Economics Lesson 1: Principles of Opportunity Cost and Trade-offs môn Kinh tế vi mô | Trường Đại học Kinh Tế Quốc Dân

Lesson 1.1: Requirements:
Note: Students who are absent more than 20% classes will not be
allowed to attend final exam (exclude absence for acceptable reasons). Midterm-Assessment:
Assignment 1 (20%): Take-home Exam and In-Class Exam (Open book)
Presentation (20%): 2 groups present two topics:
oCompetitive Market (Chapter 14) oMonopoly (Chapter 15) Final Exams: ???
After this class, the students need to discuss and form two groups for presentation.
Economics is basically the science of economic decision.
Scarcity is an important reasons to make us to study Economics.
Principle 1: People always face tradeoff when making the decisions.
The tradeoffs between efficiency and equality:
The government always face the tradeoffs when implementing the policies:
You want to focus more on the economic development and ignore the environmental issues.
The foreign direct investment (FDI) is good for the economy because it
promotes the economic growth but It also cause the environmental degradation in Vietnam. Equality or Efficiency:
oThe restroom for disability: whether we need them or not in NEU?
If you build them in A1 block, it is a waste of resource
because there is few disable students at NEU it is
ineffective. HOWEVER, you do have this INEQUALITY. Principle 2:
You make decisions based on a comparison between benefits and costs from decisions. When you make a mistake o
Even in the case, your decision is free to get it (like the case that you get the free
ticket for music concert), you still face the opportunity costs, at least time for this
decision, transportation costs…
Opportunity Cost is what you have to give up:
oNormally, you just think the money you pay when you purchase st (like
coffee, milk tea…) is the cost. But it is a simple cost.
The decision makers always face the opporturnity cost (Economic Costs):
Opportunity Costs (OC) = Explicit Costs (EC) + Implicit Costs (IC)
Explicit Cost (EC): the costs that you actually pay. For example, hiring the workers and pay the wages,
Implicit Cost (IC): the costs that you do not have to pay in hand but you must consider it when making the decision.
Opportunity costs significantly determine the economic decision.
E.g., you want to run your business (clothes shop) by using your the building (space) of your
family, what are the costs you face?
You must hire workers, buy materials, borrow money from banks (have to
pave interest rate) You have to actually pay money Explicit Costs
The other important cost is implicit costs that you don’t have to pay but you
must count them when making the decisions. Otherwise, you may make a wrong/irrational decision.
oIn this example, the IC is the rents you don’t have to pay because the
space is yours. BUT think about the case other people lease them and
you can receive money from that if you do not run your own business.
oOr because you run this business, you have the chance to earn money from other jobs. Assignment What are the EC and IC???
You are studying at NEU. But you EC= 2000+200=2200 because
cannot have a part-time job with IC = 6000
income 6000USD and cannot take a
rest. Tuition fee is 2000USD, buying OC = 6000+2200=8200
materials is 200USD, cost for daily life
Note: Opportunity costs must be relevant with the
(food, rent..) is 1400USD. What is the decision.
opportunity cost to be a student?
Note 1: Opportunity costs are the costs being relevant with your selection/decision.
It implies the costs arising from your decision. You decide between two jobs: Argument:
Job A: Income is 100$ but cost is
Selec琀椀ng job A so you cannot take job B at the same 琀椀me. 30$. EC= 30
Job B: Income is 120$ but cost is IC = 120-40=80 40$. OC=30+80=110
If we have three op琀椀ons (including Job C), you
What is the opportunity cost for con琀椀nue to select job C: selecting job A. EC =30 If we have another job as IC = 150-10=140 follows: OC=30+140=170
Based on the de昀椀ni琀椀on of OC, OC should be the best
Job C: Income is 150$ but cost is
alterna琀椀ve sacri昀椀ed. 10$. Note 2:
We have to consider the net attainment from other selection when computing the IC.
We only consider the best alternative option among many of options you have.
Note 3: Every economic decision (even you don’t have to pay anything) always
includes the opportunity costs.
