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Chapter 2

Chapter 2 - The Economic Problem - Textbook Notes

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Department
Economics
Course
ECON 1000
Professor
Steven Edwards
Semester
Fall

Description
Sept.16 , 2013 ECON 1000 Chapter 2: The Economic Problem Production Possibilities and Opportunity Cost - Across Canada, 17 million people produce a vast variety of goods and services valued at $5 billion but the quantities that we can produce are limited by our available resources and technology - If we want to increase our production of one good, we must decrease our production of something else (tradeoff) Production Possibilities Frontier (PPF) - Boundary between combinations of goods and services that can be produced and those that cannot - To illustrate the PPF, we look at a model economy in which everything remains the same except for the production of the two goods we are considering - E.g. PPF for cola and pizza [pg.30] o X-axis shows the quantity of pizzas produced, and the y-axis shows the quantity of cola produced o PPF illustrates scarcity because we cannot attain the points outside the frontier o Points that are outside the frontier are wants that cannot be satisfied o Any point inside the PPF or on the PPF can be produced o PPF separates the attainable from the unattainable Production Efficiency - When goods and services are produced at the lowest possible cost - This outcome occurs at all the points on the PPF - 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 good - Production is inefficient inside the PPF because resources are either unused or misallocated or both - Resources are unused when they are idle but could work (E.g. Leaving some of the factories idle or some workers unemployed) - Resources are misallocated when they are assigned to tasks for which they are not the best match (E.g. Assigning skilled pizza chefs to work in a cola factory and skilled cola producers to work in a pizza shop) Tradeoff Along the PPF - Every choice along the PPF involves a tradeoff which involve Opp. Cost - Limits in what we can produce define a boundary between what we can attain and what we cannot attain - This boundary defines the tradeoffs that we must make Opportunity Cost: - Highest-valued alternative forgone - There are only two goods along the PPF, so there is only one alternative forgone: some quantity of the other good - E.g. We can produce more pizzas only if we produce less cola; the opportunity cost of producing an additional pizza is the cola we must forgo - The opportunity cost of producing an additional can of cola is equal to the inverse of the opportunity cost of producing an additional pizza Opportunity Cost as a Ratio: - The decrease in the quantity produced of one good divided by the increase in the quantity produced of another good Increasing Opportunity Cost: - Opportunity cost of a pizza increases as the number of pizzas produced increases - Outward-bowed shape of the PPF reflects increasing opportunity cost – It is bowed outward because resources are not all equally productive in all activities - E.g. People who worked for PepsiCo for many years are good at producing cola but not very good at making pizzas. If we move these workers from PepsiCo to Domino’s, there is a small increase in the quantity of pizzas but a large decrease in the quantity of cola produced. - When the rate of production increases, so does the opportunity cost of production Using Resources Efficiently: We achieve production efficiency at every point on the PPF, but which point is the best? The answer is the point on the PPF at which goods and services are produced in the quantities that provide the greatest possible benefit. - Allocative efficiency is when goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit - To answer questions about allocative efficiency, we must measure and compare costs and benefits The PPF and Marginal Cost: - Marginal cost of a good is the opportunity cost of producing one more unit of it; It is calculated from the slope of the PPF - As the quantity of pizza produced increases, the PPF gets steeper and the marginal cost of a pizza increases - PAGE 33 - Marginal cost curve shows the marginal cost of producing a pizza at each quantity of pizzas as we move along the PPF - Preferences and Marginal Benefit: - Marginal benefit from a good or service is the benefit received from consuming one more unit of it; This benefit is subjective – It depends on people’s preferences – people’s likes and dislikes and the intensity of those feelings - Marginal benefit and preferences stand in sharp contrast to marginal cost and production possibilities - Preferences describe what people like and want, and the production possibilities describe the limits or constraints on what is feasible - Marginal benefit curve is used to illustrate preferences, which is a curve that shows the relationship between the marginal benefit from a good and the quantity consumed of that good - Marginal benefit curve is UNRELATED to the PPF, and cannot be derived from it - Marginal benefit is measured from a good or service by the most that people are willing to pay for an additional unit - The principle of decreasing marginal benefit – 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 - Basic reason why marginal benefit decreases is that we like variety - The more we consume of any one good or service, the more we tire of it and would prefer to switch to something else - The marginal benefit, measured by what you are willing to pay for something, is the quantity of other goods and services that you are willing to forgo - Essentially, the greater the quantity of pizza produced, the smaller the MB from a pizza (the less cola people are willing to give up to get an additional pizza) and the greater the quantity of pizza produced, the greater is the MC of a pizza (the more cola people must give up to get an additional pizza) - When MB equals MC, resources are being used efficiently Allocative Efficiency: - At ANY point on the PPF, we cannot produce more of one good without giving up some other good - 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 – the point on the PPF that we prefer above all other points - Figure 2.4 on pg. 35 – Marginal cost and marginal benefit are equal at 3 cans of cola. This allocation of resources between pizzas and cola is efficient. If more pizzas are produced, the forgone cola is worth more than the additional pizzas. If fewer pizzas are produced, the forgone pizzas are worth more than the additional cola. Economic Growth: - During the past 30 years, production per person in Canada has doubled - Expansion of production possibilities is called economic growth - Economic growth increases our standard of living, but it doesn’t overcome scarcity and avoid opportunity cost - Toe make our economy grow, we face a tradeoff – the faster we make production grow, the greater is the opportunity cost of economic growth The Cost of Economic Growth: - Economic growth comes from: 1) Technological change, which is the development of new goods and of better ways of producing goods and services 2) Capital accumulation, which is the growth of capital resources, including human capital - These two have vastly expanded our production possibilities - E.g. Automobiles that provide us with more transportation that horses and carriages, satellites that provide global communications on a much larger scale that earlier cable technology, etc. - BUT if we use our resources to develop new technologies and produce capital, we must decrease our production of consumption goods and services - New technologies and new capital have an opportunity cost - Figure 2.5 on pg.36 – The opportunity cost of producing more pizzas in the future is producing fewer pizzas today. Also, on the new PPF, we still face a tradeoff and opportunity cost. - The amount by which our production possibilities expand depends on the resources we devote to technological change and capital accumulation - The fewer resources we use for producing pizza and the more resources we use for producing ovens, the greater is the expansion of our future production possibilities - Economic growth brings enormous benefits in the form of increased consumption in the future, but it is not free and it doesn’t abolish scarcity - “Hong Kong Overtakes Canada” case study on pg.37 – Since Hong Kong devoted one-third of its resources to accumulating capital in 1960, and since Canada only devoted one-fifth of its resources to accumulating Capital, Hong Kong’s production possibilities have expanded more quickly - The more resources that is devoted to accu
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