ECON 2106 Lecture Notes - Lecture 4: North American Free Trade Agreement, United States, World Trade Organization

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1 Sep 2015
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Chapter 2: The Economic Problem
Objectives
1. Learn the Production Possibilities Frontier
2. Describe an efficient allocation of resources
3. Explain why trade can make everybody better off
4. Learn the Circular Flow Model
Production Possibilities Frontier (PPF)- the boundary between those combinations of
goods and services that can be produced and those that cannot
1. Any point on the frontier and any point inside the frontier are attainable
2. Points outside the frontier are unattainable
3. Any point inside the frontier is inefficient
a. At such a point, it is possible to produce more of one good without
producing less of the other good
b. At such a point, resources are either unemployed or misallocated
4. Any point on the frontier is efficient
a. The only way to produce more of a good is to produce less of the other
good
b. It is a tradeoff
5. Example of Cola and Pizza (see PowerPoint for graphs):
a. Assumption: society only produces two goods: cola and pizza
b. From E to F
i. Pizza increases by 1 million
ii. Cola decreases by 5 million
iii. In order to produce 1 million more pizzas, you have to give up 5
million cans of cola
iv. Opportunity cost of producing 1 pizza is 5 cans of cola
c. From F to E
i. Cola increases by 5 million
ii. Pizza decreases by 1 million
iii. The opportunity cost of the 5 million cans of cola is the 1 million
pizzas
iv. One coke costs 1/5 of a pizza
Opportunity Cost
1. As we move down along the PPF, we can produce more of one good, but the
production of the other good decreases
2. The opportunity cost of producing one good is the loss of the other good
3. Opportunity cost is a ratio
a. Example: one pizza costs 5 cans of cola; one can of cola costs 1/5 of a
pizza
b. Because resources are not equally productive in all activities, the frontier
bows outward
c. The outward bow of the PPF means that as the quantity produced of each
good increases, so does its opportunity cost
4. PPF determines the opportunity cost
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Marginal Cost- the opportunity cost of producing one more unit of it (upward sloping)
1. Marginal Cost Curve
a. The bars illustrate the increasing opportunity cost
b. The marginal cost curve passes through the middle point of each bar
c. Marginal cost is increasing because the opportunity cost of producing one
more unit is increasing
Preferences and Marginal Benefit
1. Preferences- a person’s likes and dislikes
a. Economists use the concepts of marginal benefit to describe preferences
2. Marginal Benefit- the value of or benefit received from consuming one more unit
of ita. Measured by the amount that a person is willing to pay for an additional
unit of good
Using Resources Efficiently
1. When we cannot produce more of any good without giving up some other good,
we have achieved production efficiency
a. We are producing at any point on the PPF
2. Allocative efficiency- when we cannot produce more of any one good without
giving up some other good that we value more highly, we have achieved
allocative efficiency
a. We are producing at the point on the PPF that we prefer above all other
points
b. Point of allocative efficiency is the point on the PPF at which marginal
benefit equals marginal cost
i. This point is determined by the quantity at which the marginal
benefit curve intersects the marginal cost curve
ii. If you go past the point of marginal cost, marginal cost exceeds
marginal benefit
1. We get more value from our resources by producing fewer
Economic Growth- the expansion of production possibilities- an increase in the standard
of living
1. Two key factors influence economic growth
a. Technological change- the development of new goods and of better ways
of producing goods and services
b. Capital accumulation- the growth of capital resources, which includes
human capital
2. The Cost of Economic Growth
a. To use resources in research and development and to produce new capital,
we must decrease our production of other consumption goods and services
b. So economic growth is not free
c. The opportunity cost of economic growth is you cut some of your current
consumption
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