Ekonomika Mikro

Walter Nicholson
Amherst College
Christopher Snyder
Dartmouth College
PowerPoint Slide Presentation | Philip Heap, James Madison University
©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
1
1
CHAPTER
Economic
Models
©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
2
What is Economics?
• “Economics is the study of the allocation of scarce resources
among alternative uses.”
• “Economics is the study of mankind in the ordinary business of

life.” Alfred Marshall
• “Economics never tells a man how he should act; it merely shows

how a man must act if he wants to attain definite ends.” Ludwig
von Mises
©2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Ch. 1 • 3
What is Microeconomics?
• Microeconomics is the study of the economic choices individuals
and firms make and how these choices create markets.
• Examples of economic choices.
Economic Models
• A model is a simple theoretical description that captures the
essentials of how the economy works.
– Simple since it does not capture every detail.
– But lets you see the overall picture and answer the relevant
question.
The PPF
• Suppose
We can show how much
an economy food and
produces foodclothing can be made on a
and clothing
production possibilities frontier diagram.
Amount
of food
per week
PPF
Amount of clothing
per week
The PPF
• A PPF shows the possible combination of two goods an economy
can produce with a fixed amount of resources.
Amount
of food
per week
We can produce 10 food and 12 clothing
10
Or 4 food and 12 clothing

4
Amount of clothing
3 12 per week
The PPF and Five Basic Principles
• We want to use this model to illustrate five basic principles.
– Scarce resources
– Scarcity involves opportunity costs
– Increasing opportunity costs
– Incentives matter
– Inefficiency has real costs
• Principle 1: Scarce Resources
Amount Points outside the frontier are unattainable since

of food we don’t have enough resources to produce them.
per week
10 We can make 4 food and 12 clothing.
But not 4 food and 14 clothing.
Amount of clothing
3 12 14 per week
• Principle 1: How does the PPF illustrate scarcity?
Amount But not 12 food and 3 clothing.

of food
per week
We can make 10 food and 3 clothing.
10
Amount of clothing
3 12 per week
• Principle 2: Scarcity involves opportunity cost.
• Opportunity cost is the cost of a producing a good measured by

the alternative uses that are foregone producing it.
• If I am on the PPF the opportunity cost of more clothing is less

food.
Principle 2: Scarcity involves opportunity costs
Amount What is the opportunity cost of increasing

of food clothing production from 3 to 4 units?
per week
10
9.5
Amount of clothing
3 4 12 per week
• Principle 3: Opportunity costs are increasing.
• As you produce more and more of one good, its opportunity cost
in terms of the other good foregone increases.
• To produce more and more clothing you would have to give up

increasing amounts of food.
• The law of diminishing marginal returns.
Principle 3: Opportunity costs are increasing.
Amount
of food
per week Here the opportunity cost of one
more unit of clothing was ½ food
10
9.5
Now to produce one more

4 unit of clothing you give up
2 units of food
2
Amount of clothing
3 4 12 13 per week
• Principle 4: Incentives Matter
• People will make decisions based on opportunity costs.
• When the opportunity cost of some activity increases, people are

more likely to engage in that activity.
• Sometimes it is difficult to see the true opportunity costs of the

activity.
• Principle 5: Inefficiencies involve real costs
Amount Why are points inside the frontier inefficient?

of food
per week Because we could produce more clothing without
giving up any food.
10
Or more food without giving up
clothing
Or make more of both goods

4
Amount of
3 12 clothing per week
Basic Supply-Demand Model
• A Supply-Demand Model is a model that describes how a good’s
price is determined by the behavior of the people who buy the
good and of the firms that sell the good.
• The model relates buyers’ preferences (demand) to production

costs (supply).
Adam Smith and the Invisible Hand
• What did Smith mean by the “invisible hand”?
• The invisible hand directed resources to where they would be

most valuable.
• Prices in the market tell buyers and sellers the relative value of
goods: prices act as signals.
• This enables them to make efficient choices.
Adam Smith’s Model
• Prices of goods depend on the relative value of labor used to
produce the goods.
• If it takes twice as long to make clothing as to grow food, one unit

of clothing should trade for _______ units of food.
– two
• So any number of units of clothing can be produce for two units

of food.
Price
Quantity per week
David Ricardo’s Model
David Ricardo’s Model
Price
Quantity per week
Marshall’s Model of Supply and
Demand
Marshall’s Model of Supply and
Demand
Demand: As price falls, consumers are willing to buy more:
this reflects decreasing marginal value.
Price
Demand
Quantity
Supply: As price rises, firms are able to produce more: this
reflects increasing marginal costs.
Price
Supply
Demand
Quantity
Market Equilibrium: The equilibrium price is the price at which
the quantity demanded is equal to the quantity supplied.
Price
Supply
P*
Demand
Quantity
QD=QS=Q*
On Market Equilibrium
• What does it mean to be at equilibrium?
• What would happen if the price was set above or below the
equilibrium price?
• What would cause the equilibrium price to rise or fall?
A Change in Demand
What happens if demand increases?
Price
Supply
P**
Demand shifts to the right.
P* Price and quantity
increase.
D D’
Quantity per period

