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Microeconomics Chapter 2

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Economics Chapter 2
Exchange and Opportunity Cost:
For any level of activity, scarcity implies choices; each choice will have an opportunity cost
Society will be better off, in the sense that it can maximize output, if its productive activity is
based on using resources with the lowest opportunity cost
This implies that individual specialization and exchange of goods and services will create more
output than individual self sufficiency
Absolute Advantage:
A person has an absolute advantage over another if he or she takes fewer hours to perform a
task or produces more in the same amount of time than the other person
Comparative Advantage:
A person has a comparative advantage over another if his or her opportunity cost of performing
a task is lower than the other persons
Total output is largest when each person or country concentrates on the activities for which his
or her opportunity cost is lowest
On the individual level sources of comparative advantage arise from;
inborn talent, education, training and experience
On the national level sources of comparative advantage arise from;
Differences in natural resources, society, culture, institutions and public policy
Productivity:
An individual’s labour productivity = output per hour of labour time
It is frequently calculated to compare opportunity cost of 1 good in terms of another
Productivity = Q per hr / input per hr
PPC in 1 Person Economy:
PPC -> a graph illustrating the max amount of 1 good that can be produced for every possible
level of the other good
Because more of one good implies less of the other (Scarcity) and constant costs (same OC
regardless of how much is produced), the PPC will be a negatively sloped straight line for a 1
person economy
For an individual the slope and position of the PPC with respect to the origin are influenced by
the level of inborn talent, education, training and experience
PPC in 2 Person Economies:
Individuals have constant but different opportunity costs
The kink represents where the lower cost OC person is replaced by the higher cost OC person
This causes the PPC to be bent outward or concave to the origin
Multi Person PPC:
There are many constant but different OC
Each person’s contribution is relatively small
Bows outward into a much smoother curve

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Principle of Increasing Opportunity Cost:
States that in expanding the production of any good first employ those resources with the lowest
opportunity cost. Only when all of the lowest cost resources are employed does it make
economic sense to use resources with higher opportunity costs
Benefits and Costs of Specialization:
Benefits include,
Increase in total output
Increase in total consumption that occurs when producing according to comparative
advantage
Productivity of individual workers can increase
Improved living standards
Costs include,
Fragmentation of workplace tasks
Repetitive tasks can cause psychological costs
Benefits and Costs of Trade:
Nations can also gain from specialization when you produce according to comparative
advantage
As long as trading nations have different opportunity costs of production, there can be gains
from trade
The > the difference in OC the > the potential benefits from trade
Nations can benefit from trade even if one country has an absolute advantage in all goods
The opportunity for a small nation to trade with an economic superpower will increase the
consumption possibilities for the small nation and economic superpower
Small annual productivity gains due to specialization can amount to large differences in living
standards compared to countries that do not encounter productivity gains
If a high wage country opens up trade with a low wage country, unskilled workers in the high
wage country may be hurt
Chapter 2 – Practice Questions
1. When an individual concentrates on performing the tasks and producing the goods for which he
or she has the lowest opportunity cost, they are producing in accordance with what principle?
a. Comparative Advantage
2. At the individual level, comparative advantage results from what?
a. Differences in education or training.
3. Jane can produce 50 pizzas or 100 hamburgers per day, while Sam can produce 30 pizzas or 90
hamburgers per day. What does Jane have the absolute advantage in?
a. Jane has the absolute advantage in pizzas and hamburgers because she can produce
more than Sam. Furthermore, she has a comparative advantage in the production of
pizzas because she has a lower opportunity cost.
4. When expanding the production of any good, the principle of increasing opportunity costs
implies that we use resources with higher opportunity costs when what occurs?
a. When all resources with lower opportunity costs have been used.

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Economics Chapter 2 Exchange and Opportunity Cost: For any level of activity, scarcity implies choices; each choice will have an opportunity cost Society will be better off, in the sense that it can maximize output, if its productive activity is based on using resources with the lowest opportunity cost This implies that individual specialization and exchange of goods and services will create more output than individual self sufficiency Absolute Advantage: A person has an absolute advantage over another if he or she takes fewer hours to perform a task or produces more in the same amount of time than the other person Comparative Advantage: A person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other persons Total output is largest when each person or country concentrates on the activities for which his or her opportunity c ...
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