Principles of Microeconomics Textbook PDF

# The Economic Problem ## Production Possibilities - Every day we produce a vast array of goods and services. - There are limits to what we can produce at any given time. - These limits are defined by the **production possibilities frontier (PPF)**. - **PPF** is the boundary between the combinatio...

# The Economic Problem ## Production Possibilities - Every day we produce a vast array of goods and services. - There are limits to what we can produce at any given time. - These limits are defined by the **production possibilities frontier (PPF)**. - **PPF** is the boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production—land, labor, capital, and entrepreneurship—and the state of technology. - This frontier represents the potential combinations of goods and services an economy can produce given its resources and technology. - The PPF illustrates the concept of scarcity, showing the limits of production with fixed resources and technology. **Table 3.1** illustrates the PPF of an economy that produces only DVDs and cell phones as possibilities A through F. | Cell Phones (millions) | DVDs (millions) | Possibility | |------------------------|-----------------|-------------| | 0 | 15 | A | | 1 | 14 | B | | 2 | 12 | C | | 3 | 9 | D | | 4 | 5 | E | | 5 | 0 | F | **Figure 3.1** illustrates this table graphically. - The PPF is curved outward because the opportunity cost of producing a good increases as the quantity of that good produced increases. - Any point on the PPF shows that the economy is using all its resources efficiently. - Any point inside the PPF represents a situation where the economy is not using all its resources efficiently and an opportunity cost for a free lunch exists. ## Opportunity Cost - Opportunity cost is the value of the next best alternative forgone when making a choice. - It represents the cost of a decision, measured by the value of the opportunity forgone. - It's a crucial concept for understanding resource allocation and the tradeoffs we make. **Figure 3.2** illustrates the concepts of attainable and unattainable combinations. - In Figure 3.2, the economy can produce any combination of cell phones and DVDs on the PPF or inside the PPF. - The combination at point G is unattainable. **Figure 3.3** illustrates the concepts of efficient and inefficient production, trade offs, and free lunches. - The economy produces at point H, which is inside the PPF. - The economy can move to point D, where it produces more DVD’s, or to point E, where it produces more cell phones. - Moving from point E to point D requires giving up cell phones-a **tradeoff**. - Moving from point H to point D does not require giving up any other good-a **free lunch**. ## Economic Growth - **Economic growth** is the sustained expansion of production possibilities. - It's crucial to a nation's prosperity and its ability to improve its standard of living. - You can increase the production possibilities frontier by developing better technologies, improving the quality of labor, and acquiring more machines. **Figure 3.6** illustrates how the production possibilities frontier expands. - The economy produces at point L. It produces 5 million cell phones and no new cell-phone factories. - By shifting resources from producing cell phones to building new factories, the production possibility frontier expands outward to the new PPF and the economy can move to point K. - Resources and technology can expand the production possibilities frontier outward. - However, economic growth is not free and requires a trade off. - The trade-off is that to shift the production possibilities frontier outward, or to expand production possibilities, fewer consumption goods must be produced. - The move from L to K requires giving up 2 million cell phones now. - Economic growth doesn’t eliminate scarcity. - It simply moves the production possibilities frontier outward and changes the opportunity cost. ## Specialization and Trade - **Specialization** is the process of focusing on a particular task or skill. - **Trade** makes specialization possible. - Both specialization and trade generate gains for everyone. - In the **Theory of Moral Sentiments**, Adam Smith argued that if a society would let people pursue their own self-interest, it would produce the greatest amount of wealth for everyone. **Figure 3.8** illustrates specialization and trade. - Liz has a comparative advantage in producing smoothies. She has a comparative advantage in producing smoothies because she can produce more smoothies per hour than Joe with the same resources. - Joe has a comparative advantage in producing salads. - Each firm specializes in the good in which it has a comparative advantage and trades with the other firm. - Total production increases by 10 smoothies and 10 salads. - Everyone gains because all consumers and producers in the economy can enjoy quantities of goods and services that they can not produce on their own. - Specialization and trade illustrate that there is no such thing as a free lunch. ## In the News - The loss of honeycombs affected the central valley’s production possibilities frontier, as the supply of almonds decreased from the production. - When a price floor is higher than the market equilibrium, a surplus arises. - Obama’s miles-per-gallon requirements mean that resources are allocated to pollution control (the x-axis) rather than other goods and services. - The marginal cost of reducing pollution increases with each increase in pollution control. ## Chapter Checkpoint - **Scarcity:** The fundamental condition that drives all economic decisions. - **Tradeoff:** The idea that choosing one thing means giving up another. - **Opportunity cost:** The value of the best alternative forgone. - **Marginal Analysis:** We make choices based on how much more benefit vs. cost is gained or lost from the last unit. - **Free Lunch:** There is no such thing as a free lunch; all choices involve tradeoffs. - **Demand:** Relationship between the quantity of a good or service demanded and the price of a good or service, keeping all other influences constant. - **Law of demand:** The quantity demanded of a good decreases when the price increases. - **Supply:** Relationship between the quantity of a good or service supplied and the price of a good or service, keeping all other influences constant. - **Law of supply:** The quantity supplied of a good increases when the price increases. - **Economic Efficiency:** Occurs when resources are allocated so that it’s impossible to improve the production of one good or service without reducing the production of another. - **Market Equilibrium:** Occurs when the quantity demanded equals the quantity supplied. - The market price is a powerful force, constantly adjusting to bring the economy to equilibrium through shortage or surplus. - **Consumer surplus:** Occurs when we buy a good or service for less than the maximum amount we’re willing to pay. - **Producer surplus:** Occurs when a firm sells a good or service at a price that exceeds the marginal cost of producing the good or service. - **Total Surplus:** The summation of producer and consumer surplus. Maximizing total surplus maximizes efficiency. - **Tradeoff:** Illustrated by the production possibilities frontier. - **Opportunity cost:** Measured by the slope of the production possibilities frontier. - **Marginal Analysis:** Used to determine the allocative efficiency of output levels. - **Free Lunch:** Not possible when resources are used efficiently and a tradeoff must be made. - **Microeconomics:** The study of choices made by individuals and businesses as they interact and are influenced by government. - **Macroeconomics:** The study of the total effects on the economy of the choices made by individuals and businesses. - **Globalization:** The expansion of international trade and the production of components and services by firms. - **Economic Growth:** The sustained expansion of production possibilities. Caused by improvements in technology, the quality of labor, and the quantity of capital. - All these concepts are vital for understanding the world around us and for making decisions in the personal, business, and governmental sectors. ==End of OCR for page 626==