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Trade-offs, Comparative Advantage, and the Market System

by: Caitrín Hall

Trade-offs, Comparative Advantage, and the Market System ARE 1150

Marketplace > University of Connecticut > Agricultural & Resource Econ > ARE 1150 > Trade offs Comparative Advantage and the Market System
Caitrín Hall
GPA 3.9

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About this Document

These notes cover chapter 2 of the microeconomics textbook.
Principles of Agriculture & Resource Economics
Emma Bojinova
Class Notes
Economics, Microeconomics, outline
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This 3 page Class Notes was uploaded by Caitrín Hall on Monday February 8, 2016. The Class Notes belongs to ARE 1150 at University of Connecticut taught by Emma Bojinova in Spring 2016. Since its upload, it has received 19 views. For similar materials see Principles of Agriculture & Resource Economics in Agricultural & Resource Econ at University of Connecticut.

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Date Created: 02/08/16
Chapter 2 Trade-offs, Comparative Advantage, & the Market System Scarcity exists because we have unlimited wants but limited resources  Goods, services, time, and factors of production are scarce 2.1 Production Possibilities Frontiers and Opportunity Costs  The idea of trade-off: resources devoted to producing one good/service are not available for producing other goods/services  Production possibilities frontier (PPF) – a curve showing the maximum attainable combinations of 2 products that may be produced with available resources and current technology Graphing the PPF  One good or service is plotted along the vertical y-axis  The other good or service is plotted alone the horizontal x-axis  All points on the PPF are attainable and efficient because all resources are being fully utilized  All points within/beneath the PPF are attainable but inefficient because all resources are not being fully utilized  All points outside/above the PPF are efficient but unattainable with the current given resources  Opportunity cost – highest-valued alternative that must be given up to engage in an activity o Ex) in order for BMW to produce more of one model, it must produce less of another model  Which point on the PPF is best? It depends on customers’ demands Increasing Marginal Opportunity Costs  The PPF allows us to explore issues concerning the economy as a whole  A bowed (curved) PPF  opportunity cost depends on where the economy currently is on the curve  Increasing marginal opportunity costs occur because some factors of production are better suited to 1 good over another  The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity o Ex) the more hours you spend studying, the less your grade will increase per each additional hour  greater opportunity cost of studying  Constant opportunity cost demonstrates a linear relationship between goods/services Economic Growth – ability of the economy to increase the production of goods & services  Total resources available to any economy are fixed  Resources available can increase over time o Ex) increase in labor  increase in production  PPF shifts outward 2.2 Comparative Advantage & Trade Trade – the act of buying and selling; involves the decisions of households and firms  Enables people to become better off by increasing both their production and consumption Specialization and Gains from Trade  PPFs show how each producer’s benefit of trading with another  If each trader produces only their specialty, both traders will benefit Absolute Advantage vs. Comparative Advantage  Absolute advantage – the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources  Comparative advantage – the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors o You can have comparative advantage without absolute advantage and absolute advantage without comparative advantage o The basis of trade is comparative advantage o Individuals, firms, and countries are better off specializing in goods or services for which they have comparative advantage 2.3 The Market System  Market – a group of buyers and sellers of a good or service and the institution by which they come together to trade  Product market – a market for goods or services  Factor market – a market for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability  Factors of production – the inputs used to make goods and services o Labor includes all types of work. o Capital refers to physical capital used to produce other goods. o Natural resources include land, water, oil, iron ore, other raw materials, etc. o Entrepreneurial ability is the ability to bring together the factors of production to successfully produce and sell goods and services. The Circular Flow of Income  Households o Consist of all individuals in a home o Suppliers of factors of production o People sell their labor services to firms  Firms o Demanders of factors of production o Use funds they receive from selling goods and services to buy factors of production that produce those goods and services  Circular-flow diagram – a model that illustrates how participants in markets are linked; shows the connectedness of households, firms, and product & factor markets The Gains from Free Markets  Free market – a market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed  Countries with less of a centrally planned economic system are closer to the free market benchmark (U.S., Canada, Western Europe, Hong Kong, Singapore, Estonia) The Market Mechanism  Individuals usually act in a rational, self-interested way  Prices must be flexible for the market to respond to consumers’ wants  Changes in relative prices provides info to consumers and firms  The market system responds to demand without government intervention  The “invisible hand” leads the market – firms respond individually to changes in prices by making decisions that collectively end up satisfying consumers’ wants The Legal Basis of a Successful Market System  Protection of Private Property o Property rights – rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it o Property can be physical or intangible (such as intellectual property, which is protected by patents and/or copyrights)  Enforcement of Contracts and Property Rights o If property rights are not well enforced, fewer goods and services will be produced  less economic efficiency


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