Specialization and exchange enable us to enjoy greater production and higher living standards than would otherwise be possible. The chapter explains why there are gains from specialization, and discusses some of the problems that may arise from specializing. This is also applied to countries and trade among nations. Resource allocation means deciding how to use our scarce resources; that is, deciding what to produce, how to produce, and for whom to produce. The three methods of resource allocation are tradition, command, and market. While all three methods are used in the United States, the dominant method of resource allocation is the market.
One of the key advantages of a market system is that, in most cases, it forces us to face the opportunity cost of our actions. The chapter ends with an example of what happens when we do not face the costs of our actions: the possible overuse of some life-saving techniques and underuse of others. Production possibilities frontier PPF : A curve showing all combinations of two goods that can be produced with the resources and technology currently available.
Productively inefficient: A situation in which more of at least one good can be produced without sacrificing the production of any other good. Specialization: A method of production in which each person concentrates on a limited number of activities. Exchange: The act of trading with others to obtain what we desire. Absolute Advantage: The ability to produce a good or service using fewer resources than other producers use. Comparative Advantage: The ability to produce a good or service at a lower opportunity cost than other producers. Traditional Economy: An economy in which resources are allocated according to long-lived practices from the past.
Command or centrally planned economy: An economic system in which resources are allocated according to explicit instructions from a central authority. Market economy: An economic system in which resources are allocated through individual decision making. Market: A group of buyers and sellers with the potential to trade with each other.
Price: The amount of money that must be paid to a seller to obtain a good or service. An insightful article that describes the strengths and weaknesses of market capitalism is: Robert J. PPFs are concave because the law of increasing opportunity cost holds. To see why, imagine a situation in which the law does not hold.
For example, imagine an economy that produces two products: left moccasins and right moccasins.
What would its PPF look like? A negatively sloped, degree straight line b. Explain why the PPF has this shape. Because the resources used to produce left and right moccasins are perfectly adaptable, so the law of increasing opportunity cost does not hold. What would the PPF look like if the economy produced ankle-high moccasins and knee-high moccasins?
The PPF would still be a negatively sloped straight line, although, since the knee-high moccasins use more material, it would not be a 45degree line. Construct a production possibilities frontier showing capital goods on one axis and consumption goods on the other axis. Use this PPF to demonstrate the following: a.
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What will happen to our PPF over time if we employ our current resources to produce only consumption goods? How would our PPF change over time if we concentrated, instead, on producing just capital goods? How is it going?. Invite your contacts to take the test.
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