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Chapter 2

ECON 1116 Chapter 2: Chapter 2- ECON

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ECON 1116
Michael P.Stone

Chapter 2 Trade-offs, comparative advantage, and the market system I. Production Possibilities Frontiers and Opportunity Costs Objective: use a production possibilities frontier to analyze opportunity costs and trade- offs Definitions Scarcity: unlimited wants but only limited resources Trade-off—the idea that because of scarcity, producing more of one good or service means producing less of another good or service. Production possibilities frontiers (PPF): a curve showing maximum attainable combinations of two goods that can be produced with available resources and current technology. - This model analysis trade offs Opportunity cost: The highest-valued alternative that must be given up to engage in an activity Slope of the graph Graphing the production possibilities frontier - Green line= frontier - The letters A, E on either extreme of the plotted line resemble one total mode of production (all X or all Y). - B, C, D are combinations of productions of both productions. - All points in or on the frontier are attainable - Points on the frontier are efficient because all resources are utilized at small amounts. -Points inside the frontier are inefficient because it is not at maximum output. - Points beyond the frontier are unattainable due to the scarcity of current resources. o The only way to produce more of a certain product is to produce less of another o Production levels are determined by customer demand Increasing Marginal Opportunity Costs The shape of the frontier is based upon where the economy currently is on the production possibilities frontier. When a firm moves down the PPF = increasing marginal opportunity cost because increasing Y production by a given quantity requires larger and larger decrease in X production. Marginal opportunity cost is the amounts of products lost when a company moves from one point of the frontier to another. A: some resources that are well suited to producing automobiles are forced to produce tanks From A to B: increase in automobile production without much loss of tank production  PPF bowed outwards Increasing marginal opportunity costs illustrates an important economic concept: The more resources already devoted to an activity the smaller the payoff to devoting additional resources to that activity. Economic Growth definition: ability of the economy to increase the production of goods and services - Total resources available to any economy are fixed: produce more of product X and less of product Y - Capital stock: amount of machinery and other physical capital available in an economy - Resources available to an economy may increase because both the labor force and the capital stock increase - When amount of resources increase the economy’s PPF shifts outward possible to produce more X and Y - Technological change possible to produce more goods with the same number of workers and the same amount of machinery shifts the PPF outward II. Comparative Advantage and Trade Objective: describe comparative advantage and explain how it serves as the basis trade Trade: act of buying and selling  Trade directly  Trade indirectly Specialization and Gains from Trade Absolute advantage versus Comparative advantage Absolute advantage: ability of an individual, a firm or a country to produce mo
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