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Chapter 2 mAcro spli - 1 Macroeconomics as a Second Language Chapter 2 Production Possibilities Frontier Economic Growth and Gains From Trade

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1 Macroeconomics as a Second Language Chapter 2: Production Possibilities Frontier, Economic Growth, and Gains From Trade Martha L. Olney [email protected] July 28, 2008 A simple but powerful model of the economy is the production possibilities frontier (PPF) model. Economic growth and the gains from trade can also be illustrated with the PPF. Key terms and concepts Production possibilities frontier Resources Scarce resources Trade-offs Opportunity cost Forego Law of increasing opportunity cost Attainable Efficient Inefficient Unattainable Economic growth 2 - 1
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Productivity Gains from trade Ricardian model Theory of comparative advantage Absolute advantage $ Comparative advantage Key graphs $ PPF $ Shifts of PPF $ Straight-line PPF Key equation Calculation of opportunity cost The Production Possibilities Frontier The production possibilities frontier (PPF) is a model about the allocation of scarce resources. It can be applied to a person or a company but is most often applied to an entire economy. What are the possible production combinations that an economy can produce with the available resources in a given time frame? Resources are those things used to produce goods and services. Resources are broadly defined: 2 - 2
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$ labor or time $ capital (machines and buildings) $ land or natural resources $ knowledge or technology Resources are said to be scarce because at any moment in time, there is a fixed, finite quantity of each resource. There are only 24 hours in a day, only a certain number of available workers, a certain number of machines and buildings, a certain amount of natural resources, a certain level of knowledge. Resources must be allocated because if a resource – you, for instance – is used for one activity, it cannot simultaneously be used for another. In the next minute, you can study economics or you can study chemistry. You can’t do both. The land under the building under your feet can be used for farming or for buildings, but not for both. So our resources must be allocated. The PPF makes a key simplifying assumption: there are only two types of output. We can say some useful things about scarcity and resource allocation, even when we make such an unrealistic assumption. And we don’t lose much of our story by making this assumption. So we make the assumption: only two types of output. The PPF model always considers two types of output – never more, never fewer. Because resources can’t do everything simultaneously, we face trade-offs or choices. Land can be used to produce food or produce machines. If more land is devoted to growing 2 - 3 TIP
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food, then less land must be devoted to producing machines. Why? Because there is a limited amount of land. If you are going to use the next hour to study economics, you can’t use the next hour to
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This note was uploaded on 02/04/2011 for the course ECON 100B taught by Professor Wood during the Fall '08 term at University of California, Berkeley.

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Chapter 2 mAcro spli - 1 Macroeconomics as a Second Language Chapter 2 Production Possibilities Frontier Economic Growth and Gains From Trade

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