Q* Q**
A Change in Supply
What happens if supply decreases?
S’
Price
S
P**
Supply shifts to the left.
P* Price increases and
quantity decreases.
Quantity per period

Q** Q*
Changes in Market Equilibrium
• If demand increases (shifts right) P* will __ and Q* will ___.
– rise; rise
• If demand decreases (shifts left), P* will __ and Q* will ___.

– fall; fall
• If supply increases (shifts right) P* will __ and Q* will ___.

– fall; rise
• If supply decreases (shifts left) P* will __ and Q* will ___.

– rise; fall
Changes in Market Equilibrium
• What happens to P* and Q* when both demand and supply
change?
• Suppose demand and supply increase:
– We know that Q* rises, but P* may rise or fall.
• Suppose demand increases but supply decreases:
– We know P* rises, but Q* may rise or fall.
How Economists Verify Models
• Two methods:
– Testing Assumptions: Verifying economic models by

examining validity of assumptions upon which models are
based
• Is it reasonable to assume that people are rational, that
firms maximize profits etc.
– Testing Predictions: Verifying economic models by asking

whether models can accurately predict real-world events
• If the model predicts events well, then the theory is useful
even if the assumption may not appear to be valid.
Positive-Normative Distinction
• What’s the difference between the following two statements?
– An increase in the minimum wage leads to more
unemployment.
– We should increase the minimum wage to help low income
workers.
• The first is a positive statement: it looks at “what is”.
• The second is a normative statement: it looks at “what should be”.
• Is Economics a positive or normative science?
Summar
y
• Since resources are scarce, we must make choices about how we
use them.
• We can use the PPF model to illustrate important concepts such

as opportunity cost and efficiency.
• The supply and demand model shows how prices are determined,
and how changes in demand and/or supply influence the price.
• Judge the validity of economic models by how well they explain

actual economic events.

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Walter Nicholson

PowerPoint Slide Presentation | Philip Heap, James Madison University

• “Economics is the study of mankind in the ordinary business of

• “Economics never tells a man how he should act; it merely shows

• Examples of economic choices.

– Simple since it does not capture every detail.

Or 4 food and 12 clothing

Amount Points outside the frontier are unattainable since

But not 4 food and 14 clothing.

Amount But not 12 food and 3 clothing.

• Opportunity cost is the cost of a producing a good measured by

• If I am on the PPF the opportunity cost of more clothing is less

Amount What is the opportunity cost of increasing

• To produce more and more clothing you would have to give up

• The law of diminishing marginal returns.

Now to produce one more

• People will make decisions based on opportunity costs.

• When the opportunity cost of some activity increases, people are

• Sometimes it is difficult to see the true opportunity costs of the

Amount Why are points inside the frontier inefficient?

Or make more of both goods

• The model relates buyers’ preferences (demand) to production

• The invisible hand directed resources to where they would be

• This enables them to make efficient choices.

• If it takes twice as long to make clothing as to grow food, one unit

• So any number of units of clothing can be produce for two units

Quantity per week

Quantity per week

• What would cause the equilibrium price to rise or fall?

Quantity per period

Quantity per period

• If demand decreases (shifts left), P* will __ and Q* will ___.

• If supply increases (shifts right) P* will __ and Q* will ___.

• If supply decreases (shifts left) P* will __ and Q* will ___.

• Suppose demand and supply increase:

– We know that Q* rises, but P* may rise or fall.

• Suppose demand increases but supply decreases:

– We know P* rises, but Q* may rise or fall.

– Testing Assumptions: Verifying economic models by

– Testing Predictions: Verifying economic models by asking

• The first is a positive statement: it looks at “what is”.

• The second is a normative statement: it looks at “what should be”.

• Is Economics a positive or normative science?

• We can use the PPF model to illustrate important concepts such

• Judge the validity of economic models by how well they explain

You might also like

• If demand decreases (shifts left), P* will and Q* will _.

• If supply increases (shifts right) P* will and Q* will _.

• If supply decreases (shifts left) P* will and Q* will _.