Note 4: Every cost in the economy is the opportunity cost (economic cost)
The decision you make will base on the cost-benefit analysis, thus if you make the
mistake on the opportunity cost, you may also make a wrong decision.
Principle 3: Rational people think at the margin Marginal Analysis:
Let talk about the firm behavior in the economy. Some of important questions, firms must consider:
What are the price and quantity that firms should pick to obtain their purpose
(e.g., maximizing their profit)?
Whether firms expand their business to obtain their goal?
Marginal analysis can help us to answer this answer.
Important definition in the economics: Revenue
Total revenue (TR): the total amount of income/revenue that firm obtain
from selling the goods to the markets. (TR= Price (P) x Quantity (Q))
Marginal revenue (MR): the change in total revenue from selling an
additional unit of goods. The revenue from selling the last unit of product. For example, your company:
Sell Q=100 to the market and earn TR(Q=100)= $1500
You decide to sell more units of product to the market Q’=101 and earn TR’(Q’=101)=$1600
oIt implies that selling one additional unit of product cause the TR to increase by $100.
oOr the revenue from selling the 101th unit is $100
This is the marginal revenue of 101th unit (Note the difference in definition
of revenue of 101 (TR) units and revenue of 101th unit (MR)
MR of 101th = TR(Q=101)-TR(Q=100)
oWhere MR is the revenue from selling the 101th
oTR(Q=101) is the revenue from selling 101 units and TR(Q=100) is the
revenue from selling 100 units. Q= Quan琀椀ty Total Revenue (TR) Marginal revenue (MR) 0 0 1 20 20 2 38 2nd product= 18=38-20 3 53 3rd product =15=53-38 4 65 4th product=12=65-53 5 71 6
How to compute the marginal revenue:
: The marginal revenue of the nth product
: the total revenue from selling/suppling total n units of products
: the total revenue from selling/suppling total (n-1) units of products
Based on the definition, you also compute the MR as follows:
Note: means a large amount of change and means a small amount of change. If the
change occurs by a very small amount, MR=TR’(Q) (the first derivative of total
revenue against Q). For example, The slope of TR is the MR.
The change occurs by a very small amount, the MR is slope of the line that is tangent with the TR curve
When TR is maximized? MR=TR’(Q)=0 Cost:
Total Costs (TC): The total costs is the amount of money that firm pay from producing goods
Marginal costs (MC): the change in total cost from producing an additional unit of goods.
How to compute the marginal cost:
: The marginal cost of the nth product
: the total cost from producing n products
: the total costs from producing (n-1) products
Based on the definition, you also compute the MC as follows:
e.g. Q1=10; Q2=11 change in total cost from TC1(Q1)=100 to TC2(Q2)=110
For simplicity, if you have the functional form of TC, you can obtain the function of
MC by taking the first derivative of TC function.
E.g., TC= Q^2-4Q+100 MC= TC’(Q)= 2Q-4
Adapting the marginal analysis, we seek the question:
Question 1: What are the price (P) and quantity (Q) to maximize firms’ profit?
To maximize the profit, the first order condition is given as:
To maximize profit, we need to set up P and Q such that (Profit)’=0 (First Order
Condition, the first derivative of function is equal 0)
Conclusion: To mazimize the profit, firms need set up the price and quantity such that MR=MC.
Question 2: whether the firms should expand their own business to obtain the profit-maximization goal:
MR>MC Increase in Q (expansion) leads to an increase in profit MRSum up:
Firms will maximize their profit by selling goods and services at the price (P)
and quantity (Q) at which MR=MC
MR>MC Increase Q (expansion) lead to an increase in profit
MRMarginal Analysis for general problem Member Households Firms Government
Purposes Maximize their u琀椀lity Maximize their pro昀椀t Maximize the social (Sa琀椀sfac琀椀on) u琀椀lity
The u琀椀lity, pro昀椀t, social u琀椀lity can be de昀椀ned as Net Bene昀椀t (NB) where NB=TB-TC
TB: Total Bene昀椀t (this is TR when we study the behavior of 昀椀rms) MB=TB’(Q)
TC: Total Cost (this is TC when we study the behavior of 昀椀rms) MC = TC’(Q)
All members/agents of economy wish to maximize their own net bene昀椀t. They can achieve this goal by
se琀�ng price (P) and quan琀椀ty (Q) such that: MB=MC NB is maximized
MB>MC increase in Q will lead to an increase in NB MBExercise
Total Benefit (TB) function and total cost (TC) function are respectively:
a. To maximize the total benefit, what is its quantity?
