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Lecture 2

LGS 200 Lecture 2: Macroeconomics Chapter 2 Notes

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Legal Studies
LGS 200

Macroconomics Chapter 2 Assumptions & Models • Assumptions simplify the complex world, make it easier to understand • Example: To study international trade, assume two countries and two goods. Unrealistic, but simple to learn and gives useful insights about the real world. • Model: a highly simplified representation of a more complicated reality. Economists use models to study economic issues. The Circular-Flow Diagram • The Circular Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firms. • Two types of “actors”: ➢ Households: o Own the factors of production, sell/rent them to firms for income. o Buy and consume goods and services ➢ Firms o Produce and sell goods and services o Hire and use factors of production • Two markets: ➢ The market for goods and services ➢ The market for “factors of production” Factors of Production • Factors of Production: the resources the economy uses to produce goods and services, including ➢ Labor ➢ Land ➢ Capital (buildings & machines used in production) ➢ Entrepreneurship The Production Possibilities Frontier • The Production Possibilities Frontier (PPF): a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology. The PPF and Opportunity Cost • Recall: the opportunity cost of an item is what must be given up to obtain that item. • Moving along the PPF involves shifting resources (e.g. labor) from the production of one good to the other. • Society faces a tradeoff: getting more of one good requires sacrificing some of the other • The slope of the PPF tells you the opportunity cost of one good to the other. The Shape of the PPF • The PPF could be a straight line, or bow-shaped • Depends on what happens to the opportunity cost as economy shifts resources from one industry to the other. ➢ If opportunity cost remains constant, PPF is a straight line. Essentially the same resources are equally useful for producing in either industry. ➢ If opportunity cost of a good rises as the economy produces more of the good, PPF is bow-shaped. Essentially, the resources are specialized and not easily adaptable for producing in either industry. Economic Growth and the PPF •
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