Ch. 2: The Economic Problem. Topics Production Possibilities Frontier & Oppurt. Cost Efficient...
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![Page 1: Ch. 2: The Economic Problem. Topics Production Possibilities Frontier & Oppurt. Cost Efficient Allocation of resources Trade-off between current and future.](https://reader035.fdocuments.in/reader035/viewer/2022062407/56649d3e5503460f94a16e24/html5/thumbnails/1.jpg)
Ch. 2: The Economic Problem.
• Topics
• Production Possibilities Frontier & Oppurt. Cost
• Efficient Allocation of resources
• Trade-off between current and future production.
• Gains from specialization and trade
• Importance of property rights and markets
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Production Possibilities and Opportunity Cost
Production Possibilities Frontier (PPF) – boundary between combinations of goods and
services that can be produced and those that cannot.To illustrate PPF,
– Assume economy produces only two goods at a time and hold the quantities of all other goods and services constant.
– Assume everything else remains the same (ceteris paribus) except the two goods we’re considering.
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PPF and Efficiency
Combinations of goods can be classified as
•Attainable
•Productively efficient
•Productively inefficient
•Unattainable
Coconuts
Fish
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PPF and Opportunity Cost
• Measuring opportunity cost using the PPF.
• Opportunity cost of 1 million pizzas at– C– D
• |Slope of PPF| = opportunity cost of pizza
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Production Possibilities and Opportunity Cost
Opportunity cost of 1 million CDs At C At D
|Inverse of PPF slope| = opportunity cost of CDs
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Law of IMOC
• The Law of Increasing Marginal Opportunity Cost As the quantity
produced of each good increases, so does its opportunity cost.
Causes concave (bowed away from origin) PPF
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What is the marginal opportunity cost of the 4th car?
25% 25%25%25%
30
TVs per day
Cars per day
0 1 2 3 4 5
20
17
15
10
a) 10 TVs
b) 5 TVs
c) 3 TVs
d) 1 TV
0%
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A combination of 3 cars and 12 TVS would be
33% 33%33%
30
TVs per day
Cars per day
0 1 2 3 4 5
20
17
15
10
0%a) efficient
b) inefficient
c) unattainable
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The opportunity cost of an additional TV is higher at
50%50%
30
TVs per day
Cars per day
0 1 2 3 4 5
20
17
15
10
0%A
B
a) A
b) B
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Using Resources Efficiently
• This figure illustrates the marginal cost of pizza.
• As pizza production increases, the opportunity cost and the marginal cost of pizza increases.
• The Law of IMOC implies concavity of PPF
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Using Resources Efficiently
A graph of marginal opportunity cost is upward sloping because of Law of IMOC.
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Using Resources Efficiently
• Marginal Benefit (MB) of a good or service– Reflects a person’s “preferences”– Measures the benefit received from consuming one more unit of
it.– Can be measured by the amount that a person is willing to pay
for an additional unit of a good or service.
• Law of Decreasing MB (Law of Diminishing Marginal Utility) – the more we have of any good or service, the smaller is its
MB and the less we are willing to pay for an additional unit of it.
– MB Curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed.
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Using Resources Efficiently
• The Marginal Benefit curve slopes downward to reflect Law of Decreasing Marginal
Benefit .
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Using Resources Efficiently
• Two kinds of efficiency– Productive efficiency:
• When we cannot produce more of any one good without giving up some other good
• producing at a point on the PPF.
– Allocative efficiency• When we cannot produce more of any one good
without giving up some other good that we value more highly
• producing at the point on the PPF that we prefer above all other points.
• MB of last unit = MC of last unit
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Allocative Efficiency
MB
MC
# of pizzas (in millions)
MB, MC measured in CDs
2.5
If Q<500, why should production increase?
If Q>500, why should production decrease?
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Allocative Efficiency
MB
MC
# of pizzas (in millions)
MB, MC measured in CDs
2.5
If MC increases, how would allocatively efficient level change?
If MB increases, how would allocatively efficient level change?
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Using Resources Efficiently
• The point of allocative efficiency – point at which marginal
benefit equals marginal cost.
– determined by the quantity at which MB=MC
– Changes as preferences (MB) or costs (MC) change.
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Suppose that for health reasons, people prefer more tomatoes in their diet. This will cause the allocatively efficient amount of tomato production to increase because ____.
a) MC decreases
b) MC increases
c) MB increases
d) MB decreases
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Economic Growth
• Economic Growth– expansion of PPF– Increases the standard of living
• Determinants of economic growth: Technological change Capital accumulation
Physical or human
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Economic Growth
Consumer goods
Capital Goods
•How will the choice between consumer and capital goods affect future economic growth?
• What kind of government policies can affect location on PPF?
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Gains From Trade
• Comparative Advantage– A person has a comparative advantage in
production of a good if that person can produce the good at a lower opportunity cost than anyone else.
• Absolute advantage– A person has an absolute advantage in an
activity if that person can produce more of the good in a given amount of time than anyone else.
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Gains From Trade
Coconuts per day
Fish per day
Mary
Bill
9
9
15
10
Who has absolute advantage in
coconutsfish
Who has comparative advantage in
coconutsfish
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Gains From Trade
Coconuts per day
Fish per day
Mary
Bill
9
9
15
10
Suppose no trade and on PPF. •If Bill produces 3 fish, he can produce ____ coconuts.•If Mary produces 6 fish, she can produce ____ coconuts.•World production is ____ fish and ___ coconuts.
If specialize and tradeworld production could be ____ fish and ____ coconuts.
What are the gains from trade?
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Gains From Trade
What is the “world” PPF for Mary & Bill?
Coconuts per day
Fish per day
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Gains From Trade
• Nations can gain from specialization and trade
• Because the gains from trade arise from comparative (not absolute) advantage, people can gain from trade even if they have an absolute advantage in all commodities.
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Gains from Trade Revisited
Suppose there is a small island economy with 20 Irish and 10 Germans. Each Irish can catch either 10 fish or gather 40 coconuts in a day. Each German can catch either 6 fish or 30 coconuts in a day.
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The ___ have the comparative advantage in fish and the ___ have the comparative advantage in coconuts.
a) Irish; Irish
b) Germans; Germans
c) Irish; Germans
d) Germans; Irish
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Draw PPF Here
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If everyone split their time equally between fishing and coconuts, total production would be ______ fish and _____ coconuts.
130; 550
160; 680
200; 600
240; 800
25% 25%25%25%
300%
a) 130; 550
b) 160; 680
c) 200; 600
d) 240; 800
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Based upon the PPF, if production is organized efficiently and 130 fish are produced, _____ coconuts can be produced.
360520
580640
25% 25%25%25%
300%
a) 360
b) 520
c) 580
d) 640
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Based upon the PPF, if production is organized efficiently and 130 fish are produced along with the maximum possible number of coconuts, the fish would be produced by _____ and the coconuts would be produced by _____.
Only Iri
sh; O
nly Germ
ans
Irish
and Germ
ans; Only
I...
Only Iri
sh; Ir
ish and G
er...
Irish
and Germ
ans; Iris
h a..
25% 25%25%25%
300%
a) Only Irish; Only Germans
b) Irish and Germans; Only Irish
c) Only Irish; Irish and Germans
d) Irish and Germans; Irish and Germans.
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The Market Economy
• Trade is organized using two key social institutions: Property rights Markets
• Property Rights– the social arrangements that govern ownership, use,
and disposal of resources, goods or services.
• Markets– any arrangement that enables buyers and sellers to
get information and do business with each other.