Chapter_2 - Chapter 2 Economic Models: Trade-offs and Trade...

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Chapter 2 Economic Models: Trade-offs and Trade I. Chapter 2: Models I. PPF II. Comparative advantage III. Circular Flow Diagram II. Positive vs. Normative
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Review: Principles of individual choice Resources are scarce The cost of something is what you have to give up to get it ( opportunity cost ) “How much” is a decision made at the margin. People exploit opportunities to make themselves better off: respond to incentives
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Review: Interaction of Choices There are gains from trade Markets move toward equilibrium Resources should be used as efficiently as possible to achieve society’s goals. Markets usually lead to efficiency When Markets don’t lead to efficiency, the government can improve welfare.
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Chapter 2 Next step: we need models to see the implications of our principles!
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Models A simplified representation of a real situation that is used to study that situation. Issues Ceteris paribus Correlation ≠ Causality Degree of abstraction
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Production Possibilities Frontier (PPF) Assumptions: Two outputs: x and y Two Scarce Resources—labor and capital—”ingredients” Fixed Technology—”recipe” x = f(L x , K x ) y = g(L y , K y )
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Chapter_2 - Chapter 2 Economic Models: Trade-offs and Trade...

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