Microeconomics Chapter 2

What generates economic growth?

A: Economic growth is generated by technological change and capital accumulation, including growth in human capital. Ex. A factory grows by buying better machines, training workers, and using new technology — boosting output and driving economic growth.

How does economic growth influence the production possibilities frontier (PPF)?

A: Economic growth shifts the PPF outward, representing an expansion of production possibilities. Example: Producing more pizza ovens today means more pizzas in the future, expanding the PPF.

What is the opportunity cost of economic growth?

A: The opportunity cost is fewer consumption goods today, as resources are allocated to producing capital goods and technology. Ex. Allocating resources to make ovens instead of pizzas means eating fewer pizzas now.

Explain why Singapore has experienced faster economic growth than Canada.

A: Singapore allocated more resources to capital accumulation (2/5 vs. Canada’s 1/5), leading to faster expansion of its PPF and production capacity.

Does economic growth overcome scarcity?

A: No. Economic growth expands production possibilities but scarcity remains because resources are still limited. Example: Even if a country produces more food through economic growth, it still can’t satisfy all wants—like unlimited healthcare, housing, or clean water. Resources are still limited, so scarcity remains.

Why are social institutions such as firms, markets, property rights, and money necessary?

A: They coordinate economic activity:

• Firms organize production.

• Markets enable trade.

• Property rights protect ownership and incentivize production.

• Money facilitates efficient trade.

What are the main functions of markets?

A: Markets:

• Match buyers and sellers.

• Coordinate decisions via prices.

• Allocate resources efficiently.

• Example: At a lemonade stand, the seller sets a price. Buyers decide whether to buy based on that price. If demand is high, the seller makes more. This shows how the market matches people, uses prices to guide decisions, and allocates resources (lemons, time) where they’re most valued.

What are the flows from firms to households and from households to firms?

A:

• From firms to households: Wages, rent, interest, profits, goods, services.

• From households to firms: Labor, land, capital, entrepreneurship, and spending on goods/services.

Example:
A person works at a car company (labor to firm) and earns a wage (income from firm). They use that income to buy a car (spending to firm), and the firm provides the car (goods to household).

9. How does the PPF illustrate scarcity?

A: The PPF boundary shows the limit of what can be produced with existing resources and technology, reflecting scarcity. Example: A country can produce either 100 cars or 200 computers. It can’t have unlimited amounts of both. The PPF shows this limit, illustrating that resources are scarce.

How does the PPF illustrate production efficiency?

A: Points on the PPF represent production efficiency—no more of one good can be produced without producing less of another. Example: If a factory is on its PPF, it might produce 50 bikes and 100 skateboards. To make more bikes, it must make fewer skateboards. This shows production efficiency—resources are fully used.

How does the PPF show that every choice involves a tradeoff?

A: Moving along the PPF requires giving up some of one good to gain more of another, illustrating tradeoffs.

Example: If a country moves from producing 80 computers and 40 cars to 60 computers and 60 cars, it gives up 20 computers to get 20 more cars. This shows a tradeoff—more of one good means less of another.

How does the PPF illustrate opportunity cost?

A: The slope of the PPF shows the opportunity cost—what must be given up to produce more of another good.

Why is opportunity cost a ratio?

A: It’s the loss of one good divided by the gain of another, forming a ratio (e.g., 3 cans of cola per pizza). Example: Giving up 3 million cans of cola for 1 million pizzas = 3:1 ratio.

Why does the PPF bow outward?

A: Because of increasing opportunity cost—resources aren’t equally suited to all tasks.

What does a bowed-out PPF imply about opportunity cost and production?

A: As you produce more of a good, the opportunity cost increases due to less efficient resources being used. Ex. If a farm uses its best land to grow wheat first, then switches to poorer land for more wheat, the cost in lost corn production gets bigger. The bowed-out PPF shows increasing opportunity cost as production shifts.

What is marginal cost? How is it measured?

A: Marginal cost is the opportunity cost of producing one more unit, measured by the slope of the PPF. Example: If producing one more bike means giving up 3 skateboards, the marginal cost of that bike is 3 skateboards. It’s shown by how steep the PPF is at that point.

What is marginal benefit? How is it measured?

A: Marginal benefit is the value of the next unit consumed, measured by how much people are willing to pay for it.

How does marginal benefit change as quantity increases?

A: Marginal benefit decreases—people are willing to pay less for additional units (principle of decreasing marginal benefit).

What is allocative efficiency?

A: Allocative efficiency is achieved when marginal benefit = marginal cost, maximizing total benefit from limited resources. Example: At 2.5M pizzas, MC = 3 and MB = 3 → efficient.

How is allocative efficiency related to the PPF?

A: It occurs at the point on the PPF where MB = MC, indicating the most desirable mix of goods.

What conditions must be satisfied for efficient resource use?

A: Resources must be fully employed, used where they are most productive, and production must be at a point where MB = MC.

Example: Skilled workers in the right jobs, like pizza chefs making pizza, not cola.

What gives a person a comparative advantage?

A: A lower opportunity cost of producing a good compared to others. Example: Joe has lower opportunity cost in salads, while Liz has it in smoothies.

Difference between comparative and absolute advantage?

A:

• Comparative Advantage: Lower opportunity cost.

• Absolute Advantage: Can produce more with the same resources.

Why do people specialize and trade?

A: To increase total output, consume beyond their PPF, and benefit from comparative advantage. Example: Liz and Joe both end up with 20 smoothies and 20 salads after trade—more than before.

What are the gains from specialization and trade?

A: Higher total production, efficient use of resources, and the ability to consume beyond personal production.

What is the source of gains from trade?

A: Comparative advantage—when individuals or countries produce goods at lower opportunity costs and trade. Example: Joe focuses on salads, Liz on smoothies → both gain. Example: Joe focuses on salads, Liz on smoothies → both gain.

Why is not specializing and trading inefficient?

A: It leads to production inside the PPF, wasting resources and reducing potential gains. Example: If Liz and Joe both try to make both goods, they only reach point D (20 smoothies, 20 salads), which is inside their PPF.