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Chapter 2

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ECON 1050
Eveline Adomait

Chapter 2: the economic problem Production Possibilities and Opportunity Cost -To increase our production of one good we must lower the production of another; a tradeoff -Production possibilities frontier (ppf): the boundary between those combinations of goods and services that can be produced and those that cannot -We always want things better and faster Production possibilities frontier -The ppf shows what we can and cannot produce -Focuses on 2 goods at a time and holds quantities of all other goods and services consistent -A model economy where everything remains the same (ceneris paribus); except the 2 goods we’re considering -The ppf sows scarcity because we cannot attain points that are outside of the frontier Production Efficiency -Production efficiency is achieved when we produce goods and services at the lowest possible cost -Points inside the ppf are inefficient because the necessary of one good is being given up to produce the other, such as Z The production is inefficient because resources are unused, misallocated or both. Ex. Workers unemployed, idle factories Unused when idle, misallocated when assigned to tasks which aren’t the best match, as they are at point Z -We have achieved production efficiency when we cannot produce more of one good without producing less of another Tradeoff along the PPF -every choice along the ppf involves a tradeoff -at any given point in time we have a fixed amount of labour, land, capital, and entrepreneurship -all tradeoffs involve a cost; an opportunity cost -once at production efficiency we face tradeoffs Opportunity Cost -the opportunity cost is the highest value alternative forgone -the opportunity cost of producing additional good B is the amount of good A that we must forgo -Because not all resources are equally productive in all activities the ppf bows outward -The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost Opportunity Cost is a Ratio -Decrease in quantity produced of one good divided by the increase in production of another as we move along the ppf -Because opportunity cost is a ratio, the opportunity cost of producing additional good A is the inverse of producing additional good B Increasing Opportunity Cost -the opportunity cost of good A increases as the quantity produced increases -the more of either good we try to produce the less productive are the resources we use to produce that good and the larger the opportunity cost Using Resources Efficiently -all points on ppf are efficient -we achieve efficiency at every point, but which point is best? the point where goods and services are produced in quantities that provide the greatest possible benefit -allows us to achieve allocative efficiency The ppf and marginal cost -the marginal cost of a good is the opportunity cost of producing one more unit of it and is calculated through the slope of the ppf - as the quantity produced goes up, the ppf gets steeper and marginal costs increase continuously/steadily -the marginal cost increases as quantity produced increases Preferences and Marginal Benefit -Preferences are a description of a persons likes and dislikes -In order to describe preferences economists use concept of marginal benefit and marginal benefit curve -Marginal benefit: the benefit received form consuming one more unit -measured by the MOST people are willing to pay or an additional unit -we illustrate preferences with a marginal benefit curve shows relationship between marginal benefit and quantity consumed -principle of decreasing marginal benefit  marginal benefit decreases when we consume more because we like variety -The curve slopes downward to reflect the principle of decreasing marginal benefit. Allocative Efficiency - When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency. - We are producing at a point on the PPF. - 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. - We are producing at the point on the PPF that we prefer above all other points. - Example: if we produce 2.5 million pizzas marginal benefit and cost are both 3 cans of cola - Allocation of resource
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