Microeconomics - Week 1/ Chp 2 Flashcards
What is the Production Possibility Frontier?
- The Production Possibility Frontier shows the maximum output that can be produced in an economy at any given moment, given the resources and technology available.
- If an economy is fully utilizing its resources efficiently, then it will be producing on the PPF.
What is productive efficiency?
-Productive efficiency is the ability of a firm to produce goods or services at the lowest possible cost, given the level of output and the available technology.
- It means that a firm is using all its resources in the most efficient way possible, producing the maximum output with the minimum input.
How does the reallocation of resources affect the PPF?
- Any combination of products on the frontier is productively efficient, so to have more of one product produced, there will inevitably be a reduction in the amount of the other produced due to the reallocation of resources
How are resources allocated in a free market?
- In a free market economy, the decisions about what to produce are determined by market forces of supply and demand.
- As these market conditions change the amount of different products produced would change.
- Market forces triggered by an increase in demand for the product would therefore lead to a reallocation of resources from one industry into another.
Examples of how resources allocated in a free market?
-if there was an increase in demand for product B rather than product A, then it would make this industry more attractive for producers.
- The greater demand for B would attract firms into this industry and out of A.
- The firms in industry B would then need more resources, such as labour and materials, to meet the higher demand.
- This increased demand for resources would increase the price paid for them, attracting resources into this industry and out of industry A.
How are resources allocated in a planned market?
- In a planned economy, decisions about what to produce are determined by government instructions and directives.
- This intervention may happen if the government does not trust market forces to produce what it regards as the right combinations of products for society.
What are possible problems with resources allocated in a planned market?
- if the instructions given by the government do not match what people are actually demanding, then it can lead to too much of some goods being produced, whilst too few of other goods are available in relation to present demand.
- The government may decide that resources need to be diverted to defence or nuclear energy, for example
- Government intervention may lead to surpluses and shortages.
-The lack of the profit incentive may also mean that resources are used inefficiently and that the economy operates within the PPF
Examples of how resources allocated in a Planned market?
- For example, the government may order that more factories and employees are used to produce product B rather than A. In this case, the reallocation from, say, point X to point Y is not determined by customers’ demand, but by government orders.
What is productive inefficiency?
- If the firm is producing at a point above its average cost curve, it is not productively efficient, as it could produce the same output at a lower cost.
- inefficiency may occur if there is a lack of demand in the economy
- Another reason for operating within the frontier may be the effect of poor management of the economy, meaning that production is inefficient and people’s talents are not utilized fully.
What causes the production possibility frontier shift outwards?
- more training and better management of employees, enabling them to be more productive;
- greater investment in capital goods, such as machines and equipment—in the short run, this would mean that resources would have to be shifted from consumption goods toward capital goods, and in the long run, greater investment would enable the economy to produce more products for consumption in the future;
- an increase in the population size of the working population, for example through greater net immigration or a rise in the birth rate or through an increase in the retirement age;
- improvements in technology providing better ways of doing things, such as the improvements in communications technologies in recent years.
How can an economy operate outside the frontier?
-It may well be that another country can produce some items more efficiently than you can and that your economy is able to produce some products more efficiently than your partners overseas; by trading with each other both countries can benefit.
What is scarcity?
- Resources are finite
It means that the demand for a good or service is greater than the availability of the good or service. Therefore, scarcity can limit the choices available to the consumers who ultimately make up the economy.
What is Choice?
- choice is the act of selecting one option over another when faced with a range of possibilities
What is the Principal Agent problem?
The Principal agent problem is an asymmetric information problem. The owners of a firm often cannot observe directly the day to day decisions of management
How to overcome the principal agent problem?
- Employee share ownership schemes - give employees a financial stake in the business
- Long term employment for senior management - Security of job might encourage to make decisions in the best interest of the business in the long term instead of focusing short term returns.
- Long Term Stock commitment - requires senior employees to hold their base salary in stock over x amount of years before being able to sale them.
