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Lecture

Chapter 5 - ECON 1000


Department
Economics
Course Code
ECON 1000
Professor
Sam Lanfranco

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Production Possibilities and Opportunity Cost
If you want to increase production of one good you must decrease production of something else
PPF focuses on two goods at a time and hold quantities produced of all other goods and services constant
It is a model economy where everything remains the same except for production of two goods we are considering
The production possibilities frontier is the boundary between combinations of goods and services that can be produced and those that cannot
Production Possibilities Frontier
The PPF for cola and pizza show limits to production of these two goods given total resources and technologies
Can only produce points inside the PPF or on the PPF
PPF illustrates scarcity because we cannot attain points outside of frontier
Production Efficiency
Achieved if goods and services are made at lowest possible cost
This means resources are unused or misallocated, or both
Unused: idle but could be working
Skilled pizza chefs to work in cola and skilled cola to work in pizza
Misallocated: assigned to tasks for which they are not best matched
If inside the PPF, it is inefficient because too much is given up to produce a certain good
Occurs at points on the PPF
Tradeoff Along PPF
Every choice along PPF involves tradeoff
Limit defines boundary between what we can attain and what we cannot
Boundary is the real world's production possibilities frontier and defines tradeoffs we must make
We have a set amount of labour, land, capital, and entrepreneurship and can produce goods and services but we are limited in what we can produce
Tradeoffs involve a cost -- an opportunity cost
Opportunity Cost
Opportunity cost of an action is highest-valued alternative forgone
Only two goods so there is only one alternative forgone
Opportunity cost of producing an additional pizza is the cola we must forgo
Opportunity cost of producing an additional cola is the pizza we must forgo
If you get X more pizza but Y fewer cans of cola, that means one pizza costs Y/X cans of cola
Move from one point to another
PPF allows you to calculate opportunity cost
Decrease in quantity produced of one good divided by increase of quantity produced of another good
Because it is a ratio, opportunity cost of producing an additional can of cola is equal to inverse of opportunity cost of producing an additional pizza
Opportunity cost is a ratio
Increasing Opportunity Cost
Opportunity cost of a pizza increases as the quantity of pizza produced increases
Opportunity cost of barrel is $30
When price of crude oil doubles, it is worthwhile for people to extract more crude oil and from higher-cost sources
Opportunity cost of extracting oil is $50 a barrel
As we produce more crude oil, we slide around our PPF and the opportunity cost of producing oil rises
As production increases, opportunity cost rises
Example: it costs $30 a barrel to get crude oil out of ground and to refinery
Results in less productive additional resources used to produce good and larger opportunity cost of a unit of that good
Experienced X producers are not as experienced in producing Y
PPF is bowed outward because resources are not all equally productive in all activities
Using Resources Efficiently
When goods and services are produced at lowest possible cost and in quantities that provide greatest possible benefit
Must measure costs and benefits
Allocative efficiency:
Production efficiency is at every point of PPF
PPF and Marginal Cost
Cost of producing one more unit of it
Calculate cost for 1 million X and graph it
Refer to textbook page 35
Calculated from the slope of the PPF
Marginal Cost:
Description of one person's likes and dislikes
Preferences:
Concrete way to describe preference
It is the benefit received from consuming one more unit of it
Most you are willing to pay for something measures its marginal benefit
You are willing to pay less for a good than it is worth to you but not more
Measured by most people are willing to pay for an additional unit of it
Marginal benefit:
Shows the relationship between marginal benefit of a good and quantity consumed
It decreases because we like variety
The more we consume of one good or service the more we tire of it and prefer to switch to something else
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
Principle of decreasing marginal benefit:
Marginal benefit curve
Allocative Efficiency
Chapter 2 - The Economic Problem
October-11-11
12:00 PM
ECON 1000 Page 1

