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ECON 101 (111)
Lecture

The Economic Problem Tradeoff Along the PPF, Product Efficiency, Marginal Benefit, Allocative Efficiency, Gains from Trade

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Department
Economics
Course
ECON 101
Professor
Corey Van De Waal
Semester
Fall

Description
    ECON  101  –  004:  Chapter  2   Economic  Problem   Tuesday,  September  21,  2010     • Life  is  good  and  getting  better.  But  we  all  face  costs  and  must  choose  what  we  think  is  best  for   us.  This  chapter  sharpens  the  concepts  of  scarcity  and  opportunity  cost.  It  introduces  the  idea  of   economic  efficiency.  It  also  explains  how  we  can  expand  production  by  accumulating  capital  and   specializing  and  trading  with  each  other.     Production  Possibilities  and  Frontier  (PPF)   -­‐ Describes  the  limit  to  what  we  can  produce  and  provides  a  neat  way  of  thinking  about  and   illustrating  the  idea  of  a  tradeoff.     -­‐ Is  the  boundary  between  those  combinations  of  goods  and  services  that  can  be  produced   and  those  that  cannot.   -­‐ To  illustrate  the  PPF  we  focus  on  two  goods  at  a  time  and  hold  the  quantities  produced  of  all   the  other  good  and  services  constant.   -­‐ We  look  as  a  model  economy  in  which  everything  remains  the  same  except  for  the   production  of  the  two  goods  are  considering.   -­‐ Points  outside  of  the  PPF  line  are   unattainable  and  everything  within  the  PPF  line  is   attainable   -­‐ Determines  opportunity  cost,  marginal  cost,  and  marginal  benefit       Production  Efficiency   -­‐ A  situation  in  which  goods  and  services  are  produced  at  the  lowest  cost  possible.   -­‐ All  points  on  the  line  are  efficient  &  all  points  inside  the  line  are  inefficient   -­‐ Production  is  inefficient  inside  the  PPF  because  resources  are  either  unused  or  misallocated   >  products  are  unused  when  they  are  idle  but  could  be  working     >  resources  are  misallocated  when  they  are  assigned  to  tasks  for  which  they  are  not  the  best   match     Tradeoff  Along  the  PPF   -­‐ Choices  along  the  PPF  involve  a  tradeoff   -­‐ By  using  our  available  technologies,  we  can  employ  these  resources  to  produce  goods  and   services,  but  we  are  limited  in  what  we  can  produce.   -­‐ This  limit  defines  a  boundary  between  what  we  can  attain  and  what  we  cannot  attain.   -­‐ This  boundary  is  the  real  world’s  PPF,  and  it  defines  the  tradeoffs  that  we  must  make.   -­‐ We  can  produce  more  of  an  one  good  or  service  only  if  we  produce  less  of  some  other  good   or  service   -­‐ EXAMPLE:  Prime  Minister  wants  to  spend  more  on  edu cation  and  health  care,  he  faces  a   tradeoff:  more  education  and  health  care  for  less  nation  defence       Opportunity  Cost   -­‐ The  highest  valued  alternative  we  give  up  to  get  something  else   -­‐ PPF  allows  us  to  calculate  opportunity  cost   -­‐ On  PPF,  there  are  two  goods;   therefore,  there  is  only  one  alternative  forgone   -­‐ Because  resources  are  not  all  equally  productive  in  all  activities,  the   PPF  bows  outward—is   concave  from  the  origin   -­‐ The  outward  bow  of  the   PPF  means  that  as  the  quantity  produced  of  each  good  increases,  so   does  its  opportunity  cost.               ECON  101  –  004:  Chapter  2     Opportunity  Cost  is  a  Ratio   -­‐ It  is  the  decrease  in  the  quantity  produced  of  one  good  divided  by  the  increase  in  the   quantity  produced  of  another  good       Increasing  Opportunity  Cost   -­‐ The  opportunity  cost  of  a  good  increases  as  th e  quantity  increases   -­‐ The  outward  bowed  out  shape  of  the  PPF  reflects  increasing  opportunity  cost   -­‐ EXAMPLE:  People  with  many  years  working  at  PepsiCo  are  good  at  producing  cola  but  not   very  good  at  making  pizzas.  So  if  we  move  some  of  these  people  from  Pepsi Co  to  Domino’s,   we  get  a  small  increase  in  the  quantity  of  pizzas  but  a  large  decrease  in  the  quantity  of  cola.  
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