Principles of economics openstax chapter2

• To produce goods and services, the society faces a resource constraint: the supply of labor, land, and capital available for production... CHOICES & TRADE-OFFSOpportunity cost is the

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PRINCIPLES OF ECONOMICS

Chapter 2 Choice in a World of Scarcity

CHOICES & TRADE-OFFS

In general, the higher the degree, the higher the salary

So why aren’t more people pursuing higher degrees? The short answer: choices and tradeoffs

CHOICES & TRADE-OFFS

• Individuals and societies make choices that

bring them the largest benefits given constraints they face.

• To buy goods and services, the individual faces

a budget constraint: the amount of money

available for spending.

• To produce goods and services, the society

faces a resource constraint: the supply of labor, land, and capital available for production.

CHOICES & TRADE-OFFS

Economics: the study of

allocation and use of scarce

resources to satisfy unlimited

human wants

To solve the economic problem, the society makes choices.

CHOICES & TRADE-OFFS

Opportunity cost is the

unavoidable cost of making

choices.

• Value of the best alternative

forgone

• What you give up to get

something

BUDGET LINE

Each point on the budget constraint represents a

combination of burgers and bus tickets Al can buy with $10 Slope of the line = 5/20 = $0.5/$2 = 0.25 Along the budget line, Al can give up 1 burger for 4 bus tickets.

Optimization: Gaining the largest

benefit from an action

Marginal Benefit: the increase in the benefit that results from an action

Marginal Cost: the increase in the cost that results from an action

Optimization Rule:

Marginal Benefit = Marginal Cost

PRODUCTION POSSIBILITIES FRONTIER

PPF is a graph showing the maximum amount of goods and services that an economy can produce, assuming:

• Resources are fully employed

• Resources are limited in supply

• Technology is constant

PRODUCTION POSSIBILITIES FRONTIER

Pizza

S

P 0

X

Y

Z M

This PPF shows a trade-off between allocating resources to

healthcare and education At point A all resources go to healthcare and at point B, most resources go to healthcare At point D most

resources go to education, and at F, all resources go to education.

PRODUCTION POSSIBILITIES FRONTIER

PRODUCTION POSSIBILITIES FRONTIER

Slope of the PPF is a measure of

opportunity cost of one good in terms

of the other good

The PPF is bowed-out when the

opportunity cost of one good in terms

of the other good keeps rising

The PPF becomes a straight line when the opportunity cost of one good in

terms of the other good stays

constant

CHOICES AND TRADE-OFFS

PRODUCTION POSSIBILITIES FRONTIER

Productive Efficiency: It is impossible to

produce more of one good without giving up some of the other good Thus, all choices

along a given PPF like B, C, and D display productive efficiency, but R does not

Allocative Efficiency: A specific combination

of both goods on PPF represents a

desirable allocation

PRODUCTION POSSIBILITIES FRONTIER

PRODUCTION POSSIBILITIES FRONTIER

PRODUCTION POSSIBILITIES FRONTIER

The U.S PPF is flatter than Brazil’s PPF

since the opportunity cost of wheat in terms

of sugar cane is lower in the U.S than in

Brazil Conversely, the opportunity cost of sugar cane in terms of wheat is lower in

Brazil

The U.S has “comparative advantage” in wheat production Brazil has “comparative advantage” in sugar cane production

PRODUCTION POSSIBILITIES FRONTIER

The economy can grow by expanding

production of both goods with

• Increased resources

• Improved technology

Economic growth is show by an outward

shift of the PPF

PRODUCTION POSSIBILITIES FRONTIER

Economic Growth: PPF shifts outward

CHOICES AND TRADE-OFFS

Both the individual’s budget line and the society’s PPF show the constraints they face in making economic decisions

Both diagrams show trade-off in choosing more of one good in terms of the other

good

CHOICES AND TRADE-OFFS