Production Possibilities and Opportunity Costs Chapter 2 Production Possibilities and Opportunity Costs Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing

What is a Production Possibilities Frontier (PPF)? A graph that shows the maximum combinations of goods that can be produced when resources and technology are used efficiently ©1999 South-Western College Publishing

For simplicity, lets take a world with only 2 products Lets use beer and pizza (a typical college campus?)

A typical PPF has the following shape:. Pizza Beer The curve has a negative slope. The curve is concave to the origin.

All points on the curve correspond to full use of resources. Pizza Beer A B

Points outside the the PPF are not feasible with existing resources. Pizza Beer .A

Periods of unemployment or inefficiency in production correspond to points under the PPF. Pizza Beer .A

Shape of the PPF? Why Concave? If PPF a straight line, we have constant opportunity costs If PPF concave, we have increasing opportunity costs

Consider a straight line PPF Beer given up, the opportunity cost, remains constant Beer Pizza

Concave shape, increasing opportunity costs. Beer given up, the opportunity cost, is increasing Pizza Beer

What is the Law of Increasing Costs? The opportunity cost of producing a good increases as more of the good is produced ©1999 South-Western College Publishing

Why does the Law of Increasing Opportunity costs hold? Because resources are not perfectly adaptable to all products

How do we have more of everything? By increasing our resources ©1999 South-Western College Publishing

Economic growth indicates an increase in the total output of an economy. The PPF shifts to the right ! Beer .A Pizza

Causes of rightward shifts in PPF’s? Increase in resources Increased productivity Improved technology

Can a PPF shift inward (to the left)? YES!! For just the opposite reasons as an outward shift such as a loss of resources

Economic growth and the Capital Consumer goods tradeoff: From which point would an economy grow faster, A or B?? Answer is A, with more capital goods Consumer goods Capital goods A B

What should a country specialize in producing? In those goods and services that it has a comparative advantage ©1999 South-Western College Publishing

What is Comparative Advantage? A country’s ability to produce a good at a lower opportunity cost than the country which it trades ©1999 South-Western College Publishing

What is Absolute Advantage? A country’s ability to produce a good using fewer resources than the country with which it trades ©1999 South-Western College Publishing

Example, 2 people, 2 jobs, time required Job A Job B Judy 60 min. 75 min Sam 90 min 150 min

In the table, Judy is absolutely advantaged at both tasks, but what is her comparative advantage? What is Sam’s comparative advantage?

Judy’s comparative advantage is at job B, and Sam’s comparative advantage is at job A To see why, look at the ratios in the table- Judy can do job A in 2/3 the time of Sam, but she can do job B in ½ the time, so she is relatively more efficient at job B.

Theory of comparative advantage Argues that output is greater when resources tend to specialize in their greatest comparative advantages

Problem With the same quantity of resources, Euphoria can produce 100 barrels of beer to Extasia’s 50 barrels, and Euphoria can produce 150 pizzas to Extasia’s 100. According to comparative advantage, what product should Extasia tend to specialize in? What about Euphoria?

ANSWER: Extasia should specialize in pizzas, Euphoria in beer production

What are Factors of Production? What is Production Possibilities? Why does division of labor increase productivity? What is an Opportunity Cost? What is Comparative Advantage? What is Absolute Advantage?