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Chapter 2:Economic Problem (Production Possibilities frontier (The…
Chapter 2:Economic Problem
Production Possibilities frontier
Describes the limit to what we can produce
The boundary between those combinations of goods and services that can be produced and those that cannot
on the PPF:
PRODUCTION EFFICIENCY
•cannot produce more of one good without producing less of another good. economy is efficient
•all goods produced at lowest possible cost
inside the PPF:
INEFFICIENT
•idle resources and underutilised capital
•by producing more of one good, you incur the
opportunity cost
of the other good
OC = amount of good giving up
/
amount of good gaining
To illustrate PPF:
•we only compare two products (CDs and Doughnuts)
•there are only two factors of production (technicians for CDs and bakers for doughnuts)
•Assumes a closed economy (i.e no trade or migration)
as you move along PPF graph,
OC increases
(when PPF concave shape)
reason:
•additional units of one product are produced at the
cost
of less production other product, e.g if you produce more doughnuts, technicians are transferred to doughnut production and end up being inefficient
the gradient of a PPF graph is the opportunity cost at that point
Comparative and absolute advantage
a person who has an absolute advantage does not have a comparative advantage in every activity
Comparative advantage
•who can perform the activity at the lowest opportunity cost
Absolute advantage
•who is better at producing a product (can produce more of it)
Preferences and marginal benefits
the
marginal benefit
from a good or service is the benefit received from consuming one more unit of it.
e.g one more doughnut
-This benefit depends on people's wants and needs (some people are allergic to doughnuts and won't benefit)
the most you are willing to pay for a product is its marginal benefit
Principle of decreasing marginal benefit
•The more we have of any good or service, the smaller its marginal benefit and the less we are willing to pay for an additional unit of it
Allocative efficiency:
When goods and services are produced at the
lowest possible cost
and in the quantities that
provide the greatest possible benefit
•point on PPF that is preferred above all other points
• where marginal cost = marginal benefit
Economic growth
Technological change
•the development of new goods and of better ways of producing goods and services
Capital accumulation
•the growth of capital resources
new tech and capital have an opportunity cost: the OC of new tech in future is less tech today
The expansion of production possibilities from technological change and capital accumulation is economic growth