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# Econ Chapter 2 Study Notes

By ohchanada Feb 25, 2013 1004 Words
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

-­‐ -­‐ -­‐

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

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