Chapter 2 - Trade-offs, Comparative Advantage, and the Market System

What is scarcity?

A situation in which unlimited wants exceed the limited resources available to fulfill those wants.

What does scarcity require?

Trade-offs.

What example does Ford illustrate about trade-offs?

If Ford produces more F-150 Lightnings, fewer resources are available for other models.

What is a PPF (Production Possibilities Frontier)?

A curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology.

Is the PPF a positive or normative tool?

Positive; it shows "what is," not "what should be."

What do points on the PPF represent?

Attainable outcomes.

What do points below the PPF represent?

Inefficient outcomes.

What do points above the PPF represent?

Unattainable outcomes with current resources.

What is opportunity cost?

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

Why are opportunity costs often increasing?

Because resources are better suited to some tasks than others.

What happens when more resources are devoted to an activity?

The payoff to devoting additional resources decreases.

What does a shift in the PPF (Production Possibilities Frontier) represent?

Economic growth.

Define economic growth.

The ability of the economy to increase the production of goods and services.

How does technological improvement affect the PPF (Production Possibilities Frontier)?

It allows previously unattainable combinations to become attainable.

What is trade?

The act of buying and selling.

Define absolute advantage.

The ability to produce more of a good or service than competitors using the same resources.

Define comparative advantage.

The ability to produce a good or service at a lower opportunity cost than competitors.

What is the basis for trade?

Comparative advantage, not absolute advantage.

What are the four factors of production?

Labor, capital, natural resources, entrepreneurial ability.

Give an example of labor.

A teenager working at McDonald's or a senior manager.

What is capital?

Physical capital like computers, office buildings, and machine tools.

What are natural resources?

Land, water, oil, iron ore, and raw materials.

What is entrepreneurial ability?

The ability to organize other factors of production to create goods and services.

What is a market?

A group of buyers and sellers of a good or service, plus the institutions/arrangements by which they trade.

What is a factor market?

A market for factors of production like labor, capital, and resources.

What is a product market?

A market for goods and services.

What is the circular-flow diagram?

A model showing how households and firms are linked in markets.

What is a free market?

One with few government restrictions on production, sale, or employment of resources.

Who argued for free markets in The Wealth of Nations?

Adam Smith.

What does the "invisible hand" describe?

How individuals' self-interest leads to outcomes that satisfy consumer wants.

What allows the market mechanism to work?

Flexible prices.

What is an entrepreneur?

Someone who operates a business, bringing together factors of production.

Why are entrepreneurs important?

They create products consumers didn't know they wanted and contribute to economic growth.

What must governments provide for markets to succeed?

Protection of property rights and enforcement of contracts.

What are property rights?

The rights individuals or firms have to exclusive use of their property, including buying and selling it.

Why is an independent court system important?

It enforces contracts and property rights across time.

What did Karl Marx predict in Das Kapital?

Capitalism would be replaced by communism.

What actually happened in communist countries?

They became centrally planned with government control.

What do social democratic parties support?

A larger government role in the economy, often in health care and education.