Chapter 2 Production Possibilities and Opportunity Cost ©2002 South-Western College Publishing

What are the three fundamental economic questions? What to produce? How to produce? For whom to produce?

What is opportunity cost? The best alternative sacrificed for a chosen alternative

What opportunity cost am I experiencing now? The most money that you could be making if you were somewhere else instead of studying these slides

Can opportunity cost be something other than money? That most desired activity that you are presently giving up is considered an opportunity cost Yes!

What is marginal analysis? An examination of the effects of additions to or subtractions from a current situation

What is an example of marginal analysis? When your benefit of studying these slides exceeds the opportunity cost, you will spend time studying these slides

What is a production possibilities curve? A curve that shows the maximum combinations of two outputs that an economy can produce, given its available resources and technology

What is technology? The body of knowledge and skills applied to how goods are produced

What assumptions underlie the productions possibilities model? Fixed resources Fully employed resources Technology unchanged

What is the conclusion of the production possibilities curve? Scarcity limits an economy to points on or below its production possibilities curve

What is the law of increasing opportunity costs? The principle that the opportunity cost increases as production of one output expands

What is economic growth? The ability of an economy to produce greater levels of output, an outward shift of its production possibilities curve

What makes possible economic growth? Research and development of new technologies Increase production in excess of worn out capital

What happens when a country does not invest in new technology? Everything else being equal, the country will not grow

What is investment? The accumulation of capital, such as factories, machines, and inventories, that is used to produce goods and services

What is the opportunity cost of investment? The consumer goods that could have been purchased with the money spent for plants and other capital

What does an increase in investments make possible in the future? Economic growth and more goods and services

What conclusion can we make about investments? A nation can accelerate growth by increasing production of capital goods in excess of the capital being worn out

Key Concepts

What are the three fundamental economic questions?What are the three fundamental economic questions? What is opportunity cost? Can opportunity cost be something other than money?Can opportunity cost be something other than money? What is marginal analysis? What is a production possibilities curve? What three assumptions underlie the productions possibilities curve model?What three assumptions underlie the productions possibilities curve model?

What is the conclusion of the production possibilities curve?What is the conclusion of the production possibilities curve? What is the opportunity cost of investment? What does an increase in investments make possible in the future?What does an increase in investments make possible in the future? What conclusion can we make about investments?What conclusion can we make about investments?

24 Summary

25 Thee fundamental economic questions facing any economy are What, How, and For Whom to produce goods. The What question asks exactly which goods are to be produced and in what quantities. The How question requires society to decide the resource mix used to produce goods. The For Whom problem concerns the division of output among society’s citizens.

26 Opportunity cost is the best alternative foregone for a chosen option. This means no decision can be made without cost.

27 Marginal analysis examines the impact of changes from a current situation and is a technique used extensively in economics. The basic approach is to compare the additional benefits of a change with the additional cost of the change.

28 A production possibilities curve illustrates an economy’s capacity to produce goods, subject to the constraint of scarcity. The production possibilities curve is a graph of the maximum possible combinations of two outputs that can be produced in a given period of time, subject to three conditions:

29 (1) All resources are fully employed (2) The resource base is not allowed to vary during the time period. (3) Technology, which is the body of knowledge applied to the production of goods, remains constant.

30 Inefficient production occurs at any point inside the production possibilities curve. All points along the curve are efficient points because each point represents a maximum output possibility.

31 The law of increasing opportunity costs states that the opportunity cost increases as the production of an output expands. The explanation for the law of increasing opportunity costs is that the suitability of resources declines sharply as greater amounts are transferred from producing one output to producing another output.

32 Investment means that an economy is producing and accumulating capital. Investment consists of factories, machines, and inventories (capital) produced in the present that are used to shift the production possibilities curve outward in the future.

33 Economic growth is represented by the production possibilities curve shifting outward as the result of an increase in resources or an advance in technology.

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