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Chapter 2 - Economic Problems

# Chapter 2 - Economic Problems - T H E ECON OM I C P ROBL EM...

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THE ECONOMIC PROBLEM 2 CHAPTE R

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Production Possibilities Concept: Production Possibilities Frontier (PPF) Assume given resources, technology, etc. We look at a model economy in which everything remains the same ( ceteris paribus ) except the two hypothetical goods we’re considering. PPF is the boundary between those combinations of goods that can be produced and those that cannot.
PPF and Opportunity Cost Figure 2.1 shows the PPF for “guns” and “butter” - which stand for any pair of goods and services -Finite limits because of resource constraints -“A” is maximum guns “F” is maximum butter -Downward sloping because of scarcity; devote more to one you must reduce the other -Linear: constant opportunity cost; essential tradeoff is fixed between land, labor, and capital -Bowed out: increasing opportunity cost -Opportunity cost increases as tradeoff decreases Because of a drop in efficiency in production, you get increased opportunity cost A means constant opportunity cost B means increasing opportunity cost C means decreasing opportunity cost

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PPF Opportunity Cost Some countries produce inside the frontier because they do not use their resources effectively
PPF Opportunity Cost Production efficiency - if we cannot produce more of one good without producing less of the other good. Points on the PPF are efficient.

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PPF and Opportunity Cost Points A-F are efficient. Z is inefficient. At Z , resources are unemployed or misallocated. Tradeoff along PPF
PPF and Opportunity Cost Opportunity Cost Move from point C to D: the opportunity cost of the increase in butter is the decrease in guns.

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PPF and Opportunity Cost Move from C to D: Increases butter by 1 ton Guns decreases from 12 to 9 The OPPORTUNITY COST of 1 ton of butter is 3 units of guns OR, 1 ton of butter costs 3 units of guns. Marginal Cost
PPF and Opportunity Cost Move from D to C: g uns increases by 3 units; butter decreases by 1 ton. Opportunity cost of 3 units of guns is 1 ton of butter.

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Chapter 2 - Economic Problems - T H E ECON OM I C P ROBL EM...

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