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Chapter 2

Chapter 2 - ECON 1000


Department
Economics
Course Code
ECON 1000
Professor
Sam Lanfranco
Chapter
2

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Production Possibilities and Opportunity Cost
If you want to increase production of one good you must decrease production of something else
PPF focuses on two goods at a time and hold quantities produced of all other goods and services constant
It is a model economy where everything remains the same except for production of two goods we are considering
The production possibilities frontier is the boundary between combinations of goods and services that can be produced and those that cannot
Production Possibilities Frontier
The PPF for cola and pizza show limits to production of these two goods given total resources and technologies
Can only produce points inside the PPF or on the PPF
PPF illustrates scarcity because we cannot attain points outside of frontier
Production Efficiency
Achieved if goods and services are made at lowest possible cost
This means resources are unused or misallocated, or both
Unused: idle but could be working
Skilled pizza chefs to work in cola and skilled cola to work in pizza
Misallocated: assigned to tasks for which they are not best matched
If inside the PPF, it is inefficient because too much is given up to produce a certain good
Occurs at points on the PPF
Tradeoff Along PPF
Every choice along PPF involves tradeoff
Limit defines boundary between what we can attain and what we cannot
Boundary is the real world's production possibilities frontier and defines tradeoffs we must make
We have a set amount of labour, land, capital, and entrepreneurship and can produce goods and services but we are limited in what we can produce
Tradeoffs involve a cost -- an opportunity cost
Opportunity Cost
Opportunity cost of an action is highest-valued alternative forgone
Only two goods so there is only one alternative forgone
Opportunity cost of producing an additional pizza is the cola we must forgo
Opportunity cost of producing an additional cola is the pizza we must forgo
If you get X more pizza but Y fewer cans of cola, that means one pizza costs Y/X cans of cola
Move from one point to another
PPF allows you to calculate opportunity cost
Decrease in quantity produced of one good divided by increase of quantity produced of another good
Because it is a ratio, opportunity cost of producing an additional can of cola is equal to inverse of opportunity cost of producing an additional pizza
Opportunity cost is a ratio
Increasing Opportunity Cost
Opportunity cost of a pizza increases as the quantity of pizza produced increases
Opportunity cost of barrel is $30
When price of crude oil doubles, it is worthwhile for people to extract more crude oil and from higher-cost sources
Opportunity cost of extracting oil is $50 a barrel
As we produce more crude oil, we slide around our PPF and the opportunity cost of producing oil rises
As production increases, opportunity cost rises
Example: it costs $30 a barrel to get crude oil out of ground and to refinery
Results in less productive additional resources used to produce good and larger opportunity cost of a unit of that good
Experienced X producers are not as experienced in producing Y
PPF is bowed outward because resources are not all equally productive in all activities
Using Resources Efficiently
When goods and services are produced at lowest possible cost and in quantities that provide greatest possible benefit
Must measure costs and benefits
Allocative efficiency:
Production efficiency is at every point of PPF
PPF and Marginal Cost
Cost of producing one more unit of it
Calculate cost for 1 million X and graph it
Refer to textbook page 35
Calculated from the slope of the PPF
Marginal Cost:
Description of one person's likes and dislikes
Preferences:
Concrete way to describe preference
It is the benefit received from consuming one more unit of it
Most you are willing to pay for something measures its marginal benefit
You are willing to pay less for a good than it is worth to you but not more
Measured by most people are willing to pay for an additional unit of it
Marginal benefit:
Shows the relationship between marginal benefit of a good and quantity consumed
It decreases because we like variety
The more we consume of one good or service the more we tire of it and prefer to switch to something else
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
Principle of decreasing marginal benefit:
Marginal benefit curve
Allocative Efficiency
Chapter 2 - The Economic Problem
October-11-11
12:00 PM
ECON 1000 Page 1
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