© 2003 McGraw-Hill Ryerson Limited u The choices made by society are often presented in terms of a production possibility curve. u The production possibilities curve shows the trade-offs among choices we make. The Production Possibilities Curve and Economic Reasoning

© 2003 McGraw-Hill Ryerson Limited The Production Possibility Table u A production possibility table lists the maximum combination of outputs that can be obtained from a given number of inputs.

© 2003 McGraw-Hill Ryerson Limited The Production Possibility Curve u A production possibility curve plots the maximum combination of outputs that can be achieved from a given number of inputs. u It slopes downward from left to right.

© 2003 McGraw-Hill Ryerson Limited The Production Possibility Curve u The production possibility curve not only demonstrates the opportunity cost concept, it also measures the opportunity cost.

© 2003 McGraw-Hill Ryerson Limited The Production Possibility Curve u The production possibility curve demonstrates that: l There is a limit to what you can achieve, given the existing institutions, resources, and technology. l Every choice made has an opportunity cost—you can get more of something only by giving up something else.

© 2003 McGraw-Hill Ryerson Limited Economics grade History grade 20 hours of history 0 hours of economics E D C B 20 hours of economics 0 hours of history A Hours of study in history Grade in history Hours of study in economics Grade in economics The Production Possibility Curve Fig. 2-1 (a and b), p 33

© 2003 McGraw-Hill Ryerson Limited Increasing Marginal Opportunity Cost u The production possibility curve is generally bowed outward since some resources are better suited for the production of some goods.

© 2003 McGraw-Hill Ryerson Limited Increasing Marginal Opportunity Cost u The concept of comparative advantage explains why opportunity costs increase as the consumption of a good increases. l Some resources are better suited for the production of some goods than to the production of other goods.

© 2003 McGraw-Hill Ryerson Limited Increasing Marginal Opportunity Cost, p 33 Y Y2Y 1X1X A X If the slope of the production curve is -2 at A, the opportunity cost of 1X is 2Y. 7

© 2003 McGraw-Hill Ryerson Limited Increasing Marginal Opportunity Cost u The principle of increasing opportunity cost states that opportunity costs increase the more you concentrate on an activity. u In order to get more of something, one must give up ever-increasing quantities of something else.

© 2003 McGraw-Hill Ryerson Limited A Production Possibility Table, Fig. 2-2a, p 34 % of resources devoted to production of burgers Number of burgers % of resources devoted to production of DVDs Number of DVDsRow A B C D E F

© 2003 McGraw-Hill Ryerson Limited A Production Possibility Curve, Fig. 2-2b, p 34 A DVDs Burgers burger 5 DVDs burgers 2 DVDs B C D E F burgers 1 DVD

© 2003 McGraw-Hill Ryerson Limited Increasing Marginal Opportunity Cost, p 35 DVDs Slope is flat at A. Low opportunity cost of burgers. Slope is steep at B. High opportunity cost of burgers. Burgers B A

© 2003 McGraw-Hill Ryerson Limited Efficiency u In our production, we would like to have productive efficiency—achieving as much output as possible from a given amount of inputs or resources.

© 2003 McGraw-Hill Ryerson Limited Efficiency u Any point within the production possibility curve represents inefficiency—getting less output from inputs which, if devoted to some other activity, would produce more output.

© 2003 McGraw-Hill Ryerson Limited Efficiency u Any point outside the production possibility curve represents something unattainable, given present resources and technology.

© 2003 McGraw-Hill Ryerson Limited Efficiency and Inefficiency, Fig. 2-3a, p 36 Efficiency and Inefficiency, Fig. 2-3a, p 36 DVDs Burgers CD A B Efficient points Inefficient point Unattainable point, given available technology, resources and labor force

© 2003 McGraw-Hill Ryerson Limited Shifts in the Production Possibility Curve u Society can produce more output if: l Technology is improved. l More resources are discovered. l Economic institutions get better at fulfilling our wants.

© 2003 McGraw-Hill Ryerson Limited Shifts in the Production Possibility Curve u An outward shift in the production possibility curve indicates more output that can be produced with given inputs.

© 2003 McGraw-Hill Ryerson Limited Neutral Technological Change DVDs A B Burgers 0 Shifts in the Production Possibility Curve, Fig. 2-3b, p 36 C D

© 2003 McGraw-Hill Ryerson Limited Biased Technological Change Shifts in the Production Possibility Curve, Fig. 2-3c, p 36 0 B A DVDs Burgers C

© 2003 McGraw-Hill Ryerson Limited Distribution and Production Efficiency u The production possibilities curve focuses on productive efficiency and ignores distribution. u An increase in output that goes to one person and not to anyone else would not necessarily be efficient in some societies.

