Chapter 2 - chapter: 2 > EconomicModels:...

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1 of 31 chapter:   2 >> Economic Models:  Trade-offs and Trade
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2 of 31 WHAT YOU WILL LEARN IN THIS CHAPTER Why models? Simplified representations of reality— play a crucial role in economics Two simple but important models: production possibility frontier circular-flow diagram The difference between positive economics and normative economics When economists agree and why they sometimes disagree
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3 of 31 Models in Economics A model is a simplified representation of a real situation that is used to better understand real-life situations. Create a real but simplified economy Ex.: Cigarettes in World War II prison camps Simulate an economy on a computer Ex.: Tax models, money models… The “other things equal” assumption means that all other relevant factors remain unchanged.
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4 of 31 Trade-offs: The Production Possibility Frontier The production possibility frontier (PPF) 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 PPF improves our understanding of trade-offs by considering a simplified economy that produces only two goods by showing this trade-off graphically.
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5 of 31 The Production Possibility Frontier 28 20 40 0 30 9 15 Quantity of coconuts Production possibility frontier A B D C Feasible and efficient in production Not feasible PPF Quantity of fish Feasible but not efficient
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6 of 31 Increasing Opportunity Cost A PPF 10 20 30 40 50 0 35 30 25 20 15 10 5 Producing the first 20 fish . . . …requires giving up 25 more coconuts… …requires giving up 5 coconuts But producing 20 more fish . . . Quantity of coconuts Quantity of fish
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7 of 31 Economic Growth Economic growth results in  an  outward shift  of the PPF  because production  possibilities are expanded. The economy can now  produce more of everything. Production is initially at point  (20 fish and 25 coconuts),   it can move to point  (25  fish and 30 coconuts). A 10 20 25 30 40 50 0 35 30 25 20 15 10 5 E New PPF Original PPF Quantity of coconuts Quantity of fish
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8 of 31 Production Possibilities for Two Castaways 28 40 0 30 9 (a) Tom’s Production Possibilities Tom’s consumption without trade Tom’s PPF Quantity of coconuts Quantity of fish
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9 of 31 Production Possibilities for Two Castaways 10 6 0 20 8 Hank’s PPF Quantity of coconuts Quantity of fish (a) Hank’s Production Possibilities Hank’s consumption without trade
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This note was uploaded on 10/04/2011 for the course ECON 2006 at Virginia Tech.

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Chapter 2 - chapter: 2 > EconomicModels:...

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