Or… Production Possibilities Curve (PPC ) Production Possibilities Frontier (PPF)

Resources: The Factors of Production Economists classify resources into 4 categories 1.Land  Natural resources  The payment for Land is RENT 2.Labor  Human resources  The payment for Labor is WAGES 3.Capital (a product of Investment)  Tools, machines, factories  The payment for Capital is INTEREST 4.Entrepreneurship  The special ability of risk-takers to combine land, labor and capital in new ways in order to make profit  The payment for Entrepreneurship is PROFIT

The Fundamental Problem of Economics: Scarcity People have unlimited wants but the resources to satisfy those wants are scarce. Therefore, we must make choices about how to use our scarce resources. We face trade-offs when it comes to using available resources. Ex. Assume flour is a scarce resource: 3 cups of flour can be used to make a loaf of bread or a cake, but the 3 cups cannot be used to make both.

The Fundamental Problem of Economics: Scarcity OR

Opportunity Cost Once a resource or factor of production has been put to productive use an opportunity cost is incurred. Opportunity cost is the next best alternative use for a resource. Ex. If the 3 cups of flour are used to bake bread, then the opportunity cost is the cake that could also have been baked with the 3 cups of flour. No matter what we do with our time or resources, we always incur opportunity cost. TINSTAAFL.

TINSTAAFL There is no such thing as a free lunch.

TINSTAAFL Everything has a cost.

TINSTAAFL Illustrated: The PPC The PPC = The Production Possibilities Curve The PPC = a graph showing all of the possible combinations of output for an economy fully employing all of its resources in producing 2 goods.

(DRAW) TINSTAAFL Illustrated: The PPC

Production Possibilities Model Assumptions: o Full employment o Fixed resources o Fixed technology o Two goods 1-10

Possibilities Curve Production

Individual’s Economizing Problem Limited income Unlimited wants A Budget Line Tradeoffs & opportunity costs Make best choice possible Change in income 1-12

A Budget Line/Frontier DVDs $20 Books $ $120 Budget Income = $120 P dvd = $20 = 6 Income = $120 P b = $10 = 12 Attainable Unattainable Quantity of Paperback Books Quantity of DVDs 1-13

PPF Points: Efficient, Inefficient, & Impossible An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points On (rather than inside) the production possibilities frontier represent efficient levels of production. When the economy is producing at such a point, there is no way to produce more of one good without producing less of the other. Points Inside. Represents an inefficient out-come. For some reason, perhaps widespread unemployment, the economy is producing less than it could from the current available resources. Points Outside. Represents the future and are not currently possible with the resources available, or impossible.

Production Possibilities Curve Pizzas Industrial Robots Attainable Unattainable A B C D E Law of Increasing Opportunity Cost A’ B’ C’ D’ E’ Shape of the Curve 1-15 CAPITAL CONSUMER

Future Possibilities Goods for the Present Goods for the Future Goods for the Present P F Current Curve Current Curve Future Curve Future Curve Presentville Futureville 1-16

Law of Increasing Opportunity Cost: As the production of a particular good increases, the opportunity cost of producing an additional unit rises. Rationale: Economic resources are not completely adaptable to alternative uses. Many resources are better at producing one type of good than at producing others. Pizzas Robots A B C D Italy's PPC increasing opportunity cost Pizzas Robots Italy's PPC A B C D constant opportunity cost Pizzas and Robots: Assume Italy was producing 200 pizzas and 0 robots. Surely, many of the resources (land, labor and capital) being used to make pizzas would be better suited to making robots. As Italy starts making its first two robots it has to give up very few pizzas, since only those resources that are suited for robot production will be used. At first, 2 robots "cost" Italy only 5 pizzas. But as the country makes more and more robots, the opportunity cost increases, because at some point pizza makers will have to build robots. As Italy approaches 10 robots, the opportunity cost of the last two robots is 130 pizzas, as resources better suited for pizza production are employed in robot factories. Production Possibilities Curve Shape?

T he Production Possibilities Curve 1) Which point(s) are attainable and desirable? ·Points on the PPC (A, B and C) are attainable through full employment, and thus desirable because they represent efficient use of Italy's resources. 2) Which point(s) are attainable but not desirable? ·Point D is inside the PPC, thus represents inefficient use of resources, and most likely high unemployment, and is thus undesirable. 3) Which point(s) are unattainable? Is this point desirable? ·Point E is beyond Italy's production possibilities and is thus unattainable. It is desirable because it represents greater consumption of both pizzas and robots. 4) Which point will mean more consumption in the future? ·Point A represents more consumption in the future, because Robots are a capital good, used to make other products for consumption. If Italy produces more robots now, it may mean more consumer goods in the future. 5) Which point means more consumption now? ·Point C because pizza is a consumer good. Households don't buy and use robots, but they do like to eat pizzas. 6) Why is the PPC bowed outwards? ·The Law of Increasing Opportunity Cost Pizzas Robots A B C D E Italy's PPC 10

REVIEW: Production Possibilities Frontier Production Possibilities Frontier o A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. Specific Locations o Points On Frontier Line? o Points Outside? o Points Inside?

Optimal Allocation of Resources: THE RULE: MB=MC (Equilibrium Point) a b c d e MB = MC MC MB Quantity of Pizza Marginal Benefit & Marginal Cost 1-20 MB = Marginal Benefit MC= Marginal Cost

MB=MC RULE Marginal Cost o The opportunity cost of producing one more unit of a good or service. o The marginal cost of producing a good increases as more of the good is produced. Marginal Benefit o The benefit that a person receives from consuming one more unit of a good or service. o The marginal benefit from a bottle of water is the number of CDs that people are willing to forgo to get one more bottle of water. o Marginal benefit decreases as more bottled water is available.