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Chapter 2

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Department
Economics
Course
ECON 1050
Professor
Eveline Adomait
Semester
Fall

Description
AW 9/15 ECON*1050 – Intro to Microeconomics Chapter Two – The Economic Problem Production Possibilities and Opportunity Cost PRODUCTION POSSIBILITIES FRONTIER (PPF): 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 goods and services constant PRODUCTION EFFICIENCY: is achieved when producing goods and services at the lowest possible cost - Production is inefficient inside the PPF because resources are either used or misallocated or both - Resources are unused when they are idle but could be working (eg. Leaving some factories idle or some workers unemployed) - Resources are misallocated when they are assigned to tasks for which they are not the best match (eg. Assigning skilled pizza chefs to work in a cola factory and skilled cola producers to work in a pizza shop) - Every choice along the PPF involves a tradeoff - All tradeoffs involve a cost – an opportunity cost - At any given point in time, we have a fixed amount of labour, land, capital, and entrepreneurship – 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 and cannot attain - We can produce more of any one good or service only if we produce less of some other goods or services OPPORTUNITY COST: is the highest-valued alternative forgone - Along the PPF, there are only two goods, so there is only one alternative forgone: some quantity of the other good (eg. The opportunity cost of producing an additional pizza is the cola we must forgo; similarly, the opportunity cost of producing an additional can of cola is the quantity of pizza we must forgo) - 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 as we move along the production possibilities frontier Summary - The production possibilities frontier, PPF, is the boundary between production levels that are attainable and those that are not attainable when all the available resources are used efficiently - Production efficiency occurs at points on the PPF - Along the PPF, the opportunity cost of producing more of one good is the amount of the other good that must be given up - The opportunity cost of all goods increases as the production of the good increases Using Resources Efficiently ALLOCATIVE EFFICIENCY: when we achieve production efficiency at every point on the PPF – the best point is when goods and services are produced in the quantities that provide the greatest possible benefit - At any point of the PPF, we cannot produce more of one good without giving up some other good AW 9/15 - At the best point on the PPF, we cannot produce more of one good without giving up some other good that provides greater benefits - The marginal cost of a good is the opportunity cost of producing one more unit of it. We calculate marginal cost from the slope of the PPF PREFERENCES: are a description of a person’s likes and dislikes - To describe preferences, economists use the concept of marginal benefit - The marginal benefit from a good or service is the benefit received from consuming one more unit of it - We measure the marginal benefit from a good or service by the most that people are willing to pay for an additional unit of it - Economics illustrate preferences using the marginal benefit curve – which is a curve that shows the relationship between the marginal benefit from a good and the quantity consumed of that good - It is a general principle that 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 (this tendency is so widespread and strong that we call it a principle – the principle of decreasing marginal benefit) - The reason why marginal benefit from a good or service decreases as we consume more of it is that we like variety – the more we consume of any one good or service, the more we tire of it and would prefer to switch to something else Summary - Allocative efficiency occurs when goods and services are produced at the least possible cost and in the quantities that bring the greatest possible benefit - The marginal cost of a good is the opportunity cost of producing one more unit - The marginal benefit from a good is the benefit received from consuming one more unit of it, measured by the willingness to pay for it - The marginal benefit of a good decreases as the amount of the good available increases - Resources are used efficiently when the marginal cost of each good is equal to its marginal benefit Economic Growth ECONOMIC GROWTH: an expansion of production – it increases our standard of living, but doesn’t overcome scarcity and avoid opportunity cost TECHNOLOGICAL CHANGE: is the development of new goods and of better ways of producing goods and services CAPITAL ACCUMULATION: is the growth of capital resources, including human capital Case Study – Hong Kong Overtakes Canada - In 1968, the production possibilities per person in Canada were much larger than those in Hong Kong th - Canada devotes 1/5 of itrdresources to accumulating capital - Hong Kong devotes 1/3 of its resources to accumulating capital - Since 1968, both countries have experience economic growth, but because Hong Kong devotes a bigger fraction of its resources to accumulating capital, its production possibilities have expanded more quickly - By 2008, production possibilities per person in Hong Kong had exceeded those in Canada – if Hong Kong continues to devote more resources to accumulating capital than Canada does, Hong Kong will continue to grow more rapidly - But if Hong Kong decreases capital accumulation, then its rate of economic growth will slow AW 9/15 - Hong Kong is typical of the fast-growing Asian economies, which include Taiwan, Thailand, South Korea, and China rd - To catch up with Hong Kong, Canada must devote more than 1/3 of its resour
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