Dynamics of Competition

Chapter 2 The Economic ProblemPrinciples of Microeconomics

1Production Possibilities FrontierThe boundary between those combinations of goods and services that can be produced and those that cannot

Illustrates the idea of scarcity and tradeoff when two goods or services are consideredEvery choice along the PPF involves a tradeoff

Describes the limit to which a society can produceOutcomes outside PPF are unattainable given current resources

All outcomes on the PPF achieve production efficiencyOutcomes inside PPF are inefficient, but attainable

2Example: PPF3

Opportunity Cost4

Opportunity CostThe highest-valued alternative foregone

PPF assumes two goodsOpportunity cost of Good Y is however much of Good X is given up to get more of Good YCalculated as a ratioOpportunity Cost of Y = Decrease in Good X / Increase in Good YOpportunity Cost of X = Decrease in Good Y / Increase in Good X

Increasing along the PPF as more of a good or service is produced, must use less productive resources

5For Producer: Opportunity Cost = Marginal Cost6Marginal cost of a good is the opportunity cost of producing one more unit

MC = slope of PPFHow much cola is lost for one pizza

PPF is not linear so MC is changing throughout

Relationship is Negative Usually Concave7The more pizzas you make the greater the number of cola units must give up to make one more pizza

Low hanging fruit

Slope increases in magnitude (gets more negative higher number) as pizzas produced increases

Deriving Marginal Cost Curve8

Consumers Perspective - Marginal BenefitMarginal Benefit of a good or services is the benefit a consumer gets from receiving one more unit of it

Dependant upon consumer preferences likes and dislikes

Changes from consumer to consumer and changes for each consumer as number of units increases

Principle of diminishing marginal benefit variety IS the spice of life, say economists.9Downward Sloping Marginal Benefit Curve1

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Allocative Efficiency Where MC=MB11Achieve allocative efficiency when we cannot produce more of one good without giving up another good we like more

Must be on PPF from which we derive MC curve

Must be on MB curve

What is a Market?Market Any arrangement that enables buyers and sellers to get information and do business with each otherCould be a physical place or a networkE.g. Farmers market, shop at mall, internet, auction

Evolved to facilitate trade

12Why Do We Trade?Gains from trade arise because of specialization and comparative advantageHave a comparative advantage if can perform an activity at lower opportunity cost than anyone else

Comparative vs. absolute advantage Absolute advantage if can produce more of a good than othersOne person can have absolute advantage in both goods but will only have comparative advantage in one

13Example: PPFs 14Lizs OC:1 Smoothie = 1 Salad1 Salad = 1 Smoothie

Joes OC:1 Smoothie = 5 Salads1 Salad = 1/5 Smoothie

Each has comparative advantage in good with lower OC

Example: PPFs15

Example: Gains from Trade16Before trade Calculate max # goods each can make if each makes half smoothies and half salads

Specialization Calculate max # goods if spends 1 hour making good have comparative advantage in

Negotiate price between Lizs old OC (1Sm=1Sa) and Joes (1Sm=5Sa) E.g. 1 Smoothie = 2 Salads

Gains from trade => Compare before trade consumption with consumption after trade

Example: Gains from Trade17Whenever opportunity costs differ (i.e. comparative advantage exists) the possibility for gains exists

Trade allows for production of more of all goods

Example: Gains from Trade18

What Facilitates Markets?Property RightsSocial arrangements that govern the ownership, use, and disposal of anything people valueMarkets cannot work without themTypes of property:Real land, buildings, durable goods, STUFF etc.Financial stocks, bonds, money, etc.Intellectual intangible product of creative effort

MoneyCommodity or token generally accepted as means of paymentMakes trading more efficient

19Economic CoordinationThere are over 6 billion people on Earthhow do we best coordinate production so we all gain from trade?

2 Systems:Central economic planning All decisions made my centralized govtDecentralized marketsWorks better, although not a utopiaRequires 4 social institutions:Firms economic unit that hires factors of production and organizes them to produce and sell goods & servicesMarketsProperty RightsMoney

20Coordination Btw Factor and Goods Markets21