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
Can produce any point inside the
PPF or on the PPF
Production Efficiency is achieved
when we produce g/s at the lowest
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
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