Week 2: The Economic Problem Flashcards
What is a production possibilities frontier (PPF)?
The boundary between the combination of goods and services than can and cannot be produced given the available resources and production technologies.
How does the PPF illustrate scarcity?
The points outside the frontier are unattainable. These are wants that cannot be satisfied.
How does the PPF illustrate production efficiency?
Production efficiency occurs at all points on the PPF. Goods and services are produced at the lowest cost possible. Production is inefficient at points inside the PPF.
How does the PPF illustrate tradeoffs and opportunity cost?
Moving from one point along the PPF to another, a tradeoff occurs. Some quantity of the good A is forgone to produce more of good B.
Why is opportunity cost a ratio?
It is the decrease in the quantity produced of one good over the increase in the quantity produced of another, reflected by the slope of the PPF. Opportunity costs of each good are inverses of one another.
Why does the PPF bow outward and what does that imply about the relationship between opportunity cost and quantity produced?
It has an outward-bowed shape because resources are not all equally productive in all activities. This reflects the increasing opportunity cost. Opportunity cost of a good increases as the quantity produced increases.
What is the best combination of goods to produce?
It depends on peoples’ preferences or the relative value they place on the goods. The PPF provides no information about preferences.
What is allocative efficiency?
Goods and services are produced at the lowest possible cost in quantities that provide the greatest possible benefit.
What is the most preferred combination of goods to produce and consume?
It is at the point of allocative efficiency, where marginal benefit equals marginal cost.
What is a comparative advantage?
A person has a comparative advantage if he or she can produce a good or service at a lower opportunity cost than another person.
What is an absolute advantage?
A person has an absolute advantage if he or she is more productive (uses fewer productive resources for a good or service) than another person.
Why do people specialize and trade?
People specialize in the good in which they have a comparative advantage in because they both gain a higher output. They get outside their individual PPFs and produce on the economy’s PPF.
What exchange rate (cost of trade) generates gains for trade for both parties (mutually beneficial trade)?
Any exchange rate that lies between the opportunity costs for each good of the two parties involved make both better off.
What is economic growth?
It is the expansion of production possibilities. It increases our standard of living, but does not overcome scarcity and avoid opportunity cost.
What generates economic growth?
- Technological change-development of new goods and better ways of producing goods and services
- Capital accumulation- growth of capital resources, including human capital
What is the opportunity cost of economic growth?
The decrease in today’s consumption is the opportunity cost of tomorrow’s increase in consumption, vice versa.
How does economic growth influence the PPF?
If we devote resources to expand production possibilities (e.g. produce pizza ovens), there is a decrease in the production of consumption goods (e.g. pizza).
What is the effect of economic growth on jobs?
The industrial labour force shrinks due to the advancements in technology used for manufacturing and the services sector expands.
What are the four complementary social institutions of the decentralized coordination market system?
- Firms- hires factors of production and organizes them for the production of goods and services
- Markets- any arrangement that enables buyers and sellers to do business with each other
- Property rights- social arrangements that govern the ownership, use, and disposal of anything we value
- Money- any commodity or token that is generally acceptable as a means of payment
What are the circular flows in the market economy (households, firms, factor markets, goods markets)?
a) Real flows (counterclockwise)- households provide factors of production to firms then firms produce and sell goods and services
b) Payments (clockwise)- income from firms to households then expenditure on goods and services from households to firms
