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2 - 1

The choices made by society are often presented in terms of a production possibility curve.

The production possibilities curve shows the trade-offs among choices we make.

The Production The Production Possibilities Curve and Possibilities Curve and Economic ReasoningEconomic Reasoning

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2 - 2

The Production The Production Possibility TablePossibility Table A production possibility table lists the

maximum combination of outputs that can be obtained from a given number of inputs.

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The Production The Production Possibility CurvePossibility Curve A production possibility curve plots

the maximum combination of outputs that can be achieved from a given number of inputs.

It slopes downward from left to right.

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2 - 4

The Production The Production Possibility CurvePossibility Curve The production possibility curve not only

demonstrates the opportunity cost concept, it also measures the opportunity cost.

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The Production The Production Possibility CurvePossibility Curve The production possibility curve

demonstrates that: There is a limit to what you can achieve, given the

existing institutions, resources, and technology. Every choice made has an opportunity cost—you can get

more of something only by giving up something else.

© 2003 McGraw-Hill Ryerson Limited

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Eco

nom

ics

grad

e

100

88

70

4640

58 66 78 94 98History grade

20 hours of history

0 hours of economics

ED

C

B

20 hours of economics 0 hours of historyA

Hours of study in history

Grade inhistory

Hours of study in economics

Grade ineconomics

20 19 18 17 16 15 14 13 12 11 10

9 8 7 6 5 4 3 2 1 0

98 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 64 62 60 58

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97

100

The Production The Production Possibility Curve Possibility Curve Fig. 2-1 (a and Fig. 2-1 (a and

b), p 33b), p 33

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Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The production possibility curve is

generally bowed outward since some resources are better suited for the production of some goods.

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Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The concept of comparative advantage

explains why opportunity costs increase as the consumption of a good increases.

Some resources are better suited for the production of some goods than to the production of other goods.

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Increasing Marginal Increasing Marginal Opportunity Cost, Opportunity Cost, p 33 p 33

Y

1098

6543210

.2Y

1X

A

X1 2 3 4 5 6 7 8 9

If the slope of the production curve is -2 at A, the

opportunity cost of 1X is 2Y.

7

© 2003 McGraw-Hill Ryerson Limited

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Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost The principle of increasing opportunity

cost states that opportunity costs increase the more you concentrate on an activity.

In order to get more of something, one must give up ever-increasing quantities of something else.

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A Production Possibility A Production Possibility Table, Table, Fig. 2-2a, p 34Fig. 2-2a, p 34

% of resources devoted toproduction of burgers

Number of burgers

% of resources devoted toproduction of DVDs

Number of DVDs Row

0 20 40 60 80

100

0 4 7 9 11 12

100 80 60 40 20 0

15 14 12 9 5 0

A B C D E F

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1211

A Production Possibility A Production Possibility Curve, Curve, Fig. 2-2b, p 34Fig. 2-2b, p 34

AD

VD

s

Burgers4 7 90

1 burger

5 DVDs

5

9

15

3 burgers

2 DVDsB

C

D

E

F

14

12

4 burgers

1 DVD

© 2003 McGraw-Hill Ryerson Limited

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Increasing Marginal Increasing Marginal Opportunity Cost, Opportunity Cost, p 35p 35

DV

Ds

Slope is flat at A. Low opportunity cost of burgers.

Slope is steep at B. High opportunity cost of burgers.

Burgers

B

A

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EfficiencyEfficiency

In our production, we would like to have productive efficiency—achieving as much output as possible from a given amount of inputs or resources.

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EfficiencyEfficiency

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.

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EfficiencyEfficiency

Any point outside the production possibility curve represents something unattainable, given present resources and technology.

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Efficiency and Inefficiency, Efficiency and Inefficiency, Fig. 2-3a, p 36Fig. 2-3a, p 36

DV

Ds

10

8

6

4

2

0 2 4 6 8 10

Burgers

C D

A

B

Efficientpoints

Inefficientpoint

Unattainable point, given available technology, resources and labor force

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Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve Society can produce more output if:

Technology is improved. More resources are discovered. Economic institutions get better at

fulfilling our wants.

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Shifts in the Production Shifts in the Production Possibility CurvePossibility Curve An outward shift in the production

possibility curve indicates more output that can be produced with given inputs.

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Neutral Technological Change

DVDs

A

B Burgers0

Shifts in the Production Shifts in the Production Possibility Curve, Possibility Curve, Fig. 2-3b, p Fig. 2-3b, p

3636

C

D

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Biased Technological Change

Shifts in the Production Shifts in the Production Possibility Curve, Possibility Curve, Fig. 2-3c, p Fig. 2-3c, p

3636

0

B

A

DVDs

Burgers

C

© 2003 McGraw-Hill Ryerson Limited

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Distribution and Distribution and Production EfficiencyProduction Efficiency The production possibilities curve

focuses on productive efficiency and ignores distribution.