© 2003 McGraw-Hill Ryerson Limited Distribution and Production Efficiency u Economists often talk about efficiency as if it means productive efficiency and achieving society's goals. u In our society, more is generally preferred to less and many policies have relatively small distributional effects.

© 2003 McGraw-Hill Ryerson Limited Examples of Shifts in the Production Possibility Curve u If more inputs are available for the production of X and Y equally, the PPC shifts out along both X and Y axes. u If fewer inputs are available for the production of X and Y equally, the PPC shifts in along both X and Y axes.

© 2003 McGraw-Hill Ryerson Limited Examples of Shifts in the Production Possibility Curve u If more inputs are available for good X only, the PPC shifts out on the X axis only. u If more inputs are available for good Y only, the PPC shifts out on the Y axis only.

© 2003 McGraw-Hill Ryerson Limited (a) (c) (d) (b) Examples of Shifts in the Production Possibility Curve Fig. 2-4, p 37

© 2003 McGraw-Hill Ryerson Limited Comparative Advantage, Specialization, and Trade u The production possibility curve becomes bowed out when individuals specialize in the production of goods for which they have a comparative advantage and trade with others.

© 2003 McGraw-Hill Ryerson Limited Comparative Advantage, Specialization, and Trade u The comparative advantage argument used to explain the bowed-out shape of the production possibilities curve can be used to show how trade makes society better off.

© 2003 McGraw-Hill Ryerson Limited Comparative Advantage, Specialization, and Trade u Collaboration and specialization can make society better off. u Total production can rise.

© 2003 McGraw-Hill Ryerson Limited Comparative Advantage, Specialization, and Trade u The outward bow graphically represents the potential gains from trade.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Sunder can either write one economics paper or four creative writing papers in a day. u Ti can either write one creative writing paper or four economics papers in a day.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Sunder has a comparative advantage in creating writing and Ti has a comparative advantage in economics.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u The following table and production possibility curves demonstrate how output increases when two individuals collaborate and specialize in the activity for which each has a comparative advantage.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade, Fig. 2-6a, p 41

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade, Fig. 2-6b, p 41

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Each individual's PPC is drawn by connecting the number of papers each can write in a day on a graph.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade, Fig. 2-6c, p 41 Economics (b) Sunder (a) Ti Creative writing

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u The combined PPC curve is drawn by finding three points and connecting them.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade, Fig. 2-6c, p 41 Economics (c) Combined with trade (b) Sunder (a) Ti B C A Creative writing

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Point A: This is the combined number of economics papers they both can write in a day. u If economics papers are on the Y axis, it is point 0,5.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Point B: This is the combined number of creative papers they both can write in a day. u If economics papers are on the Y axis, it is point 5,0.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u Point C: This is where each is focusing on that activity for which he or she has a comparative advantage. u Sunder writes four creative papers and Ti writes four economics papers. u This is the coordinates 4,4.

© 2003 McGraw-Hill Ryerson Limited The Gains From Trade u The combined PPC is bowed out because of comparative advantage and specialization.

© 2003 McGraw-Hill Ryerson Limited The Division of Labor u Markets allow specialization and the division of labor. u They allow individuals to develop their comparative advantages, thereby increasing the production possibilities of society.

© 2003 McGraw-Hill Ryerson Limited Markets, Specialization, and Growth u Markets and specialization have led to growth.

© 2003 McGraw-Hill Ryerson Limited Markets, Specialization, and Growth u The growth in per capita income (constant 1990 dollars) in the past 2 millennia has been astonishing. u This owes largely to the introduction of markets and democracy.

© 2003 McGraw-Hill Ryerson Limited Markets, Specialization, and Growth u As people are allowed to compete and specialize, they get better at what they do, develop new technologies and the market grows ever larger.

© 2003 McGraw-Hill Ryerson Limited Growth in the Past Two Millennia Fig. 2-7, p 42 col17930_0207.eps $6,000 $5,000 $4,000 $3,000 $2,000 $1, Per capita income (in 1990 international dollars)

© 2003 McGraw-Hill Ryerson Limited The Economic Organization Of Society End of Chapter 2