CHAPTER 1 - THE ART AND SCIENCE OF ECONOMIC ANALYSIS
CHAPTER 2 – SOME TOOLS OF ECONOMIC ANALYSIS (6e)
In Chapter 1 we discussed scarcity and the need to make choices. But how do we make choices?
What is involved in making economic decisions?
I. Choice and Opportunity Cost
“Because of scarcity, whenever you make a choice, you must pass up another opportunity; you must incur an opportunity cost.” (p. 27)
Definition of opportunity cost:
II. Comparative Advantage, Specialization, and Exchange
Two Types of Advantage
Example:
| |Type 1 Paper |Iron 1 Blouse |
|Emily |30 min. |10 min. |
|Amy |60 min. |12 min. |
1) Absolute advantage
Definition:
Who has the absolute advantage in typing?
Who has the absolute advantage in ironing?
2) Comparative advantage
Definition:
Determining who has the comparative advantage in each activity:
Opportunity cost of typing 1 paper:
Emily: typing 1 paper = _______________
Amy: typing 1 paper = ________________
Who has the comparative advantage in typing?
Opportunity cost of ironing 1 blouse:
Emily: ironing 1 blouse = _____________
Amy: ironing 1 blouse = ______________
Who has the comparative advantage in ironing?
A. The Law of Comparative Advantage
Definition:
Compare Emily and Amy’s total output without and with specialization:
In one hour, with no specialization, Emily could ______________________________ while Amy could ____________________.
In one hour, with specialization based on comparative advantage, Emily could ____________________________ while Amy could ________________________.
B. Specialization and Exchange
Specialization leads to exchange or trade, either by means of barter or by using money as a medium of exchange.
III. The Economy’s Production Possibilities
A. Simplifying Assumptions for a Production Possibilities Model
▪ Output is limited to only two classes of products
▪ Time period is defined as one year
▪ Resources are fixed during the given time period
▪ Technology does not change during the given time period
B. The Production Possibilities Frontier (PPF) Model
Definition of PPF:
Definition of “efficiency”:
See Ex. 1
Points along the PPF:
Points inside the PPF:
Points outside the PPF:
C. Shape of the PPF
See Ex. 1. How is the PPF shaped, and why is this significant?
Law of increasing opportunity cost:
D. Shifts of the PPF
The PPF shifts due to:
1) Changes in the availability of resources
2) Changes in the capital stock
3) Technological changes
See Ex. 2 for examples of PPF shifts.
E. Summary: The PPF demonstrates
• Efficiency
• Scarcity
• Opportunity cost
• Law of increasing opportunity cost
• Economic growth
• Choice
Does the PPF tell us what combination of goods our economy should produce? If not, how is this combination determined?
IV. Economic Systems
Read pp. 39-41 for general understanding. Know the basic characteristics of the following types of economic systems:
Pure capitalism
Pure command system
Mixed economy
END
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