those choices
Microeconomics: study of the choices that individuals and
businesses make, the way these choices interact in markets,
and the influence of governments
Self-interest: choice is the best one available for you
Social interest: it leads to an outcome that is the best for
society as a whole
o Efficiency is achieved when the available resources are
used to produce goods and services at the lowest
possible cost and in the quantities that give the greatest
possible value or benefit; Situation in which resources
are put to their best possible use
o Equity or fairness
b. Normative and positive economics
i. Normative economics deals with norms, values, opinions,
preferences, likes and dislikes etc
ii. Positive economics more objective, deals with facts, reasons,
c. Opportunity Cost
How much does it really cost?
Opportunity cost = value of the best forgone alternative to any
All actions carry opportunity costs
Opportunity costs are true economic costs
What you have to give up
Too simplistic to just discuss the financial/monetary cost,
explore other forms of cost (social etc.)
Explicit and implicit cost
Cost associated with what you must give up (time, money,
effort, career, relationship etc.) to get something
Benefits forgone is considered as an opportunity cost
NOT all the possible alternatives foregone, can be a composite
Different for everyone
Can use opportunity cost to measure the value of intangibles
(e.g. time saved in monetary value, value of life)
Shadow pricing not looking at market price (same for
everybody, means different things to different people e.g. high
income vs low income)
d. Total vs Marginal value
If the Canadian government undertakes a public project in
Canada where total benefits exceed total cost, then do you
think that economic surplus in Canada is positive or do you
think economic surplus in Canada is rising?
o Wellbeing has improved, deficit becomes smaller, just
because one project is positive doesn’t mean the whole
economy is good now
Total = everything, marginal = specific
Marginal benefit > marginal cost, some improvement
Marginal Value Analysis
o Marginal analysis is an incremental analysis
o Marginal = incremental
o In production, the incremental cost incurred when one
additional unit of x is produced is called marginal cost
o The incremental revenue received from it is the
marginal revenue (MR)
e. Production Possibility Curve
i. Supply side of the market (no knowledge about demand, no
demand whatsoever)
ii. You are given a fixed amount of inputs (e.g. 1 acre of land and 1
unit of annual labour)
iii. You can use your inputs to produce X and/or Y
iv. Fixed production technology
v. Straight line PPC indicates constant trade-off(shadow prices)
between good x and good y, it implies that the input(s) in
question is equally suitable in the production of x and/or y, a
bowed shape PPC implies that inputs are not equally
productive in X and/or Y
vi. The slope of the PPC is called the marginal rate of
transformation or MRT which measures what is given up vs
what you get. It measures trade-offs, it measures the
opportunity cost of X for Y, or vice versa, it measures
production substitution rate
vii. Points on the PPC represents attainable production
viii. When we are producing along the PPC, we have exhausted all
inputs, hence full employment
ix. Any point inside the PPC represents the existence of
unemployed inputs
x. The PPC does not tell you which production-mix of X and/or Y
is the best
xi. If MRt is not constant along the same PPC< the same unit of
input is not equally productive in the production of X and/or Y,
hence increasing or decreasing opportunity cost. Moving down
along a bow shaped PPC, a same unit of input will render less
and less X. Hence, rising opportunity cost (in terms of Y
forgone) as more X are produced
xii. Efficient use of inputs
Differentiate input and output
MRT: Marginal Rate of Transformation
Slope = marginal opportunity cost, every time you give up
one unit of Y, you get one unit of X
f. Absolute and Comparative Advantage
i. Crusoe 2 has absolute advantage in getting coconut while
Crusoe 1 has absolute advantage in getting fish
ii. Comparative advantage: comparing what you have to give up
iii. There are apple and pear trees in a wild orchard, in an 8 hour
work day, John can harvest either 10 apples or 10 pears, Mary
can harvest either 5 apples or 20 pears. Assume constant MRT
for the PPC unless otherwise specified. Draw a PPC diagram
when John and Mary are married and wish to produce as an
efficient joint unit
2. Demand And Supply: The Market (Chapter 3 and 4)
a. Supply side
b. Demand side