Economic models - Chapter 2 - ECON100

Economic models

The Production possibility frontier

Comparative advantage

The circular flow diagram

The Production possibility frontier

A diagram that shows the combinations of two goods that are possible for a society to produce at full employment

Shows all combinations of two goods that an economy can possibly produce given its resources and technology

Needs to be feasible and efficient

The points on the line (PPF) are feasible and efficient

The points below the line are inefficient

The points above the line are not feasible

Efficiency

An economy is efficient when there are no missed opportunities

It is inefficient in production, if it can produce more of some goos without reducing others 

Opportunity cost

What must be given up in order to get an extra good 

Opportunity cost of A = change in quantity of B/change in quantity of A

Comparative advantage

It makes sense to produce things you are especially good at producing and buy everything else from others

A country has comparative advantage in producing a good or service if its opportunity cost of producing a good or service is lover than for other countries

An individual has comparative advantage in producing a good or service if his or her opportunity cost of producing a good or service is lower than for other people

Having less opportunity cost means you are ___ at production

Better

Whoever has less opportunity cost has the comparative advantage.

Comparative advantage and gains from trade

Since each country has a different opportunity cost, it makes sense to specialize and trade

Through specialization and trade, both countries produce more and consume more than if they were self-sufficient 

Just because a country is efficient at producing both goods on a PPF, does not mean they are better off without trade 

Barter 

Exchanging goods and services for other goods or services without using money. 

Circular flow diagram

Trade takes the form of barter when people directly exchange goods or services that they have for other goods and services that they want

Represents the transactions in an economy by flows around a circle 

Household (circular flow diagram)

A person or group of people that share their income

Firm (circular flow diagram)

An organization that produces goods and services for sale

Factor Markets (circular flow diagram)

Where firms buy the resources they need to produce goods and services (land, labor, physical capital, human capital)

Income distribution (circular flow diagram)

The way in which total income is divided among the owners of various factors of production

Positive economics

Branch of economic analysis that describes the way economics actually works

Normative economics

Makes prescriptions about the way the economy should work 

example: If COVID-19 didn’t happen, what would have happened to the economy now?

Forecast

Simple prediction of the future