What is an economic model and what does it do?
What is the ONLY Latin term she said we had to know.
A simplified representation of reality.
Models graphically illustrate the relationship between two economic variables while all other variables are held constant.
Ceteris paribus - the all other things equal assumption
1. What does the Production Possibility Frontier (PPF) model illustrate?
2. Give a definition
1. The quantity of production that is possible either in an economy, or for an individual.
Resources can only be spent making one good or another, therefore the PPF shows the tradeoff when scarce resources (time, land, meterials etc.) are used.
Definition: It shows all possible combinations of goods that can be produced assuming that: 1. all resources are used and 2. technology and resources are fixed.
1. What do we call a point outside of the PPF?
2. What do we call a point inside of the PPF?
1. What is the calculation for determining opportunity cost using the PPF model?
2. example: If we had to give up 10 coconuts to get 20 fish, how would we calculate it and write it out shorthand?
- 1. Opportunity Cost = Δ lost Δ gained
Why does the opportunity cost of production generally increase as quantity produced increases?
Because as more and more of the good is being produced, resources that are less productive have to be used.
Ex. You use your best fishermen to start, but if you want to squeeze out more fish, you have to use people that are less productive and maybe would have been better at picking coconuts.
1. What would happen if Tom found a stick that increased his ability to get both goods?
2. What would happen if Tom found a new fishing pond?
3. What if Tom got sick and couldn't work as much?
4. What if some coconut trees blew over in a hurricane?
What is the difference between production efficiency and consumption efficiency in a PPF curve?
Production efficiency is any point along the PPF
Consumption efficiency is when the point of production is equal to the amount people want to consume (their preference).
When do gains from trade occur?
When people specialize and trade, and thereby consume more than they can produce (on their own).
I can ship an exhaust brake, but I can't make a cellphone. So I receive gains from trade and can consume more (a cellphone) than I would have sticking to shipping.
What is the difference between comparative advantage and absolute advantage?
Comparative advantage: When someone can produce a good with a lower opportunity cost than someone else
Absolute advantage: When someone can produce more output overall with a given amount of input.
*Even though one person may have an absolute advantage, each person has a comparative advantage in a different good.
What does the circular flow diagram
Flows of goods and services and money in an economy. It includes households, firms and markets.
Give an example of how immigrants are absorbed into the economy in a circular flow diagram?
New workers → Higher household income → More spending → More production of G.S. → More jobs
What are two things that models help economists do?
1. Explain the economy
2. Make predictions and recommendations.
What are two practical ways of doing economics?
1. positive economics: describes how the economy actually works using facts and data.
2. normative economics: prescibes how the economy should work, based on individual opinion
Why is the PPF bowed-out from the origin?
Because resources are not equally suited for the production of both goods.
In a single day, Sarah can produce 10 hamburgers while Abe can produce 5.
We then know that....
Sarah has the absolute advantage in making hamburgers
What two assumptions is the PPF curve based on?
1. All resources are used
2. Resources and technology are fixed