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Chapter 2

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Department
Economics
Course
Economics 1021A/B
Professor
Jeannie Gillmore
Semester
Summer

Description
Chapter 2 Notes Production Possibilities Frontier  the quantities of goods and services that we can produce are limited by our available resources and by technology o if we want to increase our production of one good, we must decrease production of something else (a tradeoff)  the production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot o in a PPF, two goods are focused on at a time, and the quantities of all other goods and services are kept constant  a model economy Example of a PPF:  the PPF for cola and pizza shows the limits to production of these two goods, given the total resources and technology available to produce both o illustrates scarcity because we cannot attain points outside the frontier  production efficiency is achieved if we produce goods and services at the lowest possible cost o this outcome occurs at all points on the PPF o at points inside the PPF, production is inefficient because we are giving up more than necessary of one good to produce a given quantity of the other (e/x, point Z)  conclusions o only by producing on the PPF do we produce the lowest possible cost of production  at point Z, we produce 3 pizzas for 5 cola, but 3 pizzas can get us 9 colas (E) o production is inefficient inside the PPF because resources are either unused or misallocated or both o resources are unused when they are idle but could be working (e/x some workers at the pizza factory are not working at the moment) o resources are misallocated when they are assigned to tasks for which they are not the best match  e/x if the pizza chef worked at the cola factory Tradeoffs and Opportunity Costs  Every choice along the PPF involves a tradeoff o at any given point in time, we only have a fixed amount of labour, land, capital, and entrepreneurship o because these are fixed, we are limited in the amount of goods or services that we can produce  these are called tradeoffs  every tradeoff involves an opportunity cost  the opportunity cost of an action is the highest-valued alternative forgone o in a PPF, this idea enables us to calculate opportunity cost  along the PPF, there are only two goods, so there is only one alternative forgone (some quantity of the other good) o referring to the example, if we move from point C to point D, we get 1 million more pizzas but 3 million less cans of cola  1 additional pizza costs 3 cans of cola o likewise, by moving from point D to point C, the quantity of cola increases by 3 million cans and the quantity of pizza decreases by 1 million  3 million cans cost 1 million pizzas  1 can of cola costs 1/3 of a pizza o the opportunity cost of producing an additional can of cola is equal to the inverse of the opportunity cost of producing an additional pizza  thus, opportunity cost is a ratio o it is the decrease in the quantity produced of one good divided by the increase in the quantity produced of another as we move along the PPF Efficient Use of Resources  production efficiency is achievable at every point on a PPF, but at which point is the greatest? o the point at which goods and services are produced in the quantities that provide the greatest possible benefit o 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 o marginal cost can be calculated from the slope of the PPF  relating back to the example, as the quantity of pizzas produces increases, the PPF gets steeper and the marginal cost of a pizza increases Preferences and Marginal Benefit  the marginal benefit from a good or service is the benefit received from consuming one more unit of it o benefit is subjective, depends on peoples preferences o measured by the most that people are willing to pay for an additional unit of it  people are willing to pay less for a good than it is worth to you but you are not willing to pay more  the most you are willing to pay for something is its marginal benefit  general principle that the more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it o referred to as the principle of decreasing marginal benefit o in essence, the more we consume of any good or service, the more we tire of it and prefer to switch to something else Allocative Efficiency  at any point on the PPF, we cannot produce more of one good without giving up another o at the BEST point on the PPF, we cannot produce more of one good without giving up some other good that provides greater benefit  we are producing at the point of allocative efficiency  in general, we strive for the marginal cost and marginal benefit to be equal to achieve efficiency Economic Growth  the expansion of production possibilities is called economic growth o increases our standard of living, but it doesn’t overcome scarcity and avoid opportunity cost  economic growth comes from technological change and capital accumulation
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