b. To maximize the net benefit, what is its quantity?
c. What the firm will do when Q = 50
d. What the firm will do when Q = 80 Solution:
a. To maximize the total benefit, what is its quantity?
TBmax MB=TB’(Q)=0 200-2Q=0 Q=100
b. To maximize the net benefit, what is its quantity? NBmax MB=MC MB=200-2Q MC=TC’(Q) = 20+Q 200-2Q=20+Q Q=60
c. What the firm will do when Q = 50
Q=50 MB=200-2*50=100 and MC = 20+50=70 MB>MC the firms should
produce more (Q increases NB increases)
d.What the firm will do when Q = 80
Q=80 MB=200-2*80=40 and MC = 20+80=100 MBproduce less (Q decreases NB increases)
Lesson 1.2: Thinking like Economists
Assumption: Ceteris paribus: We assume that other things hold constant.
E.g., when we study the effects of price on quantity demanded. In addition to price,
there are many other factors that affect the demand for goods. BUT when we focus
on the price-quantity demanded nexus, you assume that other factors do not change.
Production Possibility Frontier (PPF):
Some important things, we must understand: 1. Understanding of PPF
2. The shape of PPF and its implications and why
3. Analyse changes in PPF due to the external factors. 1. Understanding of PPF
–Definition: A graph showing combinations of output that the economy can possibly produce –Assumptions:
–The economic agents own a given factor of production and technology.
–The simple economy only produces two goods (food and clothings),
assuming other goods do not change.
–There is only one type resource: Labor
Possible outputs the economic agents can produce given an
amount of resources and technology. Note:
Point I: A琀琀ainable but ine昀케cient point because they do
not use all resource and technology e昀昀ec琀椀vely. They can
improve their produc琀椀vity from point I to either point C and D.
Point N: Una琀琀ainable point because they do not have
enough resource to obtain this point.
All points along the PPF is de昀椀ned as the a琀琀ainable and
e昀케cient point and they use all the resource and use
technology e昀昀ec琀椀vely. Quan琀椀ty of Quan琀椀ty of Clothes Food Possibili琀椀es A 10 0 B 9 20 C 7 40 D 4 60 E 0 80
Implications: when moving from point A to point E along the PPF
Trade-off principle: If you want to produce more one goods, you have to
reduce resources used to produce other goods.
oE.g. from A: The economy concentrate all resource to produce clothes:
10 units of clothes. The maximum amount of clothes that the economy
can possibly produce given resources and technology is 10 units.
oMoving from A to B: (9units of clothes, 20 units food): tradeoffs: reduce
1 unit of clothes for producing 20 units of food. It implies that the
opportunity cost of producing the first 20 unit of food is 1 unit of clothes.
oThe slope of PPF reflect the rate of exchange between food and clothes.
2. The shape of PPF and its implications and why The linear PPF The concave (bow-outward) PPF
Shape: Constant slope the opportunity costs of
Shape: Increasing slope, implying:
producing the same amount of food remain
A B: produce 昀椀rst 20 units of food, the unchanged.
economy needs to reduce 1 unit of clothes Opportunity costs: 1 clothes=20 food
B C: produce the addi琀椀onal 20 units of
food, the economy needs to reduce 2
units of clothes OC: 2 clothes = 20 food
C D: produce the addi琀椀onal 20 units of
food, the economy needs to reduce 3
units of clothes OC: 3 clothes =20 food Implica琀椀on:
Implica琀椀on: To produce equal addi琀椀onal units of
goods, the society has to trade-o昀昀 an increasing amount of other goods.
