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AP Economics

Unit 1
Chapter 2 Trade-offs and Trade
Review
1. Explain Scarcity.
2. Differentiate between positive and
normative.
3. Define opportunity cost.
4. What is a resource?
5. Name 10 different teachers at RWHS.
I. The Production Possibilities Frontier (curve)

a) Illustration of the trade-offs facing an


economy that produces only two goods.
Shows the maximum quantity of one good
that can be produced for any given
production of the other.
The Production Possibility Frontier
Quantity of coconuts

30 D

Feasible and Not


efficient feasible
in production

A
15

Feasible B
9 but
C
not
Production possibility frontier
efficient
PPF

0 20 28 40
Quantity of fish
Increasing Opportunity Cost
Quantity of coconuts

Producing the first requires giving


35 20 fish . . . up
5 coconuts

30 But producing
20 more fish . . .
A
25

20
requires giving up
15 25 more coconuts

10

5
PPF

0 10 20 30 40 50
Quantity of fish
Economic Growth
Quantity of coconuts
Production
Economic
The economygrowth
is initially
can results
now in A
at point
an outward
produce
(20 fish and
more shift
25ofcoconuts),
of
everything.
the PPF it
35 because
can to point E (25 fish
moveproduction
E
possibilities
and 30 coconuts).
are expanded.
30
A
25

20

15

10

5 Original New
PPF PPF

0 10 20 25 30 40 50
Quantity of fish
PPC Practice
Draw a PPC showing changes for each of the
following:
Pizza and Robots (3)
1. New robot making technology
2. Decrease in the demand for pizza
3. Mad cow disease kills 85% of cows
Consumer goods and Capital Goods (4)
4. BP oil spill in the Gulf
5. Faster computer hardware
6. Many workers unemployed
7. Significant increases in education

7
Question #1
New robot making technology
Q

A shift only for Robots


Robots

Q
Pizzas 8
Question #2
Decrease in the demand for pizza
Q
The curve doesnt shift!
A change in demand
doesnt shift the curve
Robots

Q
Pizzas 9
Question #3
Mad cow disease kills 85% of cows
Q

A shift inward only for


Pizza
Robots

Q
Pizzas 10
Question #4
BP Oil Spill in the Gulf
Q
Capital Goods (Guns)

Decrease in resources
decrease production
possibilities for both

Q
Consumer Goods (Butter) 11
Question #5
Faster computer hardware
Q
Quality of a resource
Capital Goods (Guns)

improves shifting the


curve outward

Q
Consumer Goods (Butter) 12
Question #6
Many workers unemployed
Q
The curve doesnt shift!
Capital Goods (Guns)

Unemployment is just a
point inside the curve

Q
Consumer Goods (Butter) 13
Question #7
Significant increases in education
Q
Capital Goods (Guns)

The quality of labor is


improved. Curve shifts
outward.

Q
Consumer Goods (Butter) 14
Production Possibilities for Two Castaways
(a) Toms Production Possibilities

Quantity of coconuts

30

Toms consumption
without trade

Toms
PPF

0 28 40 Quantity of fish
Production Possibilities for Two Castaways
(a) Hanks Production Possibilities

Quantity of coconuts

20
Hanks consumption
without trade

Hanks
PPF

0 6 10
Quantity of fish
Tom and Hanks Opportunity Costs

Toms Hanks
Opportunity Opportunity
Cost Cost

One fish 3/4 coconut 2 coconuts

One
4/3 fish 1/2 fish
coconut
Specialize and Trade
a) Both castaways are better off when they each
specialize in what they are good at and trade.
Comparative Advantage and Gains from Trade
(a) Toms Production and Consumption (b) Hanks Production and Consumption

Quantity of coconuts Quantity of coconuts

30 Toms
consumption Hanks
without trade production with
Toms trade
consumption with 20
Hanks
trade consumption with
trade
Toms production
10 10 Hanks
9 with trade
8 consumption
without trade
Tom's Hank's
PPF PPF
0 2830 40Quantity of fish 0 6 10 Quantity of fish
How the Castaways Gain from Trade

Both Tom and Hank experience gains from trade:


1. Toms consumption of fish increases by two, and his
consumption of coconuts increases by one.
2. Hanks consumption of fish increases by four, and his
consumption of coconuts increases by two.
II. Absolute vs. Comparative Advantage

a) Absolute advantage: greater total output. (ie.


Tom)
b) Hank has a comparative advantage in coconut
gathering (opportunity cost is lower than Toms).
c) Tom can better use his time catching fish.
d) Comparative Advantage: Opportunity cost for
producing something is lower for one person
over the other.
III. The Circular-Flow Diagram
a) Model that represents the transactions in an
economy by flows around a circle.
The Circular-Flow Diagram

Money Households Money

Goods
and Factors
services

Markets
for goods Factor Markets
and
services

Goods
and Factors
services

Firms
Money Money
Circular-Flow cont.
a) Household: a person or groups of people that
share their income.
b) Firm: Organization that produces goods and
services for sale.
c) Firms sell goods and services in the product
market.
d) Firms buy resources they need to produce in
the factor market.