Learning Objectives Explain the fundamental economic problem Define the production possibility frontier Define and calculate opportunity cost Explain the conditions in which resources are used efficiently.

Learning Objectives (cont.) Explain how economic growth expands production possibilities Explain how specialization and trade expand production possibilities

Learning Objectives Explain the fundamental economic problem Define the production possibility frontier Define and calculate opportunity cost Explain the conditions in which resources are used efficiently.

Resources and Wants Our wants for goods and services exceed the productive capacity of the resources used to produce these goods and services.

Limited Resources The resources that are used to produce goods and services are: Labor Land Capital Entrepreneurship

Limited Resources Labor Land The time and effort that we devote to producing goods and services. Land The gifts of nature that we use to produce goods and services.

Limited Resources Capital The goods we use to produce other goods and services. Includes physical capital interstate highways, buildings, and dams and human capital the knowledge and skill that people obtain from education and on-the-job training

Limited Resources Entrepreneurship The resource that organizes labor, land, and capital.

Unlimited Wants Our wants are unlimited. Humans, by nature, would like to have more of those things they find desirable.

Resources and Wants We have limited resources. We have unlimited wants. This leads to scarcity. Scarcity exists when there are insufficient resources to satisfy people’s wants.

Economics Economics is the study of the choices people make to deal with scarcity.

Learning Objectives Explain the fundamental economic problem Define the production possibility frontier Define and calculate opportunity cost Explain the conditions in which resources are used efficiently.

Resources, Production Possibilities, and Opportunity Cost The production possibilities frontier is used to illustrate the maximum quantity of two goods that can be produced due to scarcity.

A Typical PPF Picture Butter Guns The marginal opportunity cost of guns in terms of butter is increasing as we move down the PPF! The PPF is typically bowed-out or linear. It is not bowed-in unattainable just attainable Butter inefficient just attainable Guns

Production Possibilities Frontier Possiblity Guns Butter Hundreds Thousand’s Tons a 0 and 15 b 1 and 14 c 2 and 12 d 3 and 9 e 4 and 5 f 5 and 0

Production Possibility Frontier a b d c f e 15 Attainable Unattainable 10 Butter 5 z 0 1 2 3 4 5 Guns

Learning Objectives Explain the fundamental economic problem Define the production possibility frontier Define and calculate opportunity cost Explain the conditions in which resources are used efficiently.

Opportunity Costs Production Efficiency Tradeoff Production efficiency is achieved if we cannot produce more of one good without producing less of some other good. Tradeoff Tradeoffs exist when we must give up something to get something else.

Opportunity Costs Opportunity Cost All tradeoffs involve a cost — an opportunity cost.

Opportunity Costs The opportunity cost of an action is the highest valued alternative foregone, or the next best alternative. Opportunity costs increase as we desire to produce more guns. This explains the shape of the PPF — it is bowed outward.

Opportunity Costs Opportunity Cost Is a Ratio The decrease in the quantity produced of one good divided by the increase in the quantity of another good. Increasing Opportunity Cost Opportunity costs tend to increase because not all resources are equally productive in all activities.

Using Resources Efficiently Marginal cost The opportunity cost of producing one more unit of a good or service. The marginal cost of an additional gun is the quantity of butter that must be given up to get one more gun — the opportunity cost.

Opportunity Cost and Marginal Cost Increasing opportunity cost of butter… means the marginal costs of guns goes up a b c d e f 15 10 Butter 5 0 1 2 3 4 5 0 1 2 3 4 5 Guns

Marginal Benefit Marginal benefit Decreasing Marginal Benefit The benefit that a person receives from consuming one more unit of a good or service. It is measured as the maximum amount that a person is willing to pay for one more unit. Decreasing Marginal Benefit The more we have of any one good or service, the smaller is our marginal benefit.

Learning Objectives Explain the fundamental economic problem Define the production possibility frontier Define and calculate opportunity cost Explain the conditions in which resources are used efficiently.

Efficient Use of Resources Efficiency Implies that we cannot produce any more of any good without giving up something that we value even more highly. We compare the marginal cost to the marginal benefit.

Efficient Use of Resources If the marginal benefit of the last unit of a good exceeds its marginal cost, we increase production of that good. If the marginal cost of the last unit of a good exceeds its marginal benefit, we decrease production of that good.

The End