An increase in output that goes to one person and not to anyone else would not necessarily be efficient in some societies.

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Distribution and Distribution and Production EfficiencyProduction Efficiency Economists often talk about efficiency

as if it means productive efficiency and achieving society's goals.

In our society, more is generally preferred to less and many policies have relatively small distributional effects.

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Examples of Shifts in Examples of Shifts in the Production the Production Possibility CurvePossibility Curve If more inputs are available for the

production of X and Y equally, the PPC shifts out along both X and Y axes.

If fewer inputs are available for the production of X and Y equally, the PPC shifts in along both X and Y axes.

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Examples of Shifts in Examples of Shifts in the Production the Production Possibility CurvePossibility Curve If more inputs are available for good X

only, the PPC shifts out on the X axis only.

If more inputs are available for good Y only, the PPC shifts out on the Y axis only.

© 2003 McGraw-Hill Ryerson Limited

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(a) (c) (d)(b)

Examples of Shifts in the Examples of Shifts in the Production Possibility Production Possibility CurveCurve Fig. 2-4, p 37Fig. 2-4, p 37

© 2003 McGraw-Hill Ryerson Limited

2 - 27Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade 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

2 - 28Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade 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

2 - 29Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade Collaboration and specialization can

make society better off. Total production can rise.

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2 - 30Comparative Comparative Advantage, Advantage, Specialization, and Specialization, and TradeTrade The outward bow graphically represents

the potential gains from trade.

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The Gains From TradeThe Gains From Trade

Sunder can either write one economics paper or four creative writing papers in a day.

Ti can either write one creative writing paper or four economics papers in a day.

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The Gains From TradeThe Gains From Trade

Sunder has a comparative advantage in creating writing and Ti has a comparative advantage in economics.

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The Gains From TradeThe Gains From Trade

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.

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The Gains From Trade, The Gains From Trade, Fig. 2-Fig. 2-6a, p 416a, p 41

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The Gains From Trade, The Gains From Trade, Fig. 2-Fig. 2-6b, p 416b, p 41

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The Gains From TradeThe Gains From Trade

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

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The Gains From TradeThe Gains From Trade,,Fig. 2-Fig. 2-

6c, p 416c, p 41E

cono

mic

s

1 2 3 4 5

4

3

2

1

5

(b) Sunder

(a) Ti

Creative writing

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The Gains From TradeThe Gains From Trade

The combined PPC curve is drawn by finding three points and connecting them.

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The Gains From Trade, The Gains From Trade, Fig. 2-Fig. 2-6c, p 416c, p 41

Eco

nom

ics

1 2 3 4 5

(c) Combined with trade

4

3

2

1

5

(b) Sunder

(a) Ti

B

C

A

Creative writing

© 2003 McGraw-Hill Ryerson Limited

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The Gains From TradeThe Gains From Trade

Point A: This is the combined number of economics papers they both can write in a day.

If economics papers are on the Y axis, it is point 0,5.

© 2003 McGraw-Hill Ryerson Limited

2 - 41

The Gains From TradeThe Gains From Trade

Point B: This is the combined number of creative papers they both can write in a day.

If economics papers are on the Y axis, it is point 5,0.

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The Gains From TradeThe Gains From Trade

Point C: This is where each is focusing on that activity for which he or she has a comparative advantage.

Sunder writes four creative papers and Ti writes four economics papers.

This is the coordinates 4,4.

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2 - 43

The Gains From TradeThe Gains From Trade

The combined PPC is bowed out because of comparative advantage and specialization.

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The Division of LaborThe Division of Labor

Markets allow specialization and the division of labor.

They allow individuals to develop their comparative advantages, thereby increasing the production possibilities of society.

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Markets, Markets, Specialization, and Specialization, and GrowthGrowth Markets and specialization have led to

growth.

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Markets, Markets, Specialization, and Specialization, and GrowthGrowth The growth in per capita income

(constant 1990 dollars) in the past 2 millennia has been astonishing.

This owes largely to the introduction of markets and democracy.

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Markets, Markets, Specialization, and Specialization, and GrowthGrowth As people are allowed to compete and

specialize, they get better at what they do, develop new technologies and the market grows ever larger.

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Growth in the Past Two Growth in the Past Two Millennia Millennia Fig. 2-7, p 42Fig. 2-7, p 42

col17930_0207.eps

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© 2003 McGraw-Hill Ryerson Limited

The Economic The Economic Organization Of Organization Of

SocietySociety

End of Chapter 2End of Chapter 2