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ECON 101 Chapter 2

by: Megan Lester

ECON 101 Chapter 2 Econ 101

Megan Lester
GPA 2.8

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class notes
Fr. Timmons
Class Notes
Econ, Microeconomic
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This 7 page Class Notes was uploaded by Megan Lester on Wednesday September 28, 2016. The Class Notes belongs to Econ 101 at Washington State University taught by Fr. Timmons in Spring 2015. Since its upload, it has received 2 views.


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Date Created: 09/28/16
Chapter 2 Thursday, January 15, 201511:42 AM Chapter 2 Economic Models: Trade-offs and Trade • Learning Objectives ○ Understand the Production Possibilities Frontier ○ (PPF) and be able to draw one. ○ Identify a ProductivelyEfficient point. ○ Identify the Allocative Efficient point. ○ Understand and use Opportunity Cost. ○ Use the PPF and Opportunity Cost to develop a model ○ of exchange and growth. • Production Possibilities Frontier (PPF) A curve showing the maximum attainable combination of two products that may be produced with available resources and current technology. ○ Scarcity. ○ Choice. ○ Efficiency –no missed opportunities. ○ Opportunity Cost – what must be given up in order to get a good. ○ Economic Growth – the ability to increase the production of goods and services. • Consider the following scenario: ○ A tract of land that provides two important ○ services:  Tons of CO2 abatement.  Bushels of corn. ○ The trade-off is with respect to land use. ○ What combination of CO2 and corn should we pick? • Land Use options Scenario Tons of CO2 abated Bushels of Corn A 5 0 B 4 100 C 3 180 D 2 240 E 1 280 F 0 300 ○ Each scenario is a point on the PPF. ○ When we move from scenario to scenario, we assume Ceteris Paribus, all else being held equal. ○ • On the PPF you are being productively efficient. ○ To produce more of one good you must give up some of the another. • A point below the PPF is inefficient. ○ You can improve in some way without sacrificing anything else. • Opportunity Cost ○ The value of what is foregone in order to have something else. ○ In Scenario E, 1 ton of CO2 = 280 bushels of corn. ○ Move to Scenario D, ↑CO2 by 1 and ↓ corn by 40. ○ Thus, from E to D we have 1 CO2 = 40 bushels of corn. ○ The opportunity cost of 1 more unit of CO2 = 40 bushels of corn. Scenario Tons of CO2 abated Bushels of Corn A 5 0 B 4 100 C 3 180 D 2 240 E 1 280 F 0 300 ○ But, if we move from D to E, that is we want more corn. ○ Now we want to know the opportunity cost of 1 more bushel of corn (marginalunits!!). The opportunity cost of 1 more bushel of corn = 1/40 units of CO2. ○ The opportunity cost of 1 more bushel of corn = 1/40 units of CO2. ○ Note: 40 bushels of corn = 1 unit of CO2, from D to E or E to D.  Which OPC we want depends on the question! Scenario E: 1 more ton of CO2 = - 40 bushels of corn. The Opportunity cost of 1 more ton of CO2 is 40 bushels of corn. Marginal Cost. • Increasing Opportunities Cost ○ Law of increasing costs – as we keep increasing production, the opportunity cost of production increases. ○ The more resources already devoted to an activity, the smaller the payoff to devoting additional resources. ○ Explains the bowed shaped of the PPF. • Marginal Cost (MC) ○ The additional cost of producing one more unit of a good or service. Scenario Total tons of CO2 Opportunity cost in bushels of Corn MC of 1 more ton of CO2 in bushels of Corn F to E 1 20 20 E to D 2 40 40 D to C 3 60 60 C to B 4 80 80 B to A 5 100 100 ○ F to E:  Opportunity Cost: 1 ton of CO2 = 20 bushels of corn.  Marginal Cost: 1 ton of CO2 = 20 bushels of corn. ○ In our example, the opportunity cost is unique to each scenario. ○ (B to A) OPC: 1 ton of CO2 = 100 B of C. MC: 1 ton of CO2 = 100 B of C • The Opportunity Cost of more corn, decreasing the tons of CO2 that are abated. ○ A to B  Opportunity Cost: 100 bushels of corn = 1 ton of CO2  Marginal Cost: 1 bushel of corn = 1/100tons of CO2 Scenario (from to) Total bushels of Corn Opportunity cost in Tons of CO2 MC of 1 more bushel of corn in Tons of CO2 A to B 100 1 1/100 B to C 80 1 1/80 C to D 60 1 1/60 D to E 40 1 1/40 E to F 20 1 1/20 ○ (A to B) OPC: 100 b of c = 1 ton of CO2. MC: 1 b of c = 1/100 tons of CO2 • How do we decide which point on the PPF to pick? ○ Suppose we are interested in CO2 abatement. ○ We start with the Marginal Cost (MC) of giving up corn to obtain 1 tonof CO2. • Flavors of PPF and Opportunity Cost ○ The example had a bowed out PPF. ○ Due to increasing marginal costs. ○ Different Opportunity Cost along the PPF.  You must measure the Opportunity Cost between the points – the slope of the tangent line.  You must measure the Opportunity Cost between the points – the slope of the tangent line. ○ You may have a linear PPF.  Constant marginal costs.  Constant Opportunity Cost along the PPF.  You can measure the Opportunity Cost between a set of points and it will be the same. • Economic Growth/ Trade ○ We can achieve a combination beyond the PPF! ○ The PPF allows us to visualize a model of economic growth and trade.  Remember part of definition of PPF: … for a given technology and resources. □ These are two constraints that we must deal with.  How? ○ Investment to accumulate capital or change technology. ○ Comparative Advantage and Trade. ○ Greater coverage in Chapter 8! • Shifting the PPF – Innovation ○ Investing to change the technology or capital accumulation.  Recall the PPF is drawn given current technology.  What if we could invest in genetically modified trees that can capture more ○ Growth through investment.  Sacrifice some consumption to increase productivity. • Moving beyond the PPF – trade ○ Comparative Advantage and Trade:  Two or more individuals/countries/firms.  Specialize in the good or service that  yields the lowest opportunity cost.  For example, you may specialize in CO2, so you produce 5 tons of CO2.  Your neighbors produces corn.  Trade here involves selling 2 tons of CO2


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