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Allocative Efficiency
Cannot produce more of one good without giving up some other good
If marginal benefit is greater than cost then you produce more
If marginal cost is greater than benefit then you produce less
The best point is where we cannot produce more of one good without giving up some other good that provides greater benefit
Economic Growth
Increasing standard of living but does not overcome scarcity and avoid opportunity cost
The faster we make production grow, the greater the opportunity cost of economic growth
To make economy grow we face a tradeoff
Cost of Economic Growth
Development of new goods and of better ways of producing goods and services
Technological Change
Growth of capital resources, including human capital
Capital Accumulation
Economic growth comes from:
To have more T.C. and C.A. you must decrease production of consumption goods and services
Fewer resources for producing pizza dn more for ovens, the greater the future expain of production possibilities
The PPF will rotate outward
Refer to textbook page 28
T.C. and C.A. have opportunity cost
T.C. and C.A. provides us with enormous quantity of cars giving us more transportation
To make more ovens you must make fewer pizzas
Economic growth does not abolish scarcity
A Nation's Economic Growth
Canada v. Hong Kong is an example of how our choices on what and how to produce affect rate of economic growth
Decrease in today's consumption is opportunity cost of tomorrow's increase in consumption
To expand production possibilities, a nation must devote fewer resources to producing consumption goods and services and some to accumulating capital
and developing new technologies
If a nation devotes all factors of production to producing consumption goods and services, production possibilities in the future will remain the same
Gains from Trade
Producing only one good or a few goods is called specialization
If one can perform activity at a lower opportunity cost than anyone else
Differences arise form differences in individual abilities and from differences in characteristics of other resources
One machine can have great precision but hard to operate another can be fast but breaks down often
Example: land can be fertile and another can be infertile
Comparative Advantage:
One who is more productive than all others
Involves comparing productivity (production per hour) -- where comparative advantage compares opporunity costs
Absolute advantage in these two activities
Comparative advantage in folk singing
When compared to others she is a better folk singer than a painter
Joni Mitchell is a better folk singer and a better painter than most
One who has absolute advantage does not have a comparative advantage in everything
Absolute Advantage:
This is why people have different opportunity costs which are the source of comparative advantage
Ability and resources vary from person to person
Refer to page 40 for example
Dynamic Comparative Advantage
This is called learning-by-doing
When you repeatedly produce a particular good or service you become more productive
Resources and technologies available determine comparative advantages that individuals and nations have
Learning by doing is the basis of dynamic comparative advantage
Dynamic comparative advantage is a comparative advantage that a person has acquired by specializing in an activity and becoming the lowest cost producer as a
result of learning-by-doing
ECON 1000 Page 2

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Markets and Prices
Markets are arrangements that enables buyers and sellers to get information and to do business with each other
Markets exist for goods and services
Some markets are places where people can meet physically
Others can be connected only via telephone, internet and fax
Sellers are the tens of thousands of retail sports equipment and footwear stores
Each buyer can visit different stores and each seller knows that the buyer has a choice of stores
In the basketball shoe market there are buyers and sellers
Most markets are unorganized collections of buyers and sellers
A market that has many buyers and many sellers, so no single buyer or seller can influence the price
Competitive market:
Markets vary in intensity of competition that buyers and sellers face
Producers sell only if price is high enough to cover opportunity cost
Consumers respond to changing opportunity cost by seeking cheaper alternatives to expensive items
Referred to as money price
An object's price is the number of dollars that must be given up in exchange for it
Opportunity cost of one cup of coffee is two packs of gum
Relative price is an opportunity cost
The ratio of one price to another is called a relative price
To calculate: divide price of cup of coffee by price of pack of gum to find the ratio
Example: if money price of coffee is $2 a cup and the money price of gum is $1 a pack
Opportunity cost is the highest valued alternative forgone
Resulting relative price is the opportunity cost of the good in terms of "how much basket" we must give up
To calculate: divide money price of a good by money price of a basket of all goods (price index)
Normal way of expressing relative price is in terms of a basket of all goods and services
They refer to relative price
Its price will fall relative to the average price of other goods and services
When a price will fall it is not the money price
Demand and supply model determines relative prices, and the word price means relative price
Demand
Wants it
Can afford it
Plans to buy it
If one demands something, one
Wants are desires or wishes one has for goods and services
Scarcity guarantees that most of our wants will never be satisfied
Demand reflects a decision about which want to satisfy
Not same as quantity bought
May exceed goods available so quantity bought is less than quantity demanded
Demand expressed as 1 cup per day, 7 cups per week, 365 cups per year
Example: one cup of coffee a day
Measured as an amount per unit of time
Quantity demanded of a good or service is the amount consumers plan to buy during a given time period at a particular price
Influenced by many factors, one is price
"How, other things remaining the same, does the quantity demanded of a good change as its price changes?"
Keep all other influences the same then ask
Study relationship between quantity demanded and its price
Law of Demand
Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater the quantity
demanded
Can be explained by the following two effects
When the price of a good rises its relative price -- opportunity cost -- rises
Each good has substitutes -- other goods that can be used in its place
As opportunity cost of a good rises, incentive to economize on its use and switch to substitute becomes stronger
Substitution effect:
When price rises, it rises relative to income
High price & same income --> cannot afford to buy all things they previously bought
Income effect:
Energy bars can now substitute for energy drinks -- substitution effect
Budgets have more slack from the lower price so people buy more bars -- income effect
Example: an energy bar was at 3 ad falls to $1.50
Energy bars are substituted with energy drinks -- substitution effect
Tighter budgets so people buy fewer energy bars -- income effect
Example: an energy bar was at $3 now it doubles to $6
Demand Curve and Demand Schedule
The entire relationship between price of a good and quantity demanded of that good
Illustrated by the demand curve and demand schedule
Demand:
Refers to a point of the demand curve
The quantity demanded at a particular price
Quantity demanded:
Demand curve shows relationship between quantity demanded and its price when all other influences on consumers' planned purchases remain the same
Demand schedule lists quantities demanded at each price when all other influences on consumers' planned purchases remain the same
Chapter 3 - Demand and Supply
October-11-11
1:59 PM
ECON 1000 Page 3
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