Introduction to Microeconomics Class 2 Opportunity Costs and Production Possibilities Frontier

What is Opportunity Cost? For everyone (firms and households) Face trade-offs in how to use their scarce resources Cost of their choices: what they give up to get it Opportunity Cost: Explicit Costs ($) + Implicit Costs (“foregone opportunities”)

Writing to Learn Exercise Write about a recent decision that you were faced with: What were your alternative choices? How did you decide what to do? What factors influenced your decision? What did you give up when you made that choice? What was the “opportunity cost” of your decision?

Group Exercise Teams: 3 – 4 individuals Present your decision to the group (not the alternative choices) Individually: What are your personal alternatives to this decision? What are your perceived benefits of each choice? What do you have to give up for each? What is the opportunity cost for each? As a group discuss: How did your alternative choices differ? How did your perceived benefits differ? How did you final decision differ? 4. What if the costs/benefits changed? Would your decision change if: If it was Saturday morning? You were a millionaire? If you lived in Alaska?

Key Takeaway Though we all face the same choices How we make a decision is subjective Our perceived benefits and opportunity costs may differ Faced with opportunity cost in every decision we make everyday Opportunity Cost: explains the behavior and choices of firms, consumers, government, and all economic agents.

Production Possibilities Frontier Production possibilities frontier (PPF) represents the opportunity costs an economy faces in the production of two goods. All economies have scarce resources -- need to decide how to allocate those resources to produce goods. If you produce more of one good – need to produce less of the other (with no change in available resources)

PPF Exercise Consider an economy that produces two goods: Leather jackets and leather boots. Draw the PPF curve for this economy As we move from one point to the next – calculate the change in the number of boots produced and the number of jackets produced. What does this tell you about how opportunity costs change? A B C D E Boots 20 40 60 80 Jackets 100 90 70

PPF Exercise As we move along the PPF curve: Opportunity Cost changes B C D E Boots 20 40 60 80 Jackets 100 90 70 Δ Boots + 20 Δ Jackets 10 - 20 - 30 - 40 As we move along the PPF curve: Opportunity Cost changes O.C. RISES as give up more of the good that is SCARCE O.C. is LOWER when the good is in relative ABUNDANCE

PPF Exercise Suppose now that there is a shortage in rubber. - What happens in the boot industry? - What happens in the jacket industry?

PPF Exercise With a shortage in rubber, this affects the production of boots relatively more than the production of jackets Bias shift of PPF If there is a change in resources – need to consider the impact this has on both industries – equal or bias?

Application Reflection Why does this matter? PPF curves illustrate how a country (and by extension an individual or firm) faces trade offs because of scarce resources. We can’t produce an infinite amount of any good – are always constrained by how many resources we have at our disposal. Therefore, all of our decisions are based on the trade offs we face. PPF curves capture the idea of opportunity cost – to produce more of one good, we must produce less of the other (again, due to scarce resources). How much of Good A we give up to produce an additional unit of Good B is the opportunity cost of Good B. What’s the most important takeaway? Economies face trade-offs and opportunity costs in terms of what to produce Production is limited by scarce resources (or factors of production) Opportunity cost is reflected as we move along the PPF curve. MUDDIEST POINT?

Key Takeaway All economic agents face tradeoffs when making decisions Whatever they choose comes with an opportunity cost – what they could otherwise do with their time, money, resources Apply this concept to understand how an economy makes choices between the production of goods in the PPF