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Chapter 2

Chapter 2 - The Economic Problem.docx

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University of Waterloo
ECON 101
Shi Lei Niu

CHAPTER 2 The Economic Problem Production Possibilities and Opportunity Cost The production possibilities frontier (PPF) is the boundary between the combinations of goods and services that can be produced and the ones that cannot Production Possibilities Frontier - PPF illustrates scarcity because we cannot attain points outside the frontier - We can produce all points inside the PPF and on the PPF Production Efficiency - We achieve product efficiency if we cannot produce more of one good without producing less of some other good - When production is efficient, we are at a point on the PPF - If we are at a point inside the PPF, production is inefficient Tradeoff Along the PFF - Every choice along the PPF involves a tradeoff - At any point in given time, we have fixed amount of labour, land, capital and entrepreneurship. By using available technologies, we can employ resources to produce goods and services - Limit in what we can produce defines a boundary between what we can attain and what we cannot attain – real world’s production possibilities frontier – it defines what tradeoff we must make - All tradeoffs involve a cost – an opportunity cost Opportunity Cost - The opportunity cost of an action is the highest-valued alternative forgone - PPF helps us to make the concept of opportunity cost precise and enables us to calculate it - Along the PPF, there are only two goods, so there is one alternative forgone: some quantity of the other good - Opportunity cost is a ratio – it is the decrease in quantity produce of one good divided by increase of the quantity produced of another good as we move along the PPF - Producing additional is equal to inverse of opportunity cost of producing an additional alternative good - Opportunity cost increases as quantity increases Using Resources Efficiently The PPF and Marginal Cost - The marginal cost of a good is the opportunity cost of producing one more unit of it - Calculate marginal cost from the slope of the PPF - As quantity increases, PPF gets steeper and marginal cost increases Preferences and Marginal Benefit - Preferences – a description of a person’s likes and dislikes - The marginal benefit of a good or service is the benefit received from consuming one more unit of it - We measure the marginal benefit of a good or service by the most that people are willing to pay for an additional unit of it - The marginal benefit curve shows the relationship between the marginal benefit of a good and they quantity of the good consumed - The principle of decreasing marginal benefit – the more we have any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it - The basic reason why marginal benefit of a good or service decreases as we consume more of it is that we like variety Efficient Use of Resources - When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency - When we cannot produce more of any good without giving up some other good that we value more highly, we have achieved allocative efficiency Economic Growth Economic growth – the expansion of production Economic growth increases our standard of living, but it doesn’t overcome scarcity and avoid opportunity cost. The Cost of Economic Growth - Two key factors influence economic growth: technological change and capital accumulation - Technological change is the development of new goods and of better ways of producing goods and services - C
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