Opportunity Cost and the Production Possibilities Curve AP ECONOMICS Opportunity Cost and the Production Possibilities Curve What to produce? Is a fundamental economic question. Should an economy produce more education? Better health care? Improved transportation? Clean environment? After 9/11 individuals gave up time and privacy to be safe at the airport.

Trade-off (Scarcity) An alternative that we sacrifice when we make a decision A student skips school to go to ACL. Trade-off is giving up school for the concert Have you ever had to make a decision about giving up one thing you want to do or buy for something else, perhaps in the future? Sacrificing one thing for another service, product or experience.

Guns or Butter A cliché that refers to the trade-offs that nations face when choosing whether to produce more or less military or consumer goods

Opportunity cost The most desirable alternative given up as the result of a decision Going back to the ACL example... Grades have suffered due to skipping school Decisions have a consequence or “cost” In Economics tradeoffs are often expressed as opportunity costs

Why must the opportunity cost of a decision always be something desirable? An opportunity cost must be desirable because there would be no meaningful decision to be made between a desirable option and an undesirable.

What does it mean to “think at the margin”? “Thinking at the margin” means making a decision about how much more or less to do. It allows people to evaluate options based on available resources.

Thinking at the margin To think about your next step forward “Marginal” means “additional” The first glass of cold water on a hot day quenches your thirst, but the next glass, maybe not so much. If you think at the margin, you are thinking about what the next additional action means for you. Should I have another glass of water? Is the benefit of one more unit greater than its cost? If you already exercise 5 times a week and are thinking about adding a 6th day, you would use marginal analysis to determine whether the benefits of the 6th day (calories burned, endurance gained, muscle built,) would be worth the costs of adding the 6th day (giving up sleeping in on Saturday, having less energy to perform other activities, risking injury)

Production Possibilities Curve A curve depicting all maximum output possibilities for two or more goods given a set of inputs (resources, labor, etc.). The PPF assumes that all inputs are used efficiently. Shows all the goods and services that an economy is capable of producing given the factors of production available.

Production Possibilities Curve Illustrates scarcity, choices & opportunity costs Points on the curve show production amounts possible for 2 goods Capital goods Point A Consumer Goods

4 Key lessons from a PPC Scarcity (Tradeoffs) More resources for one product means less allocated to others Law of Increasing Opportunity Costs The more you want, the more you have to give up of other things A perfectly efficient economy produces on the curve, instead of inside Economic Growth Goal of all economies Moves by increasing factors of production Examples of efficient or inefficient economies i.e. Depression (25% unemployment, factories at 20% of capacity i.e. WW II – massive production and almost full employment (1% unemployment) Examples that would move curve - tech, methods, human capital (physical and human, more labor, immigration)

4 Assumptions to construct a PPC Only 2 goods or services (or aggregates of goods or services) are produced. Full and efficient use of all available resources. Supplies of resources (i.e., land, labor, and capital) are fixed. Technology is held constant.

Underutilization Using fewer resources than an economy is capable of using

Efficiency A broad term that implies an economic state in which every resource is optimally allocated to serve each person in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one person would harm another. In terms of production, goods are produced at their lowest possible cost, as are the variable inputs of production.

Economic Growth Over time, most countries see an increase in their ability to produce goods and services. This “economic growth” is shown as an outward shift of the PPC and results from a variety of factors Improved technology Better education Discovery of new resources

Law of increasing costs Law that states that as we shift factors of production from making one good or service to another, the cost of producing the second item increases Arguments that certain items are cheaper in bulk. Like computer chips. This is a problem but the model assumes this because of the low hanging fruit phenomenon

How is underutilization depicted on a production possibilities frontier? Underutilization is shown by any point that appears inside the production possibilities frontier

How does a production possibilities curve illustrate the efficiency of an economy? A production possibilities curve shows the maximum possible output along the production possibilities frontier. If a country’s economic production is on the frontier, the economy is producing at top efficiency

How does a production possibilities curve illustrate opportunity cost? Opportunity cost can be illustrated by comparing the data at various points on the production possibilities frontier. As production of one element increases, the curve shows the decrease in production of the other element: opportunity cost.