110Ch02

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Information about 110Ch02
Entertainment

Published on September 12, 2007

Author: Octavio

Source: authorstream.com

Chapter 2 The Economic Problem: Objectives:  Chapter 2 The Economic Problem: Objectives Defining the production possibilities frontier and calculating opportunity cost Distinguishing between production possibilities and preferences and describing an efficient allocation of resources Explaining how current production choices expand future production possibilities Explaining how specialization and trade expand our production possibilities Explaining why property rights and markets have evolved Production Possibilities and Opportunity Cost:  Production Possibilities and Opportunity Cost The production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot. We look at a model economy in which everything remains the same (ceteris paribus) except pizzas and CDs. Production Possibilities and Opportunity Cost :  Production Possibilities and Opportunity Cost Points inside and on the frontier, e.g. A, B, C, D, E, F, and Z are attainable. Production Efficiency Cannot produce more of one without producing less of the other. Points on PPF are efficient. Points inside are inefficient. Production Possibilities and Opportunity Cost :  Production Possibilities and Opportunity Cost A move from C to D, increases pizza production by 1 million. CD production decreases from 12 million to 9 million, a decrease of 3 million. The opportunity cost of 1 million pizza is 3 million CDs. One pizza costs 3 CDs. Production Possibilities and Opportunity Cost :  Production Possibilities and Opportunity Cost A move from D to C, increases CDs production by 3 million. Pizza production decreases by 1 million. The opportunity cost of 3 million CDs is 1 million pizza. One CD costs 1/3 of a pizza. Production Possibilities and Opportunity Cost :  Production Possibilities and Opportunity Cost Note that the opportunity cost of CDs is the inverse of the opportunity cost of pizza. One pizza costs 3 CDs. One CD costs 1/3 of a pizza. Production Possibilities and Opportunity Cost :  Production Possibilities and Opportunity Cost Because resources are not all equally productive in all activities, the PPF bows outward—is concave. The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost. Using Resources Efficiently:  Using Resources Efficiently Points along the PPF are efficient in terms of production. 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 of pizza:  Marginal cost of pizza As we move along the PPF in part a (shown here) the opportunity cost and the marginal cost of pizza increases. Using Resources Efficiently :  Using Resources Efficiently The blocks illustrate the increasing opportunity cost of pizza. The black dots, and the line labeled MC show the marginal cost of pizza. Using Resources Efficiently :  Using Resources Efficiently Preferences and Marginal Benefit Preferences are a description of a person’s likes and dislikes. The marginal benefit of a good or service is the benefit received from consuming one more unit of it. We measure marginal benefit by the amount that a person is willing to pay for an additional unit of a good or service. The marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed. Marginal Benefit Curve :  Marginal Benefit Curve The curve slopes downward to reflect the principle of decreasing marginal benefit. At point A, people are willing to pay 5 CDs per pizza. At point B, people are willing to pay 4 CDs per pizza. At point E, people are willing to pay 1 CD per pizza. Using Resources Efficiently :  Using Resources Efficiently Efficient Use of Resources When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency, and we are producing at a point on the PPF. When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency, and we are producing at the point on the PPF that we prefer above all other points. Allocative Efficiency :  Allocative Efficiency The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal cost. This point is determined by the quantity at which the marginal benefit curve intersects the marginal cost curve. Using Resources Efficiently :  Using Resources Efficiently We get more value from our resources by producing more pizza. On the PPF at point A, we are producing too many CDs, and we are better off moving along the PPF to produce more pizza. If we produce less than 2.5 million pizza, marginal benefit exceeds marginal cost. Using Resources Efficiently :  Using Resources Efficiently We get more value from our resources by producing less pizza. On the PPF at point C, we are producing too much pizza, and we are better off moving along the PPF to produce less pizza. If we produce more than 2.5 million pizza, marginal cost exceeds marginal benefit. Using Resources Efficiently :  Using Resources Efficiently We cannot get more value from our resources. On the PPF at point B, we are producing the efficient quantities of CDs and pizza. If we produce exactly 2.5 million pizza, marginal cost equals marginal benefit. Economic Growth:  Economic Growth The expansion of production possibilities—and increase in the standard of living—is called economic growth. Two key factors influence economic growth: Technological change Capital accumulation Technological change is the development of new goods and of better ways of producing goods and services. Capital accumulation is the growth of capital resources, which includes human capital. To use resources in Randamp;D and to produce new capital, need to decrease production of consumption goods and services. Change in Tradeoff :  Change in Tradeoff We can produce pizza or pizza ovens along PPF0. By using some resources to produce pizza ovens, the PPF shifts outward in the future. Economic Growth in the United States and Hong Kong:  Economic Growth in the United States and Hong Kong In 1963, Hong Kong’s production possibilities (per person) were much smaller than those in the United States. But Hong Kong grew much faster than the United States grew by devoting more of its resources to capital accumulation. Comparative Advantage and Gains From Trade:  Comparative Advantage and Gains From Trade Tom can produce 1,000 discs and 1,000 cases at point A. A person has a comparative advantage in an activity if she can perform the activity at a lower opportunity cost than anyone else. Along his PPF, Tom’s opportunity cost of a disc is 1/3 of a case and his opportunity cost of a case is 3 discs. Gains From Trade:  Gains From Trade Nancy can produce 1,000 discs and 1,000 cases at point A. Along her PPF, Nancy’s opportunity cost of a disc is 3 cases and her opportunity cost of a case is 1/3 of a disc. Gains From Trade :  Gains From Trade If Tom and Nancy produce discs and cases independently, they can produce 1,000 CD million each (2,000 total). But because Tom’s opportunity cost of producing discs is less than Nancy’s, he has a comparative advantage in disc production. And because Nancy’s opportunity cost of cases is less than Tom’s, she has a comparative advantage at producing cases. Tom and Nancy can gain from trade. Achieving the Gains from Trade:  Achieving the Gains from Trade Gains From Trade :  Gains From Trade If Tom and Nancy exchange cases and discs at one case per disc (one disc per case) they exchange along the Trade line. Tom ends up at point C with 2,000 million CD —double what he can achieve without specialization and trade. Gains From Trade :  Gains From Trade Nancy also ends up with 2,000 million CD — double what she can achieve without specialization and trade. Gains From Trade :  Gains From Trade Nations can gain from specialization and trade, just like Tom and Nancy can. Absolute Advantage A person (or nation) has an absolute advantage if that person (or nation) can produce more goods with a given amount of resources than another person (or nation) can. Because the gains from trade arise from comparative advantage, people can gain from trade in they also have an absolute advantage. Gains From Trade :  Gains From Trade Dynamic Comparative Advantage Learning-by-doing occurs when a person (or nation) specializes and by repeatedly producing a particular good or service becomes more productive in that activity and lowers its opportunity cost of producing that good over time. Dynamic comparative advantage occurs when a person (or nation) gains a comparative advantage from learning-by-doing. The Market Economy:  The Market Economy Trade is organized using two key social institutions: Property rights Markets Property Rights Property rights are the social arrangements that govern ownership, use, and disposal of resources, goods or services. Markets A market is any arrangement that enables buyers and sellers to get information and do business with each other. Circular Flows in the Market Economy:  Circular Flows in the Market Economy Goods and services and factors of production flow in one direction. And money flows in the opposite direction. The Market Economy :  The Market Economy Coordinating Decisions Prices coordinate decisions in markets.

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