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Chapter 2

Chapter 2 Production Possibilities

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Western University
Economics 1021A/B
Michael Parkin

Microeconomics- Chapter 2 Production Possibilities and Opportunity Cost quantities of goods and services that we can produce are limited both by our available • resources and by technology • increase production of one good, must decrease production of something else: a tradeoff • production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot focus on two goods, hold quantities of other goods constant • • PPF illustrates scarcity because we cannot attain the points outside the frontier • points outside the frontier describe wants that can’t be satisfied • can produce any point inside the PPF or on the PPF, these points are attainable Production Efficiency • production efficiency- produce goods and services at the lowest possible cost • occurs at all points on the PPF • points inside the PPF, we are giving up more than necessary of one good to produce a given quantity of the other good • production is inefficient inside PPF- resources are either unused or misallocated • unused- resources are idle but could be working • misallocated- resources are assigned to tasks for which they are not suited Tradeoff Along the PPF • we can employ resources to produce goods and services, but are limited in what we can produce • there is a boundary between what we can attain and what we cannot attain Opportunity Cost • opportunity cost of an action is the highest-valued alternative forgone • i.e. opportunity cost of producing an additional pizza is the cola we must forgo • opportunity cost is a ratio- decrease in the quantity produced of one good divided by the increase in the quantity produced of another good opportunity cost of producing an additional can of cola is equal to the inverse of the • opportunity cost of producing an additional pizza • outward-bowed shape of the PPF reflects increasing opportunity cost • when we produce a large quantity of cold and small quantity of pizzas, frontier has gentler slope PPF is bowed outward because resources are not all equally productive in all activities • PPF and Marginal Cost • when goods and services are produced at the lowest possible cost and in quantities that provide greatest possible benefit, we have achieved allocative efficiency • marginal cost of a good is the opportunity cost of producing one more unit of it Preferences and Marginal Benefit • preferences are a description of person’s likes and dislikes • marginal benefit from a good or service is the benefit received from consuming one more unit of it • measure the marginal benefit from a good by the most people are willing to pay for an additional unit of it • you are willing to pay less for a good than it is worth to you but you are not willing to pay more than it is worth • marginal benefit curve- shows the relationship between marginal benefit from a good and the quantity consumed of that good • principle of decreasing marginal benefit- more we have of any good, the smaller is its marginal benefit and less we are willing to pay for it • basic reason- we like variety Allocative Efficiency • at best point on PPF- we cannot produce more of one good without giving up some other good that provides greater benefit • point of allocative efficiency- point we prefer above all other points Economic Growth • expansion of production is called economic growth • doesn’t overcome scarcity and avoid opportunity cost • to make our economy grow, we face a tradeoff- faster we make production grow,
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