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Chapter 2

Chapter 2- The Economic Problem.docx

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ECON 1000
George Georgopoulos

Chapter 2 - The Economic Problem (Pages 30-45) Production Possibilities and Opportunity Cost  Quantities of goods and services that we produce are limited by our available resources and by technology.  If we want to increase our production of one good, we must decrease production of something else (tradeoff)] Production Possibilities Frontier (PPF)  The boundary between those combinations of g/s that can be produced and those that cannot.  To show this, we focus on two goods at a time and hold the quantities produced of all the other g/s constants.  Look at a model economy, which everything remains the same except the production of the two goods we’re looking at.  The PPF shows scarcity sine we cannot produce points outside the frontier.  Can produce any point inside the PPF or on the PPF  Production Efficiency is achieved when we produce g/s at the lowest possible cost.  Occurs on points on the frontier (efficient)  Points inside PPF are inefficient because we are giving up more than necessary (resources are either unused or misallocated).  Every choice along PPF is a tradeoff (involves an opportunity cost)  Opportunity Cost of an action is the highest alternative valued forgone.  Opportunity cost is a ratio  From point E to F, pizza increases by 1 million, while cola decreased by 5 million.  Opportunity cost of the fifth 1 million pizzas is 5 million cans of cola. Therefore one of these pizzas cost 5 cans of cola or a can of cola cost is 1/5 a pizza. Increasing Opportunity Cost  Because resources are not equally productive in all activities, the PPF bows outward.  The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost. Using Resources Efficiently  To determine which of the alternative efficient quantities to produce, we compare costs and benefits. The PPF and Marginal Cost  The PPF determines opportunity cost.  The marginal cost of a good or service is the opportunity cost of producing one more unit of it.  Marginal cost calculated from the slope of PPF, as quantity of pizza increases, PPF gets steeper, marginal cost of producing pizza increases. Preferences and Marginal Benefit  The Marginal Benefit from a g/s is the benefit received from consuming one more unit of it. Depends on person’s preferences (their likes/dislikes and intensity of those feelings).  We measure marginal benefit by the amount that a person is willing to pay for an additional unit of a good or service.  The general principle is: that more we have of any good, the smaller its marginal benefit, the less we are willing to pay for an additional unit of it.  We call this general principle the principle of decreasing marginal benefit.  The marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good con
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