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Here we will study our second
graphical model: the Production Possibilities Curve (PPC),
and we then will learn a tool for making decisions that we
will use throughout the course: Benefit-Cost Analysis (BCA).
Basically what we are doing is setting the stage for making
economic decisions. Remember: economics is the social
science concerned with how we CHOOSE to use our
limited resources to maximize society's unlimited wants, or,
how we make decisions.
The production possibilities curve
will show us that we must make choices and all choices have
costs. Economists call these "opportunity costs". ALL COSTS
IN ECONOMICS ARE OPPORTUNITY COSTS. Whenever we discuss the
"costs" of doing something we will mean the complete
opportunity cost.
Benefit-cost analysis (BCA) is a
model that explains how to make the best decision possible.
BCA means we should select all options where the marginal
benefits (MB) are greater than the marginal costs (MC) -- up
to where MB = MC. When the MB = MC then we have made the
best decision possible. NOTE: "marginal" means "extra" or
"additional". So to make the best decision possible select
all options where the extra benefits that you get from the
decision are greater than the extra costs of the decision.
One more thing: to make the best decisions we look only at
MARGINAL costs and benefits and we ignore FIXED, or SUNK,
costs (i.e. ignore things that will not change no matter
what choice is made).
We will use BCA many times throughout
this course. In lesson 6a we will use BCA to decide how much
to buy to maximize our satisfaction. In In lessons 8/9a,
8/9b, 10a, 10b, 11a, and 11b we will use it to decide how
much to produce to maximize profits. In lessons 12a and 13a
we use BCA to decide how many to hire to maximize
profits.
Notice that economists look at EXTRA
benefits and EXTRA costs. We call this "thinking on the
margin". Students are used to thinking about TOTAL benefits
and TOTAL costs. We do not want total benefits to equal
total costs, but we do want MB to equal MC. You probably
know that it is best if the total benefits are a lot higher
than total costs. What you will learn is that when MB = MC,
then the difference between total benefits and total costs
will be the greatest.
Be sure you understand Benefit-Cost
analysis (BCA)!
What is the connection between the
PPC and BCA? Well, when studying the PPC you will learn the
important concept of "opportunity cost". Learn the
definition well. Since all costs in economics are
opportunity costs, then when using BCA, "marginal costs"
mean the additional opportunity costs.
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