Notes
Scarcity and opportunity cost
- Scarcity: unlimited wants but limited resources, so every society must choose.
- Opportunity cost: the value of the next best alternative you give up.
- Factors of production: land, labor, capital and entrepreneurship.
The production possibilities curve (PPC)
- A PPC shows the maximum combinations of two goods an economy can produce with its resources.
- Points on the curve are efficient; points inside are inefficient (unemployment); points outside are unattainable for now.
- A bowed-out curve shows increasing opportunity costs (resources aren't equally good at making both goods). A straight line shows constant costs.
- Economic growth shifts the PPC outward (more resources, better technology).
Comparative advantage and trade
- Absolute advantage: producing more with the same resources. Comparative advantage: producing at a lower opportunity cost.
- Countries gain by specializing in what they have a comparative advantage in and trading.
- Output method: the opportunity cost of 1 unit of X is how many units of Y you give up.
Supply and demand
- Law of demand: higher price, lower quantity demanded. Demand shifts with income, tastes, prices of related goods (substitutes and complements), expectations and the number of buyers.
- Law of supply: higher price, higher quantity supplied. Supply shifts with input costs, technology, taxes and subsidies, expectations and the number of sellers.
- Equilibrium is where supply equals demand. A price ceiling below equilibrium causes a shortage; a price floor above equilibrium causes a surplus.
Practice
Opportunity cost is the value of the next best alternative given up.
The economy could produce more of both goods.
Resources aren't equally suited to producing both goods.
More productive capacity.
A gives up 2 computers per car; B gives up 3.
Fewer hot dogs bought means fewer buns needed.
Quantity demanded exceeds quantity supplied.
Lower costs increase supply.
Free response
Write your answer first, then open the scoring guide.
Free-response question
Countries X and Y each produce wheat and cloth. In one day, X can produce 40 wheat or 20 cloth, and Y can produce 30 wheat or 30 cloth.
(a) Calculate X's opportunity cost of producing 1 unit of cloth.
Show the answer and scoring guide
X gives up $\displaystyle \frac{40}{20} = 2$ units of wheat per unit of cloth.
Check off the points you earned:
(b) Which country has a comparative advantage in cloth? Explain.
Show the answer and scoring guide
Y. Its opportunity cost of 1 cloth is 1 wheat, lower than X's 2 wheat.
Check off the points you earned:
(c) If the countries specialize and trade, which good should X export? Explain.
Show the answer and scoring guide
Wheat. X's opportunity cost of wheat ($\displaystyle \frac{1}{2}$ cloth) is lower than Y's (1 cloth), so X has the comparative advantage in wheat.
Check off the points you earned: