Topic 2 - Key Business Economic Concepts.pdf

ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts ECON 2010 BUSINESS ECONOMICS Topic‐2 Key Business Economic Concepts After studying this chapter, you will be able to: 2.1 Describe production possibilities frontier (PPF), Tradeoffs & Opportunity Costs 2.2 Explain the difference...

ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts ECON 2010 BUSINESS ECONOMICS Topic‐2 Key Business Economic Concepts After studying this chapter, you will be able to: 2.1 Describe production possibilities frontier (PPF), Tradeoffs & Opportunity Costs 2.2 Explain the difference between absolute and comparative advantage 2.3 Calculate Gains from Trade © 2019 Pearson Education Ltd. Production Possibility Frontier (PPF) Let’s watch a short video explaining the concept of PPF. 1 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Production Possibilities Frontier The production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot. To illustrate the PPF, we focus on two goods at a time and hold the quantities of all other goods and services constant. That is, we look at a model economy in which everything remains the same (ceteris paribus) except the two goods we’re considering. © 2019 Pearson Education Ltd. Production Possibilities Frontier Production Possibilities Frontier Figure 2.1 shows the PPF for two goods: cola and pizzas. © 2019 Pearson Education Ltd. 2 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Production Possibilities Frontier Any point on the frontier such as E and any point inside the PPF such as Z are attainable. Points outside the PPF are unattainable. © 2019 Pearson Education Ltd. Production Possibilities and Opportunity Cost Production Efficiency We achieve production efficiency if we cannot produce more of one good without producing less of some other good. All points on the PPF are efficient. © 2019 Pearson Education Ltd. Production Possibilities Frontier Any point inside the frontier, such as Z, is inefficient. At such a point, it is possible to produce more of one good without producing less of the other good. At Z, resources are either unemployed or misallocated. © 2019 Pearson Education Ltd. 3 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Production Possibilities Frontier Every choice made is a tradeoff: You GIVE UP something to GET something Tradeoff Along the PPF Every choice along the PPF involves a tradeoff. On this PPF, we must give up some cola to get more pizzas or we must give up some pizzas to get more cola. © 2019 Pearson Education Ltd. PPF to Calculate Opportunity Costs Production Possibilities and Opportunity Cost Opportunity Cost is the highest valued alternative given up to get something else. As we move down along the PPF, we produce more pizzas, but the quantity of cola we can produce decreases. The opportunity cost of an additional pizza produced is the cola forgone (given up). © 2019 Pearson Education Ltd. 4 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Production Possibilities and Opportunity Cost In moving from E to F: The quantity of pizzas increases by 1 million. The quantity of cola decreases by 5 million cans. The opportunity cost of the fifth 1 million pizzas is 5 million cans of cola. One of these pizzas costs 5 cans of cola. © 2019 Pearson Education Ltd. Production Possibilities and Opportunity Cost In moving from F to E: The quantity of cola increases by 5 million cans. The quantity of pizzas decreases by 1 million. The opportunity cost of the first 5 million cans of cola is 1 million pizzas. One of these cans of cola costs 1/5 of a pizza. © 2019 Pearson Education Ltd. Production Possibilities and Opportunity Cost Opportunity Cost Is a Ratio The opportunity cost of producing a can of cola is the inverse of the opportunity cost of producing a pizza. One pizza costs 5 cans of cola. One can of cola costs 1/5 of a pizza. © 2019 Pearson Education Ltd. 5 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Production Possibilities and Opportunity Cost Increasing Opportunity Cost Because resources are not equally productive in all activities, the PPF bows outward. The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost. © 2019 Pearson Education Ltd. Using Resources Efficiently All the points along the PPF are efficient. To determine which of the alternative efficient quantities to produce, we compare costs and benefits. The PPF and Marginal Cost The PPF determines opportunity cost. The marginal cost of a good or service is the opportunity cost of producing one more unit of it. © 2019 Pearson Education Ltd. Class Activity Complete Chapter 2 - Worksheet Textbook Page 72 Questions 1 - 4 © 2019 Pearson Education Ltd. 6 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts PPF & Comparative Advantage Gains from Trade Comparative Advantage and Absolute Advantage A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else. A person has an absolute advantage if that person is more productive than others. Absolute advantage involves comparing productivities while comparative advantage involves comparing opportunity costs. Let’s look at Joe and Liz who operate smoothie bars. © 2019 Pearson Education Ltd. Gains from Trade Joe’s Smoothie Bar In an hour, Joe can produce 6 smoothies or 30 salads. Joe's opportunity cost of producing 1 smoothie is 5 salads. Joe's opportunity cost of producing 1 salad is 1/5 smoothie. Joe spends 10 minutes making salads and 50 minutes making smoothies, so he produces 5 smoothies and 5 salads an hour. © 2019 Pearson Education Ltd. 7 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Gains from Trade Liz's Smoothie Bar In an hour, Liz can produce 30 smoothies or 30 salads. Liz's opportunity cost of producing 1 smoothie is 1 salad. Liz's opportunity cost of producing 1 salad is 1 smoothie. Liz’s customers buy salads and smoothies in equal number, so she produces 15 smoothies and 15 salads an hour. © 2019 Pearson Education Ltd. Gains from Trade Joe’s Comparative Advantage Joe’s opportunity cost of a salad is 1/5 smoothie. Liz’s opportunity cost of a salad is 1 smoothie. Joe’s opportunity cost of a salad is less than Liz’s. So Joe has a comparative advantage in producing salads. © 2019 Pearson Education Ltd. Gains from Trade Liz’s Comparative Advantage Liz’s opportunity cost of a smoothie is 1 salad. Joe’s opportunity cost of a smoothie is 5 salads. Liz’s opportunity cost of a smoothie is less than Joe’s. So Liz has a comparative advantage in producing smoothies. © 2019 Pearson Education Ltd. 8 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts GAINS FROM TRADE Liz and Joe decide to specialize in the product they have lower opportunity cost and trade with each other. They are trading trade based on their comparative advantages which makes both of them better off. The Table on the left illustrates the “Gains from Trade.” © 2019 Pearson Education Ltd. Class Activity Complete Chapter 2 - Worksheet Textbook Page 80 Questions 1 - 2 Textbook Page 91 Problems 18 - 19 © 2019 Pearson Education Ltd. PPF & Future Expansion (Economic Growth) © 2019 Pearson Education Ltd. 9 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Economic Growth The expansion of production possibilities—an increase in the standard of living—is called economic growth. Two key factors influence economic growth:  Technological change  Capital accumulation Technological change is the development of new goods and of better ways of producing goods and services. Capital accumulation is the growth of capital resources, which includes human capital. © 2019 Pearson Education Ltd. Economic Growth The Cost of Economic Growth Increasing investment in capital and technology creates economic growth and increases income. To use resources in research and development and produce new capital, we must decrease our production of consumption goods and services. So economic growth is not free. The opportunity cost of economic growth is less current consumption. © 2019 Pearson Education Ltd. Economic Growth - Economics in Action Page 82 in the Textbook Economic Growth in Hong Kong and US compared. (1966-2016) DISCUSSION QUESTION: Why has Hong Kong experienced faster economic growth than the United States? (Refer Next Slide) © 2019 Pearson Education Ltd. 10 ECON2010 – Business Economics Chapter 2 Key Business Economic Concepts Economic Growth – Class Discussion Why Hong Kong has experienced faster economic growth than the United States? © 2019 Pearson Education Ltd. Class Activity Complete Chapter 2 - Worksheet Textbook Page 83 Questions 1 - 2 Textbook Page 82 Question 4 © 2019 Pearson Education Ltd. 11