1. The production possibility frontier line separates attainable
combinations of production (all points inside and on the line) from unattainable
combinations (all points beyond the line).
C. Production efficiency means that more of one good cannot be
produced without decreasing production of another good.
1. Production efficiency occurs only when production takes place on the
frontier line. Because another good must be given up, there is a tradeoff.
D. The opportunity cost of an action is the highest valued
alternative forgone.
1. On the production possibility frontier, the opportunity cost of
producing more of one product (for example, a bottle of soda) is the output of the other
good that must be foregone (for example, the tapes).
2. The opportunity cost of a bottle of soda is the number of tapes that
must be foregone per bottle of soda; hence opportunity cost is a ratio.
3. The opportunity cost of a tape is the inverse of the opportunity cost
of a soda.
E. Different resources are not equally effective in producing different
goods. Thus along the production possibility frontier, producing more of a good has
increasing opportunity costs.
1. The convex (bowed-out) shape of the production possibility frontier
reflects increasing opportunity costs.
2. Most activities in the real world are subject to increasing
opportunity costs.
III. Using Resources Efficiently
A. Marginal cost (MC ) is the opportunity cost of
producing one more unit of a product.
1. The marginal cost of producing a good rises because the opportunity
cost of a product rises as more of a product is produced. The marginal cost curve is
upward sloping, as illustrated in Figure 3.2.
B. The marginal benefit (MB ) of a good is the maximum
that someone is willing to pay for one more unit of it.
1. The principle of decreasing marginal benefit holds that as
more of a product is produced, its marginal benefit decreases.
2. The marginal benefit curve is downward sloping, as illustrated by the
MB curve in Figure 3.2.
C. Resources are used efficiently when they are producing the
goods and services valued most highly.
1. Efficiency is attained when the quantity of the good produced sets
the marginal benefit equal to the marginal cost.
2. In Figure 3.2, the efficient quantity of tapes is 30 million per
month.
IV. Economic Growth
A. Economic growth is the expansion in production.
B. Two factors cause economic growth: technological progress and capital
accumulation.
1. Technological progress is the development of new goods and
better ways to produce goods and services.
2. Capital accumulation refers to the growth in a society’s
capital resources.
C. The greater the rate of capital accumulation and/or technological
progress, the more rapidly the production possibility frontier expands, that is, the more
rapid is economic growth.
D. Economic growth is costly. The opportunity cost is incurred because
resources are devoted to manufacturing capital goods and developing new technologies
rather than to producing goods for current consumption.
E. Nations that incur the cost of devoting more of their resources to
capital accumulation or technological change (Hong Kong) grow more rapidly than nations
that choose not to pay the cost and thus devote fewer resources (the United States) to
such purposes.
V. Gains From Trade
A. People’s abilities differ; as a result, different people have
different opportunity costs of producing a particular good.
B. A person has a comparative advantage in producing something if
that individual can produce it at a lower opportunity cost than anyone else.
In terms of a production possibility diagram, the opportunity cost of
producing a good is related to the slope of the production possibility frontier (at the
point of production).
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1. In Figures 3.3 and 3.4 Tom’s production possibility frontier is
less steep than Nancy’s, showing that Tom can produce another tape at a lower cost in
foregone cases (0.333 cases per tape) than can Nancy (3.0 cases per tape).
2. Nancy’s production possibility frontier is steeper than
Tom’s. Thus, to produce an additional case, Nancy sacrifices fewer tapes than Tom
does (0.333 tapes per case for Nancy versus 3.0 tapes per case for Tom), so Nancy’s
opportunity cost of producing one more case is less than Tom’s opportunity cost.
3. Nancy’s opportunity cost of an additional case is relatively
lower, so she has a comparative advantage in cases; Tom’s opportunity cost of an
additional length of tape is relatively smaller, so he has a comparative advantage in
tape.
4. If Tom and Nancy specialize in the good for which they have a
comparative advantage and exchange what they produce, each can have more tape and
more cases.
D. An individual has an absolute advantage if he or she can
produce more of all goods per unit of input than anyone else.
1. An individual who has an absolute advantage does not have a
comparative advantage in producing all goods.
2. Even an individual with an absolute advantage can gain by
specializing in the good for which he or she has a comparative advantage and exchanging it
for other products.
E. Dynamic comparative advantage occurs whenever a person or
nation gains a comparative advantage by specializing in producing the good. Learning-by-doing,
whereby a person or nation becomes more productive at producing a good as more of it is
produced, is a key reason for dynamic comparative advantage.
VI. The Market Economy
A. Property rights are social arrangements that determine the
ownership, use, and disposal of factors of production, as well as of goods and services.
Property rights have been developed to facilitate specialization and exchange.
1. Property includes anything of value, not just real estate.
B. A market is any setup that allows buyers and sellers to trade
with each other. In markets, prices send signals to buyers and sellers.
C. The circular flow shows flows of resources, goods, and money.
1. Households supply resources and firms demand resources in the
resource market.
2. Households demand goods and services and firms supply them in the
goods market.
3. Money flows from firms to households in the resource market and from
households to firms in the goods market.
D. Price adjustments in markets coordinate individuals’
decisions.
Comparative Advantage
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