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Chapter 2

Microecon chapter 2 notes

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Western University
Economics 1021A/B
Michael Parkin

Chapter 2  Production Possibilities Frontier  boundary between combinations of goods and services we can produce and those that we can’t (see hand notes for graphs) o With PPF, only consider 2 goods or services  ceteris paribus with all other factors held constant o Inside the PPF, “attainable,” but “production inefficient” (resources not being used or misallocated to doing something they are not the most efficient at) o On PPF, attainable and production efficient (all resources in use) o Beyond PPF, “unattainable,” but desirable  Opportunity Cost is what’s given up as you produce more of something o Opportunity Cost of 1 beef = 3 corn o OC of 1 corn = 1/3 beef  Note how they are always the inverse of each other when it comes to the movement in opposite directions between the same points?  Transformational PPF—OC is the same all along the line o Not always the case. Some resources better suited to produce some goods  Concave PPF—resources are not equally productively efficient for both goods o Concave PPF corresponds to increasing OC  To produce more beef, you’d have to give up land that’s more and more productive for corn  Trick wording on tests! OC for FIRST beef is 3 corn; OC for ONE beef is 3 corn; OC for SECOND beef is 3 corn; but OC for TWO beef is 6 corn (3 from first one plus the 3 from the other one). It’s the difference between the OC from point A to B, B to C, then A to C on a PPF!  Production efficient  when we cannot produce more of one good/service without producing less of another good/service  Marginal Cost  the opportunity cost of producing one more unit of a good/service (derived from PPF) o If you look at the marginal cost of producing each additional unit of good A on the PPF, and plot this on a bar graph, the line that runs through the mid-point of each bar is the Marginal Cost Curve (shows relation between the margin cost and the quantity produced of a good)  Note: while the x-axis on this bar chart reflects the quantity produced of good A, the y-axis does not reflect the quantity produced of the other good/service in question—it shows the additional units of that good/service forgone when we increase production of good A by each additional unit o The idea behind this curve is to divide each additional unit into infinitesimally smaller units. The MC of producing each of these units would form the MC line (kind of like the approximation method used in integration, no?)  Marginal Benefit  the additional gain or pleasure from consuming an additional unit of a good/service. Not derived from PPF; instead, from preferences o Marginal Benefit curve  relation between the marginal benefit of consuming additional units of a g/s and the quantity consumed o Principle of decreasing marginal benefit (law of diminishing returns/marginal utility)—the more you consume of a good/service, the less benefit it gives you each additional time  Point at which MB and MC intersect  allocative efficient: when we cannot produce more of one good/services without producing less of another that we value more (that is, at a point where if we produce more, MC > MB). This point on the PPF gives us max MB net of MC. o Remember: at the aforementioned point of intersection, it is the corresponding quantity of the good on the x-axis that is the same as the x-component of the allocative efficient point on the PPF. The corresponding quantity on the y-axis of the MC/MB graph is NOT the quantity of the other good in the allocative efficient bundle on the PPF—the y-axis measures the marginal units of that good GIVEN UP to produce each additional unit
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