Econ Chapter 2 Study Notes

Econ 101: Micro Economics 09-­‐16-­‐10 Chapter 2: The Economic Problem

The production possibility Frontier -­‐ The boundary between those combinations of goods and services that can be produced and those that cannot -­‐ Shows the trade-­‐off between more of one good in terms of the other o PPF looks at an model economy (two goods are forced upon while everything else stays constant)

-­‐ The PPF for cola and pizza limits the production of these two -­‐ Illustrates scarcity because we cannot attain points OUTSIDE the frontier E: typical month; produce 4 million pizzas and 5million cola A: all people who produce pizza are moved to producing cola = 15 million cola

Production efficiency if we produce goods and services at lowest possible cost.

 Occurs when all points are ON PPF Production inefficiency inside PPF because resources are unused/misallocatedPOINT Z o Unused: favorites are idle or workers are unemployed o Misallocated: assigned for tasks which they are not best match/inefficient for -­‐ Assumptions: fixed amount of labour, land, capital, -­‐ The PPF is typically bowed-­‐out or linear. It is not bowed-­‐in o This is because resources are not all equally productive in all activities o As the quantity of each good increases, so does the opportunity cost -­‐ The more of either good we try to produce, the less productive are the additional resources we use to produce that good and the larger is the opportunity cost of a unit of that good o If skilled pizza makers are moved from Domino’s to Pepsi, you get small increase in quantity of cola but large decrease in quantity of pizza

Econ 101: Micro Economics 09-­‐16-­‐10 *On our real-­‐world PPF, we can produce more of any good/service only if we produce less of some other good/service

-­‐ Opportunity cost of an action is the highest-­‐valued alternative forgone -­‐ It is a ratio: decrease in quantity produced of one good divided by increase in quantity produced of another o Opp. Cost of additional can of cola = INVSERSE opp. Cost of additional pizza o Along the PPF, there are only two goods so there is only one alternative forgone: some quantity of the other good  Moving from point CD (more pizza but less cola) -­‐ The slope of the PPF measures the marginal opportunity cost of producing one good in terms of the amount of the other good foregone.

Increasing opportunity cost -­‐ Between AB frontier has gentle slope o Increase in quantity of pizza costs small decrease in quantity of cola= opportunity cost of pizza is a small quantity of cola

Marginal Cost opportunity cost of producing one more unit of a good Marginal Benefit benefit received from consuming one more unit of it -­‐ Measured by one’s willing to pay for an additional unit Allocative Efficiency goods/services are produced at the lowest possible cost and in the quantity that provide the greatest possible benefit MC=MB

Econ 101: Micro Economics 09-­‐16-­‐10

The principle of decreasing marginal benefit the more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it

Economic Growth -­‐ -­‐ Expansion of production possibilities and increase standing of living Influenced by two factors: 1. Technological change development of new goods and better ways of producing goods/services 2. Capital accumulation growth of capital resources (including human capital) For new resources in technology and producing new capital= decreasing production of consumption goods and services *Economic growth is not free Opportunity cost of economic growth = less current consumption

By reducing pizza production now, we use its resources for more technology for pizza ovens and the PPF expands in future

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Econ 101: Micro Economics 09-­‐16-­‐10

Gains of Trade Specializationproducing only one good or a few goods A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else A person has an absolute advantage if that person is more productive than others Comparative advantage is comparing opportunity costs *One can have absolute advantage but not have comparative advantage in every activity o I.E. Bob is a great singer and artist  absolute advantage  But, compared to others, he is better at folk singing than painting comparative advantage is in folk singing (lower opp. cost) Absolute advantage is comparing productivities (production per hour)

Learning-­by-­doing repeatedly producing in that activity (basis of dynamic comparative advantage) Dynamic comparative advantage person (or country) has acquired by specializing in an activity and becoming the lowest-­‐cost producer as a result of “learning-­‐by-­‐doing **When specializing you need to have… Economic Coordination Two competing economic coordination systems: 1. Central economic planningmay appear to be bet system because it can express national priorities 2. Decentralized coordination-­‐4 different social institutions a. Firms b. Markets c. Property rights d. Money A: Firms hires factors of production and organizes those factors to produce and sell goods/services (gas station, Canadian Tire, Roots) o More efficient for firms to specialize and trade with each other in markets

B: Marketsany arrangement where buyers and sellers get information to do business w/ each other (world oil market network) o Can work only with property rights C: Property Rightssocial arrangement that governs ownership use and disposal of anything that people value

Econ 101: Micro Economics 09-­‐16-­‐10 o o o Real property land/buildings and durable goods like plant/equipment Financial propertystocks/bonds and money in the bank Intellectual propertyproduct of creator protected by copyrights and patents (books, music, computer software)

D: Moneycommodity or taken generally acceptable as means of payment Circular Flow through Market Red o Households use their skills in factors of production to firms through “factor market” o Firms give households goods and services through “good markets”

Green(payments for red flows) o Household expenses for the goods/services o Firms pay through rent, wages, interest, profit to households