H e l p f u l H i n t s

1. CHOICES AND INCENTIVES :

The basic assumption made by economists about human behavior is that people try to make themselves as well off as possible. As a result, people respond to changed incentives by changing their decisions. The key idea is that an individual compares the additional (or “marginal”) benefit from taking an action to the additional (or “marginal”) cost of the action. If the marginal benefit from the action exceeds the marginal cost, taking the action makes the person better off, so the person takes the action. Conversely, if the marginal benefit falls short of the marginal cost, the action is not taken. Only the additional benefit and additional cost are relevant because they are the benefits and costs that the person will enjoy and incur if the action is undertaken. Keeping straight the distinction between additional benefits and costs versus total benefits and costs is a vital part of economics, particularly of microeconomics.

2. MODELS AND SIMPLIFICATION :

In attempting to understand how and why something works (for example, an airplane or an economy), we can use description or we can use theory. A description is a list of facts about something. But it does not tell us which facts are essential for understanding how an airplane works (the shape of the wings) and which facts are less important (the color of the paint). Scientists use theory to abstract from the complex descriptive facts of the real world and focus only on those elements essential for understanding. These essential elements are fashioned into models — highly simplified representations of the real world. In a real sense, models are like maps, which are useful precisely because they abstract from real world detail. A map that reproduced all the details of the real world (street lights, traffic signs, electric wires) would be useless. A useful map offers a simplified view, which is carefully selected according to the purpose of the map. A useful theory is similar: It gives guidance and insight into how the immensely complicated real world functions and reacts to changes.

3. ASSUMPTIONS OF THE PPF :

The PPF provides an example of the role played by simplifying assumptions in economic analysis. Clearly, no society in the world produces only two items but by assuming that there are such “two-good” nations, we can gain invaluable insights into the real world. For instance, we see that once a nation is producing on its production possibilities frontier, no matter how many goods it produces, to increase the production of one good necessarily has an opportunity cost in terms of some other good or goods that must be foregone. In addition, we also see that countries that devote a larger proportion of their resources to capital accumulation will have more rapid growth.

4. INEFFICIENT PRODUCTION POINTS :

Points within the PPF curve are attainable but are inefficient. These production point occur whenever some inefficiency or misallocation emerges within the economy, such as excessive unemployment of any resource or an inefficient use of resources. Points beyond the PPF are unattainable. They are not classified as either efficient or inefficient because they are not production combinations that the society can reach.

5. CALCULATING OPPORTUNITY COST:

A helpful formula for opportunity cost results from the fact that opportunity cost is a ratio. Opportunity cost equals the quantity of goods you must give up divided by the quantity of goods you will get.

For instance, consider the nation whose PPF is in Figure 2.3. If we move along the PPF from a to b, what is the opportunity cost of an additional yard of cloth? The nation must give up 2 pounds of corn (25 – 23) to get 1 yard of cloth (1 – 0). So the opportunity cost of the first yard of cloth is 2 pounds of corn divided by 1 yard of cloth or 2 pounds of corn per yard of cloth. Next, if we move from b to c , the opportunity cost of the second yard of cloth is calculated the same way and is 3 pounds of corn per yard of cloth.