Chapter 2
ECONOMIC PROBLEM
Economic Problems
The main economic problems faced by every
society are:
Unlimited human wants,
Limited availability of resources to satisfy
those wants, and
Fulfillment of unlimited wants with limited
resources.
Economic Problems
Main economic problems
What is to be produced and in what quantity?
How is to be produced?
For whom to be produced?
Production Possibilities and
Opportunity cost
Production possibilities frontier (PPF)
The PPF is the boundary between those
combinations of goods and services that can be
produced and those cannot.
Production Possibilities and
Opportunity cost
Production Possibilities and
Opportunity cost
unattainable
Production Efficiency
We achieve production efficiency if we
produce good and services at the lowest
possible cost.
This outcome occurs at all the points on the
PPF.
Tradeoff Along the PPF
Tradeoff Along the PPF
Every choice along the PPF involves a tradeoff. On the
PPF, we trade off cola for pizzas.
We can employ these resources to produce goods and
services, but we are limited in what we can produce. This
limit defines a boundary between what we can attain and
what we cannot attain.
All tradeoffs involve a cost—an opportunity cost.
Opportunity Cost
Opportunity cost
The opportunity cost of an action is the higher-
valued alternative forgone.
Opportunity Cost Is a Ratio
Opportunity cost is a ratio. It is the decrease in the
quantity produced of one good divided by the increase
in the quantity produced of another good as we move
along the PPF.
Opportunity Cost
Increasing Opportunity Cost
The opportunity cost of a good increases as the
quantity of good produced increases.
The outward-bowed shape of the PPF reflects
increasing opportunity cost.
Resource Efficiency
When goods and services are produced at the
lowest possible cost and in the quantities that
provide the greatest possible benefit, we have
achieved allocative efficiency.
The PPF and Marginal cost
Marginal Cost
The marginal cost of a good is the opportunity
cost of producing one more unit of it.
We calculate marginal cost from the slope of
PPF.
The PPF and Marginal cost
The PPF and Marginal cost
Preferences and Marginal Benefit
Marginal Benefit
The marginal benefit from a good or service is
the benefit received from consuming one more
unit of it.
It depends on people’s preferences.
The device that we use to illustrate preferences
is the marginal benefit curve.
Marginal Benefit Curve
Marginal Benefit Curve
It is the curve that shows the relationship
between the marginal benefit and the quantity
consumed of that good.
Preferences and Marginal Benefit
Preferences and Marginal Benefit
Allocative Efficiency
At any point on the PPF, we cannot produce more of
one good without giving up some other good.
We are producing at the point of allocative
efficiency.
Allocative Efficiency
The point on the PPF that we prefer above all other
points.
Allocative Efficiency
Economic Growth
Economic Growth
The expansion of production possibilities is
called Economic Growth.
Economic Growth
Economic
Growth
Technological Capital
change accumulation
Economic Growth
Technological change
Technological change is the development of
new goods and of better ways of producing
goods and services.
Capital accumulation
Capital accumulation is the growth of capital
resources, including human capital.
Economic Growth
Gains from Trade
People can produce for themselves all the goods
and services that they consume, or they can
produce one good, or a few goods and trade with
others.
Producing only one good or a few goods is
called specialization.
Gains from Trade
Comparative Advantage and Absolute
Advantage
Comparative Advantage
A person has a comparative advantage in an
activity if that person can perform the activity at
a lower opportunity cost than anyone else.
Gains from Trade
Comparative Advantage and Absolute
Advantage
Absolute Advantage
A person who is more productive than others has
an absolute advantage.
Absolute advantage involves comparing
productivity, whereas comparative advantage
involves comparing opportunity costs.
Gains from Trade
Gains from Trade
Smoothies per hour
Gains from Trade
Gains from Trade
Gains from Trade
Gains from Trade
Gains from Trade
Economic Coordination
Two competing coordination systems have been
used.
Central Economic Planning
Markets.
Economic Coordination
Decentralized coordination works best but to do
so it needs four complementary social
institutions.
They are
Firms
Markets
Property rights
Money
Economic Coordination
Firms
A firm is an economic unit that hires factors of
production and organizes them to produce and
sell goods and services.
Markets
In economics, a market is any arrangement that
enables buyers and sellers to get information and
to do business with each others.
Economic Coordination
Property Rights
The social arrangements that govern the ownership, use
and disposal of anything that people value are called
property rights.
Real property includes land and buildings
Financial property includes bonds, stocks, and money.
Intellectual property is the intangible product of
creative effort. This type of property includes computer
programs, music.
Economic Coordination
Money
Money is any commodity or token that is
generally acceptable as a means of payment.
Circular Flows Through Markets