Micro and Macro Models
Agec 217
Micro and Macro Models
• Terms (almost all not involving money)
– Opportunity Cost
– Absolute Advantage
– Comparative Advantage
– Specialization
– Production Possibility Frontier
– Imports
– Exports
– Circular Flow Diagram
Opportunity Cost
• Opportunity Cost: The next best
alternative you give up in order to obtain or
produce an item
Opportunity Cost
• What would you be doing if you were not
in class today?
Opportunity Cost
Opportunity cost for each of three identical
jobs with identical benefits, but with
employers paying different salaries:
– Employer A: $70,000
– Employer B: $50,000
– Employer C: $30,000
Absolute and Comparative
Advantage
• Two individuals, Kate and Charlie, are
stranded on a desert island and subsist on
a diet of bananas and coconuts.
Absolute and Comparative
Advantage
• Production per Hour
Bananas
• Kate: 40 per hour
• Charlie: 20 per hour
Coconuts
• Kate: 20 per hour
• Charlie: 4 per hour
Absolute and Comparative
Advantage
• Absolute Advantage: The person, firm, or
nation with a higher level of productivity
compared to that of another.
Absolute and Comparative
Advantage
• Kate has the absolute advantage
producing both bananas and coconuts
Absolute and Comparative
Advantage
• Who has the comparative advantage?
• Comparative Advantage: the person, firm,
or nation with the lower opportunity cost
vs. that of another.
Absolute and Comparative
Advantage
Calculating opportunity cost (the next best
alternative)
– Opportunity cost of producing bananas = the
number of coconuts produced in a unit of time
divided by the number of bananas produced
in the same unit of time.
Absolute and Comparative
Advantage
• Opportunity Cost
Bananas
• Kate: ½ coconut
• Charlie: 1/5 coconut
Coconuts
• Kate: 2 bananas
• Charlie: 5 bananas
Absolute and Comparative
Advantage
• Let’s assume that each is eating only their
own production in the following manner:
– Kate: 20 bananas and 10 coconuts
– Charlie: 10 bananas and 2 coconuts
• Are there any shifts in production or trades
that could be taken advantage of?
Absolute and Comparative
Advantage
• Specialization: focusing production more
heavily on a good for which you have a
comparative advantage, with the
expectation of trading for other goods for
which you do not have a comparative
advantage
Absolute and Comparative
Advantage
• Let’s assume that they produce:
– Kate: 12 bananas and 14 coconuts
– Charlie: 20 bananas and 0 coconuts
• Is this a valid direction?
• Are the numbers valid?
Absolute and Comparative
Advantage
• If Charlie trades 9 bananas to Kate for 3
coconuts, they will have
– Kate: 21 bananas and 11 coconuts
– Charlie: 11 bananas and 3 coconuts
• Compared to before:
– Kate: 20 bananas and 10 coconuts
– Charlie: 10 bananas and 2 coconuts
Absolute and Comparative
Advantage
• The comparative advantage allows
people, firms, or nations to specialize and
trade
Production Possibility Frontier
• A graph of all potential production
combinations in an economy (compare to
the flat PPF for an individual)
Production Possibility Frontier
- Often Called the
Production Possibility
Curve (PPC)
Efficient Points: points on
the curve
Inefficient Points: points
below the curve
Impossible Points: points
above the curve
Imports and Exports
• Imports: goods or services produced
abroad and sold in ones own country
• Exports: goods or services produced in
ones own country and sold abroad
Circular Flow Diagram (Mankiw)
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
Copyright © 2004 South-Western
Circular Flow Diagram
• Enhanced diagram: Wikipedia
– http://upload.wikimedia.org/wikipedia/en/e/ee/
Circular_flow_of_income.JPG
Circular Flow Diagram: Enhanced
Experiment Tomorrow
• EconPort
– www.econport.org