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Chapter 2 (Textbook Notes and Lecture Notes)

Tuesday, January 17, 2023
Birdget O’Shaughnessy
ECON 1BB3 C02

Textbook Notes (pg 33 –54)

Introduction
 All economics start w scarcity
→ Exists b/c unlimited wants but limited resources
→ Requires trade-offs
 Factors of production = inputs used to make goods/services

2.1 PPF and Opportunity Cost

 Production possibilities frontier (PPF) = curve showing max attainable combos of 2 products that
may be produced w available resources and tech

→ On line = productively efficient

→ Inside = inefficient
→ Outside = unattainable given current resources

 Opportunity cost = highest-valued alternative that must be given up to engage in activity

 Allocative efficiency = production in accordance w consumer preferences

 PPF bowed out

→ Experience increasing marginal opportunity costs b/c give up more of one good
to get other
→ Resources can't keep up
→ More resources already devoted to activity, smaller payoff to devoting additional
resources to that activity

 PPF shifts as economic resources become available and change occurs

→ Represent economic growth
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2.2 Comparative Advantage and Trade

 Trade = act of buying and selling

 Absolute advantage = ability to produce more good/service than trading partner using same
amount of resources
 Comparative advantage = ability to produce good/service at lower opportunity cost than trading
partner
→ Basis for trade
→ Specialize where comparative advantage

2.3 The Market System

 Market = group of buyers and sellers of good/service and institutions/arrangements by which
come together to trade
→ Where trade happens
 Product market = market for goods
 Factor market = market for factors of production

 Participants in markets
1. Households
2. Firms
 Circular-flow diagram = illustrates how participants in market linked

 Free market = market w few govt restrictions

→ Higher standards of living in free market economy countries
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 Property rights = rights individuals/firms have to exclusive use of property

→ If not enforced, fewer goods/services produced reducing economic efficiency

 Trading allows specialization and those to pursue comparative advantage

 Markets should facilitate trade
 Firms must respond to desires of consumers = prices

Lecture Notes (Tuesday, January 17, 2023)

The Market System
 Market = place where buy and sell products/services

1. Product market = goods and services

→ Firms supply
→ Household demand
2. Labour market = availability of employment/labour
→ Household supply
→ Firms demand

 "Freer markets" = higher living standards

 Protection of property rights essential for market economy to function smoothly and
successfully

Trade Offs and Comparative Advantage

 Production possibilities frontier (PPF)
 2 x 2 = 2 people/countries producing 2 goods
 Comparative advantage decides trade
 Absolute advantage = produce more using same amount of resources
 Comparative advantage = produce at lower opportunity cost
→ Basis for trade

Example
Mike and Sandy are two woodworkers who both make tables and chairs. In 1 month, Mike can make 4
tables or 20 chairs, while Sandy can make 6 tables or 24 chairs. What range of “prices” makes both
parties better off?

Tables (T) Chairs (C)

Mike 4 20

Sandy 6 24
Sandy has absolute advantage.
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Opportunity cost of 1:
Table (T) Chairs (C)

Mike 4T=20C 20C=4T

1T=5C 1C=1/5T

Sandy 6T=24C 24C=6T

1T=4C 1C=1/4T
Sandy has comparative advantage in T and Mike in C
 Mike sells C and buy T
 Sandy buys C and sell T

Therefore, the price of trade is between 4 chairs and 5 chairs for 1 table.