Econ 4346 Test 1 Topic Review PARETO OPTIMALITY

Econ 4346 Test #1 Topic Review

PARETO OPTIMALITY • An allocation of resources such that: • It is impossible to make at least one person better off without making someone else worse off • If two people are in a room, and one person has a full allocation of clothes… • And the other person a full allocation of food, then… • Trade will occur to a point where both people • Benefit from the interaction • Cannot improve any further without harming the other • Pareto Optimality serves as the basis for the Production Possibilities Frontier • Review video on blog http: //tc 6617. wordpress. com/2010/10/13/econ-4346 -basicprinciples-part-1/

(non) Pareto optimality EXAMPLE RECTANGLE REPRESENTS ECONOMIC CONSTRAINTS A B Two Economic players A and B. Non-Pareto Optimal, since there is room for both to improve

p. RODUCTION POSSIBILITIES FRONTIER • Displays efficient combinations of output when factors of production (labor, land, and capital) are used to full potential • Bowed shape represents increasing costs • In order to increase production of one good (A), production of the other (B) must be given up • Sounds like Pareto Optimality, perhaps? • Review Mankiw pp 25 -28 • Review blog: http: //tc 6617. wordpress. com/2010/10/13/econ-4346 basic-principles-part-1/

Production Possibilities frontier • Country can produce two goods: Grain and Wine • Bowed curve is the frontier. Any point on the curve is Pareto Optimal • Point ‘b’ is infeasible • Point ‘a’ is non-Pareto Optimal or ineffecient

Demand curve • Why is it downward sloping? • Because of the Law of Demand • The quantity demanded of a good falls when the price rises

Supply Curve • Why does it slope upward? • Because of the Law of Supply • The quantity supplied of a good rises when the price of the good rises

Equilibrium • A situation in which the market price has reached the level at which quantity supplied equals quantity demanded

Equilibrium of supply and demand P S Equilibrium D Q

Solving for equilbrium • Expedia did the following study (fictional) on its market for package tours • Demand schedule • Qd = 28, 000 – 300 P • Supply schedule • Qs = 23, 000 + 200 P • CALCULATE EQUILIBRIUM PRICE AND QUANTITY

Solving for equilibrium P Qs = 23, 000 + 200 P $10 Qd = 28, 000 – 300 P 25, 000 1. 2. 3. 4. 5. 6. 7. Q Set Qs = Qd 23, 000 + 200 P = 28000 – 300 P Solve for P 500 P = 5, 000 P = 10 Plug in value for P in one of equations (we’ll use Qd) 28, 000 -300(10) = Qd = 25, 000

PRICE CEILING • Occurs when government puts legal limit on how high the price of a product can be • Why? • Government thinks that price ceilings protect consumers • If government didn’t impose a price ceiling, the product wouldn’t be obtainable to the “average consumer” • Therefore unfair

Price ceiling P S CEILING SHORTAGE D Q Price ceiling below equilibrium. Shortage occurs because demand exceeds supply

Elasticity of demand • See figure 1, Mankiw, page 93 • Perfectly inelastic: Ed = 0 • Inelastic: Ed < 1 • Unit Elastic: Ed = 1 • Elastic: Ed > 1 • Perfectly Elastic: Ed = infinity

Elasticity of supply • See figure 5, Mankiw page 101 • Perfectly Inelastic: Es = 0 • Inelastic: Es < 1 • Unit Elastic: Es = 1 • Elastic: Es > 1 • Perfectly Elastic: Es = infinity

Shifts in supply and demand curves • Thoroughly review pages 67 – 82 in Mankiw