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Chapter 2 - Notes Chapter 2 ECONOMIC MODELS TRADE-OFFS AND...

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Notes: Chapter 2 02/06/2008 20:34:00 ECONOMIC MODELS: TRADE-OFFS AND TRADE Section 1  Models in Economics: Some Important Examples Model  – a simplified representation of a real situation that is used to better  understand real-life situations.  They allow economists to focus on the effects of only  one change at a time; we can hold everything else constant and study how one change  affects the overall economic outcome. Other things equal assumptions  – means that all other relevant factors remain  unchanged Economists can find or create a real, but simplified economy Economists can also simulate the workings of the economy on a computer For many purposes, the most effective form of economic modeling is the  construction of “thought experiment”: simplified, hypothetical versions of real- life situations. Three simple, but important economic models: o The Productions Possibility Frontier  – a model that helps economists  think about the trade-offs every economy faces o Comparative Advantage  – a model that clarifies the principle of gains  from trade—trade both between individuals and between countries o Circular-flow Model  – helps economists analyze the monetary  transactions taking place in the economy as a whole Trade-offs: The Production Possibility Frontier Since resources are scarce, any economy faces trade-offs The  production possibility frontier  illustrates the trade-offs facing an economy  that produces only two goods.  It shows the maximum quantity of one good  that can be produced for any given production of the other. The frontier—the curve in the diagram—shows the maximum number of X a  company can get/produce during an allotted period of time  given  the number  of Y the company is also getting/producing, and vice versa.
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