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Chapter 2 - Economic models, trade off and trade. From Microeconomics 5th edition, Paul Krugman
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MicroeconomicsChapter 2 – Economic Models: Trade-offs and Trade
Chapter 2 – Economic Models: Trade-offs and Trade
KEY TERMS
Model Other things = assumption Production possibility frontier
Factors of production Technology Comparative advantage
Absolute advantage Barter Circular-Flow diagram
Households Firms Market for goods and services
Factor Markets Income Distribution Positive economics
Normative economics Forecast
Models in economics: Some important examples
Model – Simplified representation of a real situation that is used to better understand real life
situations.
Allows economists to focus on the effects of only one change at a time.
Another important assumption when building economic models is the other things equal
assumption.
The other things equal assumption – all other relevant factors remain unchanged.
I- Trade-offs: The Production Possibility Frontier
Resources are scarce and as a result any economy faces trade-offs.
To think about the trade-offs that face any economy, economists often use the model known
as the production possibility frontier.
The production possibility frontier illustrates the trade-offs facing an economy that produces
only two goods. It shows the maximum quantity of one good that can be produced for any
given quantity produced of the other.
Point A & B – Feasible and efficient
Point C – Feasible but not efficient
Point D – Not feasible
The maximum quantity of Dreamliner
manufactured per year depends on the quantity
of small jets manufactured per year.
a. Efficiency
, Microeconomics
Chapter 2 – Economic Models: Trade-offs and Trade
Something is efficient if there are no missed opportunities. One key element of efficiency is
that there are no missed opportunities in production. (there is no way to produce more of one
good without producing less of other goods).
Efficiency for the economy as a whole requires both efficiency in production and efficiency
in allocation: To be efficient, am economy must produce as much of each good as it can
given the production of other goods, and it must also produce the mix of goods that people
want to consume (must also deliver those goods to the right people).
b. Opportunity cost
The true cost is not the money it costs to buy but what must be given up in order to get that
good.
Increasing opportunity cost. When it is
increasing the production possibility
frontier is a bowed-out curve rather than a
straight line.
c. Economic growth
Economic growth – Growing ability of the economy to produce goods and services.
Economic growth results in an outward shift
of the production possibility frontier
because production possibilities are
expanded. The eco can produce more of
everything.
If the economy produces at point A,
economic growth means that the economy
could move at point E.
2 Sources of economic growth:
- Increase in the economy’s factors of production (refer to a resource that is not used up
in production).
o Factors of production – Resources used to produce goods and services.
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