Review for Exam 1 Chapters 1 Through 5. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production possibilities frontier.

Review for Exam 1

Chapters 1 Through 5

Production Possibilities Frontiersand Opportunity Costs

Learning Objective 2.1

Production possibilities frontier (PPF) A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology.

Opportunity cost The highest-valued alternative that must be given up to engage in an activity.



Graphing the Production Possibilities Frontier

FIGURE 2-1

BMW’s Production Possibilities Frontier



Economic GrowthFIGURE 2-3

Economic Growth

Economic growth The ability of the economy to produce increasing quantities of goods and services.


Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.

Absolute Advantage versus Comparative Advantage

Comparative Advantage and Trade

Absolute advantage The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources



Trade The act of buying or selling.

Specialization and Gains from Trade

FIGURE 2-4

Production Possibilities for You and Your Neighbor, without Trade


Specialization and Gains from Trade

TABLE 2-1

A Summary of the Gains from Trade


YOU YOUR NEIGHBOR

APPLES(IN POUNDS)

CHERRIES(IN POUNDS)

APPLES(IN POUNDS)

CHERRIES(IN POUNDS)

Production and consumption without trade 8 12 9 42

Production with trade 20 0 0 60

Consumption with trade 10 15 10 45

Gains from trade (increased consumption) 2 3 1 3


Solved Problem 2-2Comparative Advantage and theGains from Trade

BEFORE TRADE AFTER TRADE

HONEY(IN TONS)

MAPLE SYRUP(IN TONS)

HONEY(IN TONS)

MAPLE SYRUP (IN TONS)

CANADA 30 15 30 20UNITED STATES 10 40 20 40

CANADA UNITED STATES

HONEY(IN TONS)

MAPLE SYRUP(IN TONS)

HONEY(IN TONS)

MAPLE SYRUP (IN TONS)

0 60 0 50

10 45 10 40

20 30 20 30

30 15 30 20

40 0 40 10

50 0


Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it.

The Legal Basis of a Successful Market System

The Market System

Protection of Private Property

Enforcement of Contracts and Property Rights

If property rights are not well enforced, fewer goods and services will be produced. This reduces economic efficiency, leaving the economy inside its production possibilities frontier.

–Perfectly competitive market A market in which there are many buyers and sellers, all the products are identical, and there are no barriers to new sellers entering the market.

Where Prices Come From: The Interaction of Demand and Supply

•Law of demand Holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

The Demand Side of the MarketLearning Objective 3.1

FIGURE 3-2

Shifting the Demand Curve

Holding Everything Else Constant:The Ceteris Paribus Condition


Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves


Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves (continued)

The Supply Side of the Market

•Law of supply Holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.


The Law of Supply

The Supply Side of the MarketLearning Objective 3.2

FIGURE 3-5

Shifting the Supply Curve

The Law of Supply


Variables That Shift Supply

TABLE 3-2

Variables That Shift Market Supply Curves


TABLE 3-2

Variables That Shift Market Supply Curves (continued)

Variables That Shift Supply

Market Equilibrium: Putting Demand and Supply Together

FIGURE 3-7

Market Equilibrium


The Effect of Demand and Supply Shifts on Equilibrium

FIGURE 3-9

The Effect of an Increase in Supply on Equilibrium

The Effect of Shifts in Supply on Equilibrium


The Effect of Demand and Supply Shifts on Equilibrium

FIGURE 3-10

The Effect of an Increase in Demand on Equilibrium

The Effect of Shifts in Demand on Equilibrium


Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays.Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service.

Consumer Surplus and Producer Surplus


Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives.

Marginal cost The additional cost to a firm of producing one more unit of a good or service.

The Efficiency of Competitive Markets

FIGURE 4-6

Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus

Economic Surplus


Economic surplus The sum of consumer surplus and producer surplus.


Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. The net benefit equals the total benefit received by consumers minus the total amount they must pay to buy the good.

Producer surplus measures the net benefit received by producers from participating in a market, or the total amount firms receive from consumers minus the cost of producing the good.

• What Consumer Surplus and Producer Surplus Measure

Consumer Surplus and Producer Surplus


FIGURE 4-7

When a Market Is Not in Equilibrium There is a Deadweight Loss

Deadweight Loss

Deadweight loss The reduction in economic surplus resulting from a market not being in competitive equilibrium.



Economic efficiency

A market outcome in which

1)the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and

2)the sum of consumer surplus and producer surplus is at a maximum.

Economic Surplus and Economic Efficiency


Government Intervention in the Market:Price Floors And Price Ceilings

FIGURE 4-8

The Economic Effect of a Price Floor in the Wheat Market

Price Floors: Government Policy in Agricultural Markets


Government Intervention in the Market:Price Floors And Price Ceilings

FIGURE 4-9

The Economic Effect of a Rent Ceiling

Price Ceilings: Government Rent Control Policy in Housing Markets


The Economic Impact of TaxesThe Effect of Taxes on Economic Efficiency

FIGURE 4-10

The Effect of a Tax on the Market for Cigarettes


The Economic Impact of TaxesTax Incidence: Who Actually Pays a Tax?

Tax incidence

The actual division of the burden of a tax between buyers and sellers in a market.


The Economic Impact of TaxesTax Incidence: Who Actually Pays a Tax?

Determining Tax Incidence on a Demand and Supply Graph

FIGURE 4-11

The Incidence of a Tax on Gasoline


–Externality A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service.

Externalities, Environmental Policy, and Public Goods


–Private cost The cost borne by the producer of a good or service.

–Social cost The total cost of producing a good, including both the private cost and any external cost.

–Private benefit The benefit received by the consumer of a good or service.

–Social benefit The total benefit from consuming a good or service, including both the private benefit and any external benefit.

Externalities and Economic EfficiencyThe Effect of Externalities


Externalities and Economic EfficiencyThe Effect of Externalities

FIGURE 5-1

The Effect of Pollution on Economic Efficiency

How a Negative Externality in Production Reduces Economic Efficiency


Externalities and Economic Efficiency•How a Positive Externality in Consumption Reduces Economic Efficiency

FIGURE 5-2

The Effect of a Positive Externality on Efficiency


Externalities and Economic EfficiencyExternalities May Result in Market Failure

Market failure A situation in which the market fails to produce the efficient level of output.

What Causes Externalities?

Property rights The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it.

Private Solutions to Externalities: The Coase Theorem


The Coase Theorem

Transactions costs The costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services.

The Problem of Transactions Costs

Coase theorem The argument of economist Ronald Coase that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities.


Pigovian taxes and subsidies Government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities.

Command and Control versus Tradable Emissions Allowances

Command and control approach An approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices.

Government Policies to Deal with Externalities



FIGURE 5.5

When There Is a Negative Externality, a Tax Can Bring about the Efficient Level of Output



FIGURE 5.6

When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output


Command and Control versus Tradable missions Allowances

FIGURE 5.7

Estimated Cost of the Acid Rain Program in 2010



FIGURE 5.8

Four Categories of Goods



FIGURE 5.10

Constructing the Market Demand Curve for a Public Good

Four Categories of GoodsThe Demand for a Public Good



FIGURE 5.11

The Optimal Quantity of a Public Good

The Optimal Quantity of a Public Good


Four Categories of GoodsCommon Resources

Tragedy of the commons The tendency for a common resource to be overused.

FIGURE 5.12

Overuse of a Common Resource

Review for Exam 1 Chapters 1 Through 5. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production possibilities frontier.

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