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Unformatted text preview: Chapter 2 Trade-offs, Comparative Advantage, and the Market System Chapter Summary A nation can produce only limited quantities of goods and services because it has scarce resources. Economists use the production possibilities frontier ( PPF ) to analyze the opportunity costs and trade- offs that nations, firms, and individuals face as a result of scarcity . The PPF is a curve that illustrates the combinations of two goods a nation can produce using all of its economic resources and a current state of technology in a given time period. The more resources that are devoted to an activity, the smaller the payoff to devoting additional resources to that activity. Production possibilities frontiers can be used to demonstrate the benefits of specialization in production and trade for two individuals or two nations. Markets enable buyers and sellers of goods and services to come together to trade. The circular-flow diagram shows how buyers (households) and sellers (firms) interact in both product and factor markets. Free markets exist when governments place few restrictions on how a good or service can be produced and sold or on how a factor of production can be employed. Entrepreneurs , those who own and operate businesses, are critical to the working of a market system. The businesses they operate produce goods and services consumers want. The entrepreneur decides how these goods and services should be produced to yield the most profit. Entrepreneurs organize factors of production and risk their own funds to start businesses. Successful entrepreneurs are rewarded for their efforts with profits, but most entrepreneurs, including many who later meet with success, suffer financial losses and business failures if they do not satisfy consumers’ wants. Although government does not restrict how firms produce and sell goods and services in a free market, it is essential that government protect an individual’s right to private property in order for a market system work well. Learning Objectives When you finish this chapter, you should be able to: 1. Use a production possibilities frontier to analyze opportunity costs and trade-offs . Each point on a production possibilities frontier represents a combination of two goods that can be produced by using all of a nation’s available resources given the state of technology and during a specific time period. Along the frontier, an increase in production of one good requires a decrease in production of the other good. Production possibilities frontiers usually appear bowed outward because marginal opportunity costs typically increase as the production of any good or service rises. CHAPTER 2 | Trade-offs, Comparative Advantage, and the Market System 28 2. Understand comparative advantage and explain how it is the basis for trade. Comparative advantage explains why a person is better off specializing in the production of the good or service that he or she can produce at a lower opportunity cost than another person. Each person can then trade for he or she can produce at a lower opportunity cost than another person....
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This note was uploaded on 05/19/2008 for the course ECO 001 taught by Professor Gunter during the Spring '06 term at Lehigh University .
- Spring '06
- Comparative Advantage