Chapter 2 Flashcards
Production Possibilities Frontier
The boundary between those combinations of goods
and services that can be produced and those that cannot. The PPF looks at a MODEL
ECONOMY where only TWO GOODS CHANGE and all others do not.
PPF illustrates scarcity because all points inside of the curve are ATTAINABLE and all
points outside of the curve are UNATTAINABLE.
Production efficiency
Occurs when we produce the greatest amount of goods for the
lowest cost. This occurs at all the points ALONG the PPF.
● Production is INEFFEICIENT when resources are unused or misallocated or both
● Resources are unused when they could be working
● They are misallocated when they are assigned to tasks for which they are not the
best match (example: assigning pizza chefs to work in a cola factory)
Opportunity cost
Highest valued alternative forgone. Since there are only two goods on
the PPF, the opportunity cost directly correlates to changes in the production rates of
both products.
Marginal cost
The opportunity cost of producing one more unit
Marginal cost is explained through the diagrams below, as it is measured through the
marginal increase in the opportunity cost of a good.
Marginal benefit
The benefit from consuming one more unit of a good or service.
● The most you are willing to pay for something
● Cannot be derived from the PPF
Principle of decreasing marginal benefit: The more we have of a good or service the
lower the marginal benefit and thus the lower the price we are willing to pay.
Allocative efficiency
When goods and services are produced at the lowest possible cost
for the greatest possible benefit. This can be found by superimposing both the MC
(marginal cost) and MB (marginal benefit) curves on one plane and finding where they
reach equilibrium.
Specialization
Producing only one or few goods.
COMPARATIVE ADVANTAGE and ABSOLUTE ADVANTAGE
A COMPARATIVE ADVANTAGE occurs if an individual can produce a product at a
lower opportunity cost than anyone else.
An ABSOLUTE ADVANTAGE occurs when an individual is more productive than
others.
Economic growth
Expansion of production possibilities.
● Increases standard of living
● Does not overcome scarcity or avoid opportunity cost
Two key factors of economic growth:
- Technological change
- Capital accumulation
Capital accumulation
Growth of capital resources, including human capital.
In the context of economic growth, we must give up producing an abundance of one
resource to gain new capital.
● The more of an existing resource a firm gives up to accumulate more capital, the
greater their PPF will expand outwards
Two types of economic coordination systems:
Central planning and Decentralized (market) coordination
Central planning
Does not work because individuals are tasked with planning
the economy’s future without knowing people’s production possibilities and
preferences. Thus, production ends up INSIDE the PPF (wrong things are
produced)
Decentralized (market) coordination
Works best, but requires four
complementary social institutions
a. Firms – Unit that hires factors of production and organizes them to
produce and sell goods and services (ex. Loblaws)
b. Markets – Any arrangement that enables buyers and sellers to get
information and do business with each other (ex. World Oil Market)
c. Property rights – Social arrangements that govern the ownership, use, and
disposal of anything that people value are called property rights
d. Money – Any commodity or token that is generally acceptable as a means
of payment
