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© 2006 Thomson/South-Western
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The Economic Problem
Economics examines how people use their
scarce resources to satisfy their unlimited wants
Scarce resource
Not freely available when its price exceeds zero
Resources
Inputs
Factors of production
Used to produce goods and services
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Opportunity Cost
3
Time and Information
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Opportunity Cost
Monetary cost
May be a reasonable approximation but can omit
the time involved which may be substantial for some
activities
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Sunk Cost and Choice
Sunk cost
A cost that has already been incurred
Cannot be recovered regardless of further actions
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Law of Comparative Advantage
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Law of Comparative Advantage
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Specialization and Exchange
Barter
System of exchange in which products are traded
directly for other products
Works best in simply economies with little
specialization and few goods
In advanced economies with specialization, money
plays an important role in facilitating exchange
Money serves as a medium of exchange because it is
the one thing that everyone is willing to accept in
return for all goods and services
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Specialization and Exchange
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Division of Labor
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Production Possibilities Frontier
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Exhibit 1: The Economy’s PPF
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The Economy’s PPF
Points A and F = amount of
consumer goods and capital goods that
can be produced per year if all
resources are used efficiently A B
50
Points between A and F = other 48
possible combinations of the two goods 43 C
Consumer Goods
34
Points inside the curve, I, =
combinations that do not employ
resources efficiently or fully I
20 E
Point C yields more consumer goods
and no fewer capital goods than I,
while point E yields more capital goods 10
and no fewer consumer goods than I,
and all points between C and E yield F
0
more of both goods
0 10 20 30 40 50
Points outside the PPF, such as U, =
unattainable combinations PPF
Capital Goods
serves as the frontier between (millions of units per year)
unattainable and attainable
combinations. 15
Movements along the PPF
Technological Change
Employs available resources more efficiently
17
Exhibit 2a: Shifts in the Economy’s PPF
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Exhibit 2c: Shifts in the Economy’s PPF
Increase in
resources or
technological
change that
benefits
consumer goods
would rotate the
PPF outward from
the horizontal
axis, from A to A'
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Exhibit 2d: Shifts in the Economy’s PPF
Increase in
resources or
technological
advance that
benefits capital
goods would
rotate the PPF
outward from
the vertical axis,
F to F'
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Lessons of PPF
Efficiency PPF represents the
combinations of output that are possible,
given the economy’s resources and
technology
Scarcity Given the stock of resources
and technology, the economy can produce
only so much
Economic Growth rightward shift or
rotation of PPF
Choice
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Three Questions
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Economic System
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Pure Capitalism
Markets
Transmit information about relative scarcity of
goods and services
Provide individual incentives
Distribute income among resource supplies
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Mixed / Transitional Economies
30