Lecture 3: Production, Growth, and Trade  Define production possibility frontier  Define production efficiency  Choosing Production Mixes  An introduction to Growth  Work for the Weekend  Read Chapters 3 and 4  Work EIA Chapter 3

Here are some of the issues we will address  Economic growth has made us richer than our grandparents.  Why must we still deal with scarcity?  Why are there no “free lunches?”  Why is there so much specialization and trade in the world economy?

The Production Possibility Frontier  Production is the conversion of land, labor, capital, and entrepreneurial ability into goods and services.  The production possibilities frontier (PPF) marks the boundary between those combinations of goods and services that can be produced and those that cannot- given available resources.

Tapes Soda (millions (millions of bottles Possibility per month) per month) Production Possibilities Frontier a 0and15 b1and14 c2and12 d3and 9 e4and 5 f5and 0

Production Possibilities Frontier Tapes (millions per month) Soda (millions of bottles per month)

Production Possibilities Frontier Tapes (millions per month) a Soda (millions of bottles per month)

Production Possibilities Frontier Tapes (millions per month) a b Soda (millions of bottles per month)

Production Possibilities Frontier Tapes (millions per month) b c Soda (millions of bottles per month) a

Production Possibilities Frontier Tapes (millions per month) a b c d Soda (millions of bottles per month)

Production Possibilities Frontier Tapes (millions per month) a b c d e Soda (millions of bottles per month)

Production Possibilities Frontier Tapes (millions per month) a b c d e f Soda (millions of bottles per month) 10

Production Possibilities Frontier Tapes (millions per month) a b c d e f Soda (millions of bottles per month)

Production Possibilities Frontier Attainable Unattainable Tapes (millions per month) a b c d e f Soda (millions of bottles per month)

Production Possibilities Frontier Soda (millions of bottles per month) Attainable Unattainable Tapes (millions per month) a b c d e f z

Opportunity Costs  Tradeoff  Tradeoffs exist when we must give up something to get something else.  Opportunity Cost  All tradeoffs involve a cost — an opportunity cost.

Opportunity Costs  An opportunity cost is the highest valued alternative foregone.  Opportunity costs increase as we desire to produce more tapes.  This explains the shape of the PPF — it is bowed outward.

Opportunity Costs  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 tape is the quantity of soda that must be given up to get one more tape — the opportunity cost.

Opportunity Cost and Marginal Cost Tapes (millions per month) a b c d e f Soda (millions of bottles per month)

Opportunity Cost and Marginal Cost Tapes (millions per month) a b c d e f Soda (millions of bottles per month)

Opportunity Cost and Marginal Cost a Tapes (millions per month) b c d e f Soda (millions of bottles per month) Increasing opportunity cost of tapes

Tapes (millions per month) a b c d e f Soda (millions of bottles per month) Opportunity Cost and Marginal Cost Increasing opportunity cost of tapes...

Opportunity Cost and Marginal Cost Tapes (millions per month) a b c d f Soda (millions of bottles per month) Increasing opportunity cost of tapes... e

Opportunity Cost and Marginal Cost Tapes (millions per month) a b c d e f Soda (millions of bottles per month) Increasing opportunity cost of tapes...

Opportunity Cost and Marginal Cost Tapes (millions per month) Soda (millions of bottles per month) …means increasing marginal cost of tapes.

Tapes (millions per month) MC Opportunity Cost and Marginal Cost Soda (millions of bottles per month) …means increasing marginal cost of tapes.

Where Should we Produce on a PPF  Any point on the curve is efficient  Some choices has implications for economic well being  How should we choose?  What Choices are best for Economic Growth?

The Cost of Shifting the Frontier  If society chooses to allocate resources toward capital investment, fewer goods and services are available for consumption today.  However, more goods and services will be produced in the future.  In General what determines how this choice is made?

Factors That Influence Economic Growth  Technological progress is the development of new and better ways of producing goods and services.  Capital accumulation is the growth of capital resources.  does education play a role?  does tax policy play a role?