Chapter 2: The Economic ProblemAfter studying this chapter, you will be able to:-Define the production possibilities frontier and calculate opportunity cost from it.-Distinguish between production possibilities and preferences and describe an efficient allocation of resources.-Explain how current production choices expand future production possibilities-Explain how specialization and trade expand our production possibilities-Explain why property rights and markets have evolvedThe Production Possibilities Frontier (PPF) is the boundary between those combinations of goods and services that an economy can produce and those that it cannot in a given period of time with its available resources and technology.Assumptions:- Fixed Resources- Fully Employed Resources- Technology Unchanged 1-Production points beyond the PPF are _____________ -Production points within the PPF are attainable, but are _______.-Production points on the PPF are attainable and ________in production. Production EfficiencyProduction efficiency only occurs on the frontier.When a country moves along the PPF, there is always a ________ involved in diverting resources from the production of one thing to another. We gain one thing but at the __________ of losing something else.-Recall that the opportunity cost of an action is the ______________ forgone. 2PPF for an economy Producing pizza and CDsIncreasing Opportunity Costs -The Principle that the opportunity cost increases as the production of one output expands.-Primary reason is because resources are ____________________ in producing one good compared to another good. -Increasing opportunity costs implies that the PPC is displayed with a ____ ____________________.The economic reason for the bowed out shape is the _______________________. To say the shape is due to increasing opportunity costs only _____________________________________________.3Using Resources EfficientlyWe know what efficiency in production means but we can be efficient in production anywhere onthe PPF.Which point on the PPF best serves the public interest? -To answer this question, we must _____________________________.4The PPF and Marginal CostMarginal cost is the opportunity cost of producing one more unit of a good.As more books are produced, the marginal cost of a book ________. Books(i)Movies(ii)MC of a book (Δii/Δi)A 0 600 ---------------B 200 500C 400 300D 600 0Preferences and Marginal Benefit-Preferences are a description of a person’s likes and dislikes.-The marginal benefit of a good or services is ______________________ _______________________.-The principle of decreasing marginal benefits implies that a marginal benefit curve slopes downward. 5Allocative efficiency occurs only when ______________________________. -When marginal cost equals marginal benefit it is ______________________ _________________________.Economic Growth is the ability of an economy to produce greater levels of output, represented by an outward shift of its production possibilities frontier.Sources of Economic Growth Changes in _________ Changes in __________-6- 7Present Investment and Future Production Possibilities Frontier- Investment means that an economy is producing and accumulation capital. - This new capital ________________ ______________________________. CapitalGoods Consumer GoodsThe Cost of Economic Growth- Economic growth requires that resources must be devoted to developing technology or accumulating capital, which means that current consumption decreases. The decrease in current consumption is ____________________________.- Countries that devote a higher share of _________________ or ___________ are more likelyto grow faster.8Through trade can countries be better off?Does living standards of a nation increase with trade?Absolute Advantage is _____________ ______________________________. The analysis focuses on the resource cost considering only an equal number of labor hours per day in producing wheat and cloth in countries A and B. 9Suppose we have the following production in the two countries per day for wheat and cloth. Remember we are assuming the same number of labor hours being used in each country.Country Wheat ClothA 60 or 20B 20 or 40Which country has the absolute advantage in wheat production?Which country has the absolute advantage in cloth production?Is there incentive for the two countries to trade?What happens if the production of the two countries was the following? Again assume an equal number of labor hours being used in each country.Country Wheat ClothA 30 or 50B 200 or 100Which country has the absolute advantage in Wheat production?Which country has the absolute advantage in Cloth production?Is there incentive for the two countries to trade?The principle of comparative advantage is _______________________________ _________________________________________________________.What are the opportunity costs for country A and country B to produce wheat and cloth?Opportunity CostCountry Wheat ClothABWhich country has a comparative advantage in the production of wheat?Which country has a comparative advantage in the production of cloth?Does the assumption that each country is using the same number of labor hours matter now?Will the world gain in a day of production if trade occurred?10Specialization allows countries to produce those goods that they have a comparative advantage in and trade some of these goods for those goods it does not have a comparative advantage in.11Terms of Trade are the feasible prices for goods between trading partners. Opportunity CostCountry Wheat ClothA 5/3 of cloth 3/5 of wheatB 1/2 of cloth 2 of wheatWhat are the possible terms of trade in the above example? In units of wheat: ________ < PCloth < ________In units of cloth: ________ < Pwheat < __________ 12Suppose that country A agrees to sell cloth at a price of 6/5 units of wheat and thus country B sells wheat for 5/6 units of cloth. If there is complete specialization how much will each country consume of each good if A buys __________ for B.Pcloth = 6/5wheat How much end up withCountry Wheat ClothAB13Country A Country B International trade allows a country to consume a combination of goods that exceeds its production possibilities curve. When we consider production capabilities then buy using comparative advantage we can see reason why all trading partners can gain. However, this is only one