The opportunity cost is increasing when
moving along the PPF from A to E.
The costs of producing food are
increasing when we produce more units of food.
Finding: To produce equal additional units of goods, the society has to trade-off
an increasing amount of other goods Two striking points:
Slop of PPF reflects a rate of exchange
Concave PPF has an increasing slope, thus the trade-off to produce equal
additional units of goods is increasing opportunity cost is increasing.
Why does the cost of producing equal additional units of goods increase???
Assumption: there is one kind of resource used to produce food and clothes that is
the labour. But there are two type of labor: tailor and chef. Initially, there are 100
tailors and 100 chefs and the economy stands at point A in the PPF.
At point A, the economy uses 100 tailors and 100 chefs to produce 10 units of clothes
When move from point A to point B: the economy has to move some labor
from producing clothes to producing food. Considering two types of labor,
they will move the chefs because they are appropriate for producing food.
oA B: we need 60 chefs to produce the first 20 units of food 60 units
of labor, in general, to produce the first 20 units of food since all labors are appropriate.
oB C: since we only have 40 units of chefs, we need to move some
tailors that is inappropriate for producing food the economy needs 40
units of chefs and 40 units of tailors 80 units of labor, in general, to
produce the additional 20 units of food since some labor is appropriate but some labors are not.
oC D: we run out of chefs, in order to produce the same of food, we
need 120 units of tailors 120 units of labor, in general, to produce
the additional 20 units of food since all labors are inappropriate.
That explain why the opportunity costs of producing the same amount of food are increasing. Sum up:
•When the produced quantity is low, we only use appropriate resources
that are inappropriately produce other goods.
•When the produced quantity increases, we have to use less appropriate
resources that are more appropriately used to produce other goods opportunity costs increase.
Some important things, we must understand: 1. Understanding of PPF
oA graph showing combinations of output that the economy can possibly produce
2. The shape of PPF and its implications and why oThe tradeoff pricinple
oThe concave (bow-outward) PPF means the opportunity costs of
producing the same amount of good are increasing.
3. Analyse changes in PPF due to the external factors.
Three-step analysis principle to analyse changes in PPF:
Step 1: the shocks and external factor affect only one good or both of them
Affect two goods: PPF will shift
oPositively: PPF shifts outward the possible combination
between produced goods increases.
oNegatively: PPF shifts inward the possible combination
between produced goods decreases.
Affect one good: PPF will rotate
Step 2: the shocks are negative and positve
Step 3: Using the PPF model for simulation.
The shocks can be economic growth, technology improvement, natural disaster (like
pandemic, flood, drought…) crisis and so on. PPF shi昀琀s PPF rotates Reasons
Both goods are a昀昀ected by external
Either good X or Y is a昀昀ected by the shocks external shocks Situa琀椀on
Economic growth or technological (A drought occurs) improvement -Nega琀椀ve shock -Posi琀椀ve shocks
-A昀昀ect only one good (Food) -A昀昀ect both goods More
PPF shi昀琀s outward produc琀椀vity implica琀椀ons of both X and Y increases
PPF shi昀琀s inward produc琀椀vity of both X and Y decreases Opportunity
Shape: Increasing slope, implying: costs
A B: produce 昀椀rst 20 units of food, the economy needs to reduce 1 unit of clothes
Opportunity costs: 1 clothes=20 food
B C: produce the addi琀椀onal 20
units of food, the economy needs to reduce 2 units of clothes OC: 2 clothes = 20 food 1 clothe=10 food
C D: produce the addi琀椀onal 20 units of
food, the economy needs to reduce 3
units of clothes OC: 3 clothes =20 food The case of rotating PPF Example:
Suppose that the economy experiences a drought. Let explain impacts of this event on the curve? 3-step analysis:
Step 1: a drought only affects the productivity of food.
Step 2: it is a negative effect. Step 3: Simulation
Conclusion: The effects of a drought are shown below. The drought reduces the amount of food
that can be produced, shifting the production possibilities frontier inward.