Chapter 2
Choice, Opportunity Costs and Specialization
Economics, 7th Edition Boyes/Melvin
Opportunity Cost
Opportunity cost: the value of the highest-valued alternative that must be forgone when a choice is made. It is the evaluation of a trade-off. Marginal benefits and costs: the benefits and opportunity costs associated with one additional unit of the good.
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Opportunity Costs and Concerts
Youve just won a free ticket to see a Madonna concert. U2 is performing on the same night. Tickets to see U2 cost $75. On any given day, you would be willing to pay up to $100 to see U2. Based on this information, what is the opportunity cost of seeing Madonna? (a) $0, (b) $25, (c) $75, or (d) $100.
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Opportunity Costs
The opportunity cost of seeing Madonna is the total value of everything you must sacrifice to attend her concert - namely, the value to you of attending the U2 concert. That value is $25 - the difference between the $100 that seeing his concert would be worth to you and the $75 you would have to pay for a ticket.
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Decision Making
Principle: Decision making involves trade-offs. A trade-off means a sacrifice--giving up one good or activity in order to obtain some other good or activity .
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Production Possibilities Curve
The production possibilities curve shows the maximum quantity of goods and services that can be produced when the existing resources are used fully and efficiently.
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Production Possibilities
Defense A1 Only defense goods produced B1 C1 D1 Impossible E1 F1 200 175 130 70 0 130 Non-defense 0 75 125 150 160 25 75
Defense Goods
200 175 150 125
A1
G1 B1
F1
C1
G1 200 Efficient Combinations
Underutilized (Inefficient)
100 75 0
D1 E1
Only nondefense goods produced
25 50 75 100 125 150
Nondefense Goods
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Growth
The PPC moves outward (growth occurs) as the result of:
Increased resources
Larger labor force Change in labor force participation Chance in labor-leisure decision
Improved technology (innovation) Expansion of capital stock An improvement in the rules (laws, institutions, and policies) of the economy
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A Shift of the PPC
Defense Non-defense 0 75 120 150 160 165
225 A2
Defense Goods
A2
225 200 175 130 70 0
200 175 150 125 100 75 0
A1
B2 B1 C2 C1
B2 C2 D2 E2 F2
D2
D1 E1
E2 F2
Nondefense Goods
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25 50 75 100 125 150
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Marginal Opportunity Cost
The Production Possibilities Curve (PPC) illustrates the concept of opportunity cost. Each point on the PPC means that every other point is a forgone opportunity. The PPC bows outward because there are ever-increasing marginal opportunity costs to the production of any good.
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Specialization
Economic agents (individuals, firms, nations) will be better off if they choose to produce those things for which they have the lowest opportunity costs, and trade for those with higher costs. Agents do this because such choices involve giving up the least amount of other things.
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Specialization & Trade
Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than someone else. Law of comparative advantage:
proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer.
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Private Property Rights
Private property rights are necessary for a market economy to develop. If no one owns something, no one has the incentive to take care of it.
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