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Chapter 2

ECON 101 Chapter 2 Notes.odt

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ECON 101
Sharmistha Nag

• If we want to increase the production of one product, we must decrease the production of another – this is a trade off. W our e are limited by our available resources and by technology. • Production possibilities frontier is the boundary between the combination of goods and services that can be produced, and those that cannot. • PPF focuses on two goods, and holds quantities of all other goods and services produced to be constant. • PPF focuses only on the production of two goods, and the available resources and technology to make these goods. • Any point outside the PPF is unattainable, and example of scarcity as the available resources and technology are not enough to produce those combinations outside of the PPF. • Any point on, or inside the PPF is attainable. • Production deficiency is when goods and services are produced as the lowest possible cost. • Therefore, any point on the PPF is efficient, and any point inside is inefficient as more of one product to produce another is being given up than needed. • Production is inefficient when resources are either unused or misallocated or both. • Resources are unused when they could be used but aren't. For example, leaving some workers unemployed or some parts of the factory not used. • Resources are misallocated when they are used for tasks which they are not best suited for. For example, sending pizza makers to make cola and cola makers to make cola. • Every point on the PPF represents a trade off. This leads to every point on the PPF having an opportunity cost. • The opportunity cost in a PPF is merely the quantity of one good given up to produce more of the other good. • In the current example, the marginal cost for some increase in the production of pizza is the corresponding quantity of cola given up. • From point C to D, making 1 million more pizzas costs 3 million cans of cola, so the opportunity cost is 3 cans of cola per pizza. In the opposite direction, from D to C, producing 3 million more cans of cola costs 1 million pizzas, therefore the opportunity cost is 1/3 pizza per can of cola. Clearly, the opportunity cost of cola is the inverse of the opportunity cost of pizza. Remember to express opportunity cost as a ratio. • The curved PPF indicates that an increase in production of pizza results in an increasing opportunity cost of cola. Initially the slope is low, but it increase as pizza production increases. • Opportunity cost increases in both directions. Opportunity cost must increase because resources are not equally as productive in all activities. To increase production of pizza, some of the cola workers would be sent to making pizza. This would result in only a small increase of pizza production and pizza workers have never made cola, but a large decrease in cola production. • Universal principal: increasing production = increasing opportunity cost. • When goods and services are produced at the lowest possible cost, that is production efficiency, and are made in the combination that provides maximum benefit, there is allocative efficiency. • Marginal cost is defined as the opportunity cost of a good for producing one more unit of it. • Marginal benefit is defined as the benefit of producing one more unit of a good. • Benefit is however, subjective, as it depends on preferences. • Marginal benefit curve is the marginal benefit of a good per quantity consumed of it. Note that this curve es completely unrelated to PPF as it is based
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