EREC Chapter 2 Flashcards
The three questions an economy must answer
- What to produce
- How to produce it
- For whom to produce it
How do economies answer the three question?
Based on different markets, command, mixed and market economies
What is a market?
Definition: A set of arrangement by which buyers and sellers of a good or service are in contact
to trade that good or service
Necessary conditions of a market
- Gains to be made from trade (each party will find some benefit from the trade)
- Existence of property rights that are
a. Exclusively owned (only one person can own the rights to the good/service
that is being sold/bought)
b. Transferable (the ownership rights of the good/service being sold CAN be
transferred from one person to another
Private property rights only exist if they are…
Exclusively owned/transferable - when property rights are EXCLUSIVELY controlled by one owner and are transferable to others
(IF an interaction or trade DOESN’T have these conditions- then it isn’t a market (maybe even illegal)
Functions of the market
Information for decision makers
- Reduces transaction cost
-Helps move scare resources to their highest valued uses
Provides forum for participants
-Coordinates buyers and sellers
Provides motivation for producers
Adam Smith’s invisible hand theory-
In a market, when each person acts in their own self-interest, it will lead to the best possible outcome for everyone. It is almost as if individuals in a market are guided by an invisible hand… that pushes the market to equilibrium.
At equilibrium, sellers make what people
want and sell it at a price that buyers are willing to pay. Buyers spend their money to buy up what
people are selling. In an equilibrium, there is no excess stock every good finds a home and every dollar
finds a wallet.
What is the Production Possibility Frontier (PPF)?
is a curve on a graph that illustrates the possible quantities that can be produced of two products if both depend upon the same finite resource for their manufacture
Why does a PPF slope down like that?
Because of diminishing marginal returns
The Law of Diminishing Marginal Returns:
If the quantities of SOME factors of
production are FIXED, then the marginal product(the extra output that results from adding one unit of the input to the existing combination of productive factors.) of any variable factor will EVENTUALLY DECLINE as the use of that factor is increased
What will shift a PPF?
- Increase in resource availability
- Technology
- Trade
Why?
These things will impact the efficiency of production. They will change how much of the products can physically be made. If it doesn’t impact how much or how well something can be made, it likely doesn’t impact the PPF
Comparative advantage
the ability to produce a good at a lower opportunity cost than others could
Ex: Italy has a comparative advantage with making pasta. This means that Italy, because
of its skilled pasta-makers, abundance of wheat, and great pasta reputation can make pasta more efficiently than any other country!
What does it mean if the PPF is a straight line?
the opportunity cost is constant as production of different goods is changing.
equilibrium
situation where there is no inherent forces that produce change; economic forces are balanced
In an equilibrium, there is no excess stock every good finds a home and every dollar
finds a wallet
marginal product
the extra output that results from adding one unit of the input to the existing combination of productive factors