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Chapter 2

ECN104 - CHAPTER 2 Review.docx

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ECN 104
Helene Moore

ECN104 ­  CHAPTER 2 • Economists play two roles  Scientists: try to explain the world  Policy Advisors: try to improve it • Economics is the study of human behaviour ASSUMPTIONS AND MODELS • Assumptions makes the world easier to understand  Example: to study international trade, assume there are two countries and two goods • Model: a simplified representation of a complicated reality • To construct a model we need to make assumptions because without that we are going to have description THE CIRCULAR-FLOW DIAGRAM • Circular Flow Diagram: visual model of the economy, shows how dollars flow through market among households and firms • Actors: they are both buyers and sellers 1. Households - people - consume (Households consume) 2. Firms - business - invest (Firms invest) • Markets: people come together in market 1. the market for goods and services 2. the market for "factors of production" - land (pay rent), labour(pay wages) and capital (pay interest) FACTORS OF PRODUCTION • Factors of Production: the resources economy uses to produce goods and services. This includes  labour  land  capital (buildings and machines used in production) DIAGRAM BREAKDOWN • Households: Own the factors of production, sell/rent them to firms for income. Buy and consume goods and services  We sell our labour to the market to earn income and buy goods and services to consume • Firms: buy/hire factors of production, use them to produce goods and services. Sells goods and services  They sell goods and services to make income and buy "us" to produce goods and services and pay wages • Monetary Flows: flows of money • Non-Monetary: goods and services • This chart shows how these two are interconnected. Everything needs to act together to flow properly • Green: Monetary flows • Red: Non-Monetary THE PRODUCTION POSSIBILITIES FRONTIER • PPF: it's a graph that shows the combinations of two goods the economy can possibly produce given the available resources and technology  this is a production model - What does economy produce?  Example  Two goods: computer and wheat  One resource: labour  Economy has 50,000 labour hours per month for production PPF EXAMPLE • Producing one computer requires 100 hours labour. • Producing one ton of wheat requires 10 hours labour PPF EXAMPLE #2 • Are points (A,B,C,D,E) attainable and efficient? • A -Points on the right are neither attainable nor efficient • B – Points on the left are attainable but are not efficient, unemployed labour • Only along the PPF, points are attainable and efficient • They are attainable because we can produce them and they require 50 000 hours and are efficient - no labor is left unused (used in making wheat an computers) • OC to the right of the PPF is not relevant • OC to the left of the PPF is also irrelevant - you didn’t give up anything to get • Only along the PPF is OC a relevant concept – give up/get • If you move anywhere along the PPF you have to give up something to get something • PPF are only set of points that are efficient and attainable THE PPF: SO FAR Points on the PPF (like A – E)  possible  efficient: all resources are fully utilized Points under the PPF (like F)  possible  not efficient: some resources underutilized (e.g., workers unemployed, factories idle) Points above the PPF (like G)  not possible THE PPF AND OPPORTUNITY COST • Opportunity Cost: cost of what you didn't buy • Slope of PPF = OC = rise/run = give up/get • Moving along a 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 in terms
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