Good grades or nice life Learning success maximum achievable combinations of leisure and learning success = transformation curve from leisure to learning success We can choose where we want to be on the curve. Leisure
Good grades or nice life learning success unattainable transformation curve attainable leisure time
Good grades or nice life Learning success more free time with greater learning success more free time with same learning success poor learning technique free time
Weapons or housing Fighters A country has: Labor, raw materials, machinery 5 With these resources and existing technology, it can produce weapons or housing. 4 3 2 1 0 0 5' 000 10' 000 15' 000 Flats
Weapons or apartments Fighters unattainable 5 Transformation curve = limit of production possibilities 4 Points on transformation curve are technically efficient. 3 2 attainable 1 0 0 5' 000 10' 000 15' 000 apartments
Weapons or housing fighter If we want to produce more weapons, we have to give up some housing production. 5 4 more weapons We "transform" apartments into weapons. 3 2 1 0 0 5' 000 10' 000 15' 000 fewer dwellings
The opportunity cost of a decision is the value of the alternatives that must be foregone because of that decision.
Weapons or Flats Fighter Airman The number of apartments we have to give up for an additional airman is the opportunity cost of the airman. 5 4 Here is the opportunity cost of an airman 3' 000 dwellings 3 + 1 airman 2 1 0 0 5' 000 10' 000 15' 000 – 3' 000 dwellings
Weapons or housing fighter On this transformation curve, the opportunity cost increases. 5 Why? 5000 4 4000 3 Part of resources more suitable for weapons production and part more suitable for housing 3000 production. 2 2000 1 1000 0 0 5' 000 10' 000 15' 000 Dwellings
What is a model? L l A model is a simplified representation of reality. Example map: A map that is at a scale of 1: 1 is useless. Simplification is useful when we need the map to solve a practical problem.
What is a model? L But economic models are different from map models: è We don't know the economic relationships as well as we know the landscape. È Economic variables are not easy to measure. È Economic models represent causal relationships.
Economic Models l l Economic models are the core of the theory. Structure of a Model: Hypothesis Given resources and technology, society must give up some housing if it is to produce more weapons. Assumptions Properties of the technology are given. The world does not change ceteris paribus Society produces technically efficient exogenous variables Input labor Input machines Causality endogenous variables Output dwellings Output arms
Representations economic models verbal graphical basic relationship complexity apparent mathematically quantifiable prerequisite for statistical testing
Difficulties with economic models l l In contrast to the natural sciences, experiments are extremely difficult. È It is difficult to perform and repeat experiments. È A test of the hypothesis assumes that the assumptions are actually met. Different models can explain the same event.