Production Points Efficient Production Point
Represents a combination of goods for which currently available resources (i.e. time) do not allow an increase in the production of one good without a reduction in the production of the other. All the points on the PPC (production possibility curve) are efficient.
Inefficient Production
Represents a combination of goods for which currently available resources (i.e. time) allow an increase in the production of one good without a reduction in the production of the other. All the points below and to the left of the PPC are inefficient.
Attainable Production Point
Represents any combination of goods that can be produced with the currently available resources (i.e. time). All the points on the PPC or below and to the left of the PPC are attainable.
Unattainable Production Point
An Unattainable Production Point represents any combination of goods (bananas & rabbits) that cannot be produced with the currently
Terms
Absolute Advantage
An agent (or an economy) has an Absolute Advantage in a productive activity (like collecting bananas or catching rabbits) when he/she can carry on this activity with less resources (i.e. less time) than another agent.
Opportunity Cost
The Opportunity Cost of a given action is the value of the next best alternative (e.g. OCbananas= (loss in rabbit/gain in bananas)).
Comparative Advantage
An agent (or an economy) has an Comparative Advantage in a productive activity (like collecting bananas or catching rabbits) when he/she has a lower opportunity cost of carrying this activity than another agent.
Principle of Comparative Advantage
Everyone is better off if each agent (or each country) specializes in the activities for which they have a comparative advantage. The gains from specialization grow larger as the difference in opportunity cost increases!
Principle of Increasing Opportunity Cost
In the process of increasing the production of any good, first employ those resources with the lowest opportunity cost and only once these are exhausted turn to resources with higher cost.
Comparative Advantage & Basis for Trade
Course Notes Page 1
Market Equilibrium
Occurs when the price and the quantity sold of a given good is stable. Or market equilibrium occurs when the equilibrium price is such that the quantity that consumers want today is the same as the quantity that suppliers want to sell.
Perfectly Competitive Market
Consumers and Suppliers are Price-Takers Homogeneous Goods
No Externality
Goods are Excludable and Rival Full Information
Free Entry and Exit
Marginal Benefit & Cost Marginal Benefit
The Marginal Benefit of producing a certain unit of a given good is the extra benefit accrued by producing that unit.
Marginal Cost
The Marginal Cost of producing a certain unit of a given good is the extra cost of producing that unit.
* Relevant cost is the "opportunity cost" not just the "absolute cost" of producing the good.
Cost-Benefit Principle
The Cost-Benefit Principle states that an action should be taken if the marginal benefit is greater than the marginal cost.
Economic Surplus
The Economic Surplus of a certain action is the difference between the marginal benefit and the marginal cost of taking that action.
Supply Decision for an Individual
Need to trade-off Marginal Benefit v Marginal Cost Marginal Benefit Marginal Cost Yes, Do It!
Marginal Benefit < Marginal Cost
Quantity Supplied
The Quantity Supplied represents the quantity of a given good or service that the supplier is willing and able to supply at a particular price.
Law of Supply
The Law of Supply is the tendency for a producer to offer more of a certain good or service when the price of that good or service increases (i.e. supply curves slope upwards).
Supply Curve for an Individual
The Supply Curve represents the relationship between the price of a good or service and the quantity supplied of that good or service.
Can be interpreted:
Horizontally: Start from a certain Price and then use the supply curve to derive the Quantity of goods that will be supplied at that price.
Vertically: Start from a given Quantity, find the associated Price on the supply curve - the minimum amount of money the producer is willing to accept to supply the marginal unit of the good == Producer Reservation Price.
Supply in Perfectly Competitive Markets
Course Notes Page 2
Cost Factors
Fixed Cost & Sunk Cost
A fixed cost is a cost associated with a fixed factor of production.
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A sunk cost is a cost that once paid cannot be recovered.
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If a factor of production is fixed, then its cost does not vary with the quantity produced.
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Variable Cost
A variable cost is a cost associated with a variable factor of production.
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If a factor of production is variable, then its cost tends to vary with the quantity produced.
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A Variable Cost (VC) is a cost associated with a variable factor of production.
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Marginal Cost
The marginal cost (MC) of producing a certain unit of a given good is the extra cost of producing that unit.
TC/ Q
Short Run vs Long Run
The Short Run is a period of time during which at least of one factor of production is fixed.
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The Long Run is a period of time during which all factors of production are variable.
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Maximise Profit - Firm's Goal
) represents the difference between total revenue (TR) and total costs (TC).
Total Revenue (TR) is the amount of money collected from sales = price x quantity sold
Firm Shut-Down
When Should a Firm Shut Down in the Short-Term?
In the short run, shut down production if: Price below min (AVC)
production< produce zero (i.e. if TR > TVC)(i.e. if loss is $100 but fixed cost is $100, keep producing as it is not >).
Otherwise, if loss is less than the fixed cost, keep producing and hire the optimal number of workers.
When Should a Firm Exit the Industry in the Long-Run?
production< 0.
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Exit when price below min (ATC).
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Otherwise, she should hire the optimal number of workers and continue operations.
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Note: All factors are variable in the long run.
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A Firm's Supply Curve
The part of the MC Curve above the AVC (short run) The part of the MC Curve above the ATC (long run)
Supply Curve Shifters
What shifts the supply curve to the right:
Drop in the price of (variable) inputs
Advancements in technology (via its impact on productivity) Expectations (of future prices / demand increase)
Drop in the price/demand of other products Increase in number of suppliers
Price Elasticity of Supply
Represents the % change in quantity supplied resulting from a very small % change in price (measures responsiveness of the supply to changes in price).
s = % QS/% P QS/QS)/( P/P)
Definitions
Course Notes Page 3
