E-201.Study Guide Chapter2.Key Terms and Questions

# E-201.Study Guide - Chapter 2 THE ECONOMIC PROBLEM Key Concepts Production Possibilities and Opportunity Cost The quantities of goods and services

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25 2 THE ECONOMIC PROBLEM Key Concepts ± Production Possibilities and Opportunity Cost The quantities of goods and services that can be pro- duced are limited by the available amount of resources and by technology. The production possibilities fron- tier ( PPF ) is the boundary between those combina- tions of goods and services that can be produced and those that cannot. A PPF is illustrated in Figure 2.1. All production pos- sibilities frontiers have two characteristics in common: Production points inside and on the PPF are attain- able. Points beyond the PPF are not attainable. Production points on the PPF achieve production efficiency because there the goods and services are produced at the lowest possible cost. Production points inside the PPF are inefficient , with misallo- cated or unused resources. Moving between points on the PPF involves a tradeoff because something must be given up to get more of something else. The opportunity cost of an action is the highest-valued alternative foregone. In Figure 2.1, the opportunity cost of obtaining 20 more pizzas by moving from point a to point b is the 10 DVDs that are foregone. Opportunity cost is a ratio. It equals the decrease in the production of one good divided by the increase in the production of the other. For the move- ment from a to b the opportunity cost is 10 DVDs divided by 20 pizzas or 1/2 of a DVD per pizza. When resources are not equally productive in produc- ing different goods and services, the PPF has increasing opportunity costs and bows outward, as illustrated in Figure 2.1. As more pizza is produced, the opportunity cost of a pizza increases. ± Using Resources Efficiently Allocative efficiency is reached when goods and ser- vices are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit. The marginal cost of a good is the opportunity cost of producing one more unit of it. Because of in- creasing opportunity cost, when moving along the production possibilities frontier the marginal cost of an additional unit of a good increases as more is produced. So, the marginal cost curve, illustrated in Figure 2.2 on the next page, slopes upward. Preferences are a description of a person’s likes and dislikes. Preferences can be described using the con- cept of marginal benefit. The marginal benefit from a good or service is the benefit received from consuming one more unit of it. The marginal bene- fit of a good is measured as the maximum amount that people are willing to pay for another unit of it. The marginal benefit from additional units of a good decreases as more is consumed. The marginal Chapter

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26 CHAPTER 2 benefit curve , which shows the relationship between the marginal benefit of a good and the quantity consumed, slopes downward as shown in Figure 2.2. Allocative efficiency occurs when the marginal benefit
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## This note was uploaded on 04/11/2010 for the course ECON E-201 taught by Professor Baiyee-mbi during the Spring '10 term at IUPUI.

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E-201.Study Guide - Chapter 2 THE ECONOMIC PROBLEM Key Concepts Production Possibilities and Opportunity Cost The quantities of goods and services

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