Please enable JavaScript.
Coggle requires JavaScript to display documents.
Week 2: Model Building and Gains from Trade (Modeling (Endogenous Factors,…
Week 2: Model Building and Gains from Trade
Scientific Method
Positive Analysis
Hypothesis or statement can empirical testable
We can use science to establish wether its true or false
Normative analysis
Basically an opinion.
Cannot be tested or validated
"What ought to be"
Modeling
Simplistic but can emphasis key concepts
Demonstrate the relations between two or more variables.
Important to only change one variable at a time when modeling (Ceteris Parabus), or holding other things constant.
Judge the quality of models by how well they work in real life.
Endogenous Factors
Variables that can be controlled for in the model.
Exogenous Factors
Variables that cannot be controlled for in the model.
Watch out for faulty assumptions! They directly lead to a bad model
Opportunity Cost
The loss of potential gain from other alternatives when one alternative is chosen
.
learn how to value time
Production Possibility Frontier (PPF)
Model that tells us what were capable of making
Combination of outputs that society can produce if all resources are used efficiently.
Assumption of this model
Technology is fixed
Resources are fixed
Inverse relationship between outputs
Producing more of one good at the expense of the other
Any point that lies within the PPF line means that resources are used efficiently. However which point is better isn't depicted by this model.
The better point depends on societies preferences.
We want PPF to shift away from the origin, therefore demonstrating growth.
Law of Increasing Relative Cost
Not all resources are perfectly adaptable for producing both goods.
PPF will not have a constant slope.
Increasing opportunity cost
of production as you produce more of that good
Opportunity Cost and PPF
The PPF becomes non linear as you increase the production of a determined good. Therefore increasing its opportunity cost.
The increase of the output of a product doesn't lead to a linear decrease in the production of the other.
Shift in PPF (Economic Growth)
As the PPF curve shifts towards the right or way from the origin, economic growth is happening.
Usually happens with:
Growth in workforce
Better technology
More specialized and effective workforce
Specialization and Trade
Specialization and trade also creates gains for society
Absolute Advantage
Who is better at the production of a good?
When an party is better at production with the same quantity of resources
Specialization leads to greater output and if several parties want variety, if they specialize and trade they would be better off. Regardless if one party has an absolute advantage
Comparative Advantage
Comparative advantage is best
In order for two parties to trade each needs to have comparative advantage over a product.
Finding the right price for trade
Parties benefit from exchange when the price fro a product is lower than the opportunity cost of producing.
In order to for the trade to be mutually beneficial the amount of items traded needs to fall between the opportunity cost of both parties
Trade Off Between Now and Later
Consumer Goods
Goods produced for present consumption
Capital Goods
Goods that will help produce other goods and services in the future.