AP Economics

Unit 1Chapter 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

2820 400

30

9

15

Quantity of coconuts

Production possibility frontier

A

B

D

C

Feasible and efficientin production

Not feasible

PPF

Quantity of fish

Feasible butnot efficient

Increasing Opportunity Cost

A

PPF

10 20 30 40 500

35

30

25

20

15

10

5

Producing the first 20 fish . . .

…requires giving up 25 more coconuts…

…requires giving up 5 coconuts

But producing 20 more fish . . .

Quantity of coconuts

Quantity of fish

Economic GrowthEconomic growth results in an outward shift of the PPF because production possibilities are expanded.

The economy can now produce more of everything.

Production is initially at point A (20 fish and 25 coconuts), it can move to point E (25 fish and 30 coconuts).A

10 20 25 30 40 500

35

30

25

20

15

10

5

E

NewPPF

OriginalPPF

Quantity of coconuts

Quantity of fish

PPC PracticeDraw a PPC showing changes for each of the

following:Pizza and Robots (3)

1. New robot making technology2. 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

New robot making technologyQ

Q

Rob

ots

Pizzas

Question #1

8

A shift only for Robots

Decrease in the demand for pizzaQ

Q

Rob

ots

Pizzas

Question #2

9

The curve doesn’t shift!A change in demand

doesn’t shift the curve

Mad cow disease kills 85% of cowsQ

Q

Rob

ots

Pizzas

Question #3

10

A shift inward only for Pizza

BP Oil Spill in the GulfQ

QCap

ital G

oods

(Gun

s)

Consumer Goods (Butter)

Question #4

11

Decrease in resources decrease production possibilities for both

Faster computer hardwareQ

QCap

ital G

oods

(Gun

s)

Consumer Goods (Butter)

Question #5

12

Quality of a resource improves shifting the

curve outward

Many workers unemployedQ

QCap

ital G

oods

(Gun

s)

Consumer Goods (Butter)

Question #6

13

The curve doesn’t shift!Unemployment is just a point inside the curve

Significant increases in educationQ

QCap

ital G

oods

(Gun

s)

Consumer Goods (Butter)

Question #7

14

The quality of labor is improved. Curve shifts

outward.

Production Possibilities for Two Castaways

28 400

30

9

(a) Tom’s Production Possibilities

Tom’s consumptionwithout trade

Tom’sPPF

Quantity of coconuts

Quantity of fish

Production Possibilities for Two Castaways

1060

20

8

Hank’sPPF

Quantity of coconuts

Quantity of fish

(a) Hank’s Production Possibilities

Hank’s consumptionwithout trade

Tom and Hank’s Opportunity Costs

Tom’s Opportunity Cost

Hank’s Opportunity Cost

One fish 3/4 coconut 2 coconuts

One coconut 4/3 fish 1/2 fish

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

28 400

30

910

1060

20

810

(a) Tom’s Production and Consumption

Tom’s consumption without trade

30

Tom'sPPF

Hank'sPPF

Quantity of coconuts Quantity of coconuts

Quantity of fishQuantity of fish

Tom’s consumption with trade

Tom’s production with trade

(b) Hank’s Production and Consumption

Hank’s production with trade

Hank’s consumption with tradeHank’s consumption without trade

How the Castaways Gain from Trade

Both Tom and Hank experience gains from trade: 1. Tom’s consumption of fish increases by two, and his consumption of coconuts increases by one. 2. Hank’s 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

FactorsGoods

andservices

Factors

Households

Firms

Markets for goods and services

Factor Markets

Goodsand

services

Money 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.