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Introduction
An economic system has to solve threecoordination problems: What, and how much, to produce. How to produce it. For whom to produce it.
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Introduction
All economic knowledge can be boileddown to a single phrase:
There aint no such thing as a free lunch.
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Introduction
Every decision has an opportunity cost the cost in foregone opportunities.
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Opportunity Cost
Opportunity cost : the value of thehighest-valued alternative that must beforgone when a choice is made. It is theevaluation of a trade-off .
Marginal benefits and costs : the benefitsand opportunity costs associated with oneadditional unit of the good.
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Introduction
A production possibility curve is used toillustrate opportunity cost.
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The Production PossibilitiesModel
The production possibilities curve showsthe trade-offs among choices we make.
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The Production Possibility Table
A production possibility table lists achoice's opportunity costs by summarizingwhat alternative outputs you can achievewith your inputs.
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The Production Possibility Table
Output an output is simply a result of anactivity.
Input an input is what you what you putinto a production process to achieve anoutput.
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The Production PossibilityCurve for an Individual
A production possibility curve measures the maximum combination of outputs that can be achieved from a givennumber of inputs.
It slopes downward from left to right.
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The Production PossibilityCurve for an Individual
The production possibility curve not onlyrepresents the opportunity cost concept, italso measures the opportunity cost.
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The Production PossibilityCurve for an Individual
The production possibility curvedemonstrates that:
There is a limit to what you can achieve, giventhe existing institutions, resources, andtechnology.
Every choice made has an opportunity costyou can get more of something only by givingup something else.
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A Production Possibility Curvefor a Society
The production possibility curve isgenerally bowed outward. Some resources are better suited for the
production of some goods than others.
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A Production Possibility Curvefor a Society
Y
109
8
6543210
.2Y
1 X
A
X 1 2 3 4 5 6 7 8 9
If the slope of the production
curve is -2 at A, theopportunity costof 1 X is 2 Y.
7
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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A Production Possibility Curvefor a Society
Comparative advantage explains whyopportunity costs increase as theconsumption of a good increases. Some resources are better suited for the
production of some goods than to theproduction of other goods.
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A Production Possibilities Tableand Curve
% of resourcesdevoted toproductionof guns
Number of guns
% of resourcesdevoted toproductionof butter
Poundsof butter Row
020
406080
100
04
791112
10080
604020
0
1514
12950
AB
C DE F
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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1211
A Production Possibilities Tableand Curve
A
B u
t t e r
Guns4 7 901 gun
5 poundsof butter
5
9
15
3 guns
2 poundsof butter
BC
D
E
F
1412
4 guns
1 poundof butter
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Marginal Opportunity Cost
The Production Possibilities Curve (PPC)illustrates the concept of opportunity cost .Each point on the PPC means that every other point is a forgone opportunity.
The PPC bows outward because there areever-increasing marginal opportunity costs tothe production of any good.
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Increasing Marginal OpportunityCost
The principle of increasing marginal opportunity cost states that opportunitycosts increase the more you concentrateon an activity.
In order to get more of something, onemust give up ever-increasing quantities of something else.
This principle is discussed but Not Named in the Boyes Text
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Increasing Marginal OpportunityCost
B u t t e r
Slope is flat at A. Lowopportunity cost of
guns.
Slope is steep at B. Highopportunity cost of guns.
Guns
B
A
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Specialization
Economic agents (individuals, firms, nations)will be better off if they choose to producethose things for which they have the lowestopportunity costs, and trade for those with
higher costs.
Agents do this because such choices involvegiving up the least amount of other things.
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Specialization & Trade
Comparative Advantage : the ability to producea good or service at a lower opportunity costthan someone else.
Law of comparative advantage : proposition that the joint output of trading
partners will be greatest when each good is produced by the low opportunity cost producer.
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Efficiency
In production, wed like to have productive efficiency achieving asmuch output as possible from a givenamount of inputs or resources.
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Efficiency
Efficiency involves achieving a goal ascheaply as possible.
Efficiency has meaning only in relation toa specified goal.
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Efficiency
Any point within the production possibilitycurve represents inefficiency.
Inefficiency getting less output frominputs which, if devoted to some other activity, would produce more output.
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Efficiency
Any point outside the production possibilitycurve represents something unattainable,given present resources and technology.
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Efficiency and Inefficiency
G u n s
10
86
4
20
2 4 6 8 10Butter
C D
A
B
Efficientpoints
Inefficientpoint
Unattainable point,given available technology,resources and labor force
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Production Possibilities Curve
The production possibilities curve showsthe maximum quantity of goods andservices that can be produced when theexisting resources are used fully and efficiently .
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Production Possibilities
Underutilized(Inefficient)
Nondefense Goods
B 1
F 1C 1
D 1Only nondefensegoods produced
E 1
Only defensegoods produced
A 1
EfficientCombinations
Defense Goods
Impossible
200
175
150
125
100
75
0
7525 50
G 1
100 125
Defense Non-defense
A1 200 0B1 175 75
C 1 130 125
D1 70 150
E 1 0 160
F1 130 25
G 1 200 75
150
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Shifts in the ProductionPossibility 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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Growth
The PPC moves outward (growth occurs) asthe result of: Increased resources
Larger labor force Change in labor force participation Chance in labor-leisure decision
Improved technology (innovation) Expansion of capital stock
An improvement in the rules (laws, institutions,and policies) of the economy
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A Shift of the PPC
Nondefense Goods
B 1
C 1
D 1
E 1
A 1 Defense Goods 200
175
150
125
100
75
0
7525 50
B 2
100 125 150
225 A2
C 2
D 2
E 2
F 2
Defense Non-defense
A 2 225 0
B2 200 75
C 2 175 120
D2 130 150
E 2 70 160
F 2 0 165
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Shifts in the ProductionPossibility Curve
More output is represented by an outwardshift in the production possibility curve.
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Neutral Technological Change
Butter
A
B Guns0
Shifts in the ProductionPossibility Curve
C
D
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Biased Technological Change
Shifts in the ProductionPossibility Curve
0
B
A
Butter
Guns
C
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Distribution and ProductionEfficiency
The production possibilities curve focuseson productive efficiency and ignoresdistribution.
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Distribution and ProductionEfficiency
In our society, more is generally preferredto less and many policies have relativelysmall distributional effects.
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(a) (c) (d)(b)
Examples of Shifts in theProduction Possibility Curve