<p>CHAPTER 2 – SOME TOOLS OF ECONOMIC ANALYSIS (6e)</p><p>In Chapter 1 we discussed scarcity and the need to make choices. But how do we make choices? What is involved in making economic decisions?</p><p>I. Choice and Opportunity Cost</p><p>“Because of scarcity, whenever you make a choice, you must pass up another opportunity; you must incur an opportunity cost.” (p. 27)</p><p>Definition of opportunity cost:</p><p>II. Comparative Advantage, Specialization, and Exchange</p><p>A. Two Types of Advantage</p><p>Example:</p><p>Type 1 Paper Iron 1 Blouse</p><p>Emily 30 min. 10 min.</p><p>Amy 60 min. 12 min.</p><p>1 1) Absolute advantage</p><p>Definition:</p><p>Who has the absolute advantage in typing?</p><p>Who has the absolute advantage in ironing?</p><p>2) Comparative advantage</p><p>Definition:</p><p>Determining who has the comparative advantage in each activity:</p><p>Opportunity cost of typing 1 paper:</p><p>Emily: typing 1 paper = ______</p><p>Amy: typing 1 paper = ______</p><p>Who has the comparative advantage in typing?</p><p>2 Opportunity cost of ironing 1 blouse:</p><p>Emily: ironing 1 blouse = ______</p><p>Amy: ironing 1 blouse = ______</p><p>Who has the comparative advantage in ironing?</p><p>B. The Law of Comparative Advantage</p><p>Definition:</p><p>Compare Emily and Amy’s total output without and with specialization:</p><p>In one hour, with no specialization, Emily could ______while Amy could ______.</p><p>In one hour, with specialization based on comparative advantage, Emily could ______while Amy could ______. </p><p>3 C. Specialization and Exchange</p><p>Specialization leads to exchange or trade, either by means of barter or by using money as a medium of exchange.</p><p>III. The Economy’s Production Possibilities</p><p>A. Simplifying Assumptions for a Production Possibilities Model</p><p>. Output is limited to only two classes of products . Time period is defined as one year . Resources are fixed during the given time period . Technology does not change during the given time period</p><p>B. The Production Possibilities Frontier (PPF) Model</p><p>Definition of PPF:</p><p>Definition of “efficiency”:</p><p>See Ex. 1</p><p>4 Points along the PPF:</p><p>Points inside the PPF:</p><p>Points outside the PPF:</p><p>C. Shape of the PPF</p><p>See Ex. 1. How is the PPF shaped, and why is this significant? </p><p>Law of increasing opportunity cost:</p><p>5 D. Shifts of the PPF</p><p>The PPF shifts due to:</p><p>1) Changes in the availability of resources</p><p>2) Changes in the capital stock</p><p>3) Technological changes</p><p>See Ex. 2 for examples of PPF shifts.</p><p>E. Summary: The PPF demonstrates</p><p> Efficiency  Scarcity  Opportunity cost  Law of increasing opportunity cost  Economic growth  Choice</p><p>Does the PPF tell us what combination of goods our economy should produce? If not, how is this combination determined?</p><p>6 IV. Economic Systems</p><p>Read pp. 39-41 for general understanding. Know the basic characteristics of the following types of economic systems:</p><p>Pure capitalism</p><p>Pure command system</p><p>Mixed economy</p><p>END</p><p>7</p>