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Chapter 2

ECON 101 - Chapter #2 Notes.doc

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ECON 101
Corey Van De Waal

ECON 101 – Chapter #2 The Production Possibilities Frontier is the boundary between the combinations of goods and services that can be produced and those that cannot - When we talk about PPF’s we focus on two goods at a time and hold the quantities of all other goods and services constant ( Ceteris Paribus) - The quantities of goods and services that we can produce are limited by our available resources and by technology. - If we want to increase our production of one good we must decrease our production of something else – we must face a trade-off. - A PPF shows us the limit to the production of these two goods - The PPF depicts scarcity because – the points outside the curves are points of production that are unattainable. Points inside or on the PPF are attainable. - We achieve production efficiency if we produce goods and services at the lowest possible cost. This occurs on ALL the point ON the PPF. - ANY points INSIDE the curve however show that production is inefficient because either resources are unused or misallocated or both. - Misallocated resources are so when they are assigned to tasks for which they are not the best match - EVERY choice along the PPF involves a trade-off. - Example – When the Prime Minister decides that he wants to spend more on Education and healthcare, he must face a trade-off: more health and education, and less national defence and less private spending. - The Opportunity Cost of an action is the highest-valued option forgone (that you give up – or that you don’t take). - On a PPF the opportunity costs (since there’s only 2 goods) is the quantity of the good forgone, or that was given up in order to produce the good. In the case of the textbook, the opportunity cost of producing cola is the pizza forgone and vice- versa. - Because opportunity cost is a ratio, the opportunity cost of producing pizza is the inverse of the opportunity cost of producing cola. - The more of either good we try to produce, the less productive are the additional resources we use to produce that good and the larger the opportunity cost for that good is. So we achieve production efficiency at ALL points on the PPF but which point is the BEST? The answer is: The point of the PPF at which goods and services are produced in the quantities that provide the greatest possible benefit This is because when goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit, we have achieved allocative efficiency. The Marginal Cost of a good is the opportunity cost of producing one more unit of it. -We calculate marginal cost of something by the slope of the PPF. As the quantity of pizzas produced increases, the PPF gets steeper and the marginal cost of pizza increases. - Preferences are a description of a person’s likes and dislike. - The Marginal Benefit from a good or service is the benefit received from consuming one more unit of it. - We measure marginal benefit by how much people are willing to pay for an additional unit of it. - The most you are willing to pay for something is its marginal benefit. - The principal of decreasing marginal benefit – states that the more consume of any good or service, the smaller the marginal benefit and the less we’re willing to pay for an additional unit of it. - The basic reason for that is that we as humans like variety. The more we consume of any one good or service, the more we tire of it and the more likely we are to switch to something else. Example – IF pizza is scare and you only buy a couple of slice a year, then you’re more willing to pay a higher price for an additional slice. - BUT if pizza is ALL you’ve eaten ALL year then your probably willing to pay next to nothing for an extra slice. - Think of marginal benefit as the willingness to pay for an extra unit of something, or in terms of opportunities – it is the quantity of goods and services you are willing to forego. - Economic Growth is an increase in the production per person. Economic growth increases standard of living. To make our economy grow, we face a trade- off – the faster we make the economy grow, the higher the opportunity cost of economic growth - Economic growth comes from two things: 1. Technological Change is the development of new goods and better ways of producing them. 2. Capital accumulation is the growth of capital resources, including human capital. - If we use our resources to develop new technologies and produce capital we must decrease our production of consumption goods. Comparative Advantage – A person or firm or nation has a
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