1 Chapter 2 Production Possibilities and Opportunity Costs

2 What is a Production Possibilities Frontier (PPF)? A graph that shows the maximum combinations of goods that can be produced when resources and technology are used efficiently © ©1999 South-Western College Publishing

3 For simplicity, lets take a world with only 2 products Lets use cola and pizza (a typical college campus?)

4 A typical PPF has the following shape:. Pizza cola The curve has a negative slope. The curve is concave to the origin.

5 All points on the curve correspond to full use of resources. Pizza cola A B

6 Points outside the the PPF are not feasible with existing resources. Pizza cola.A.A

7 Periods of unemployment or inefficiency in production correspond to points under the PPF. Pizza cola.A.A

8 Shape of the PPF? Why Concave? If PPF a straight line, we have constant opportunity costs If PPF concave, we have increasing opportunity costs

9 Consider a straight line PPF cola Pizza Beer given up, the opportunity cost, remains constant

10 Concave shape, increasing opportunity costs. Pizza cola Beer given up, the opportunity cost, is increasing

11 What is the Law of Increasing Costs? The opportunity cost of producing a good increases as more of the good is produced © ©1999 South-Western College Publishing

12 Why does the Law of Increasing Opportunity costs hold? Because resources are not perfectly adaptable to all products

13 How do we have more of everything? By increasing our resources © ©1999 South-Western College Publishing

14 Economic growth indicates an increase in the total output of an economy. Pizza cola.A.A The PPF shifts to the right !

15 Causes of rightward shifts in PPF’s? Increase in resources Increased productivity Improved technology

16 Can a PPF shift inward (to the left)? YES!! For just the opposite reasons as an outward shift such as a loss of resources

17 Economic growth and the Capital Consumer goods tradeoff: Consumer goods Capital goods A B From which point would an economy grow faster, A or B?? Answer is A, with more capital goods

18 What should a country specialize in producing? In those goods and services that it has a comparative advantage © ©1999 South-Western College Publishing

19 What is Comparative Advantage? A country’s ability to produce a good at a lower opportunity cost than the country which it trades © ©1999 South-Western College Publishing

20 What is Absolute Advantage? A country’s ability to produce a good using fewer resources than the country with which it trades © ©1999 South-Western College Publishing

21 Example, 2 people, 2 jobs, time required Job A Job B Judy Sam 60 min.75 min 90 min150 min

22 In the table, Judy is absolutely advantaged at both tasks, but what is her comparative advantage? What is Sam’s comparative advantage?

23 Judy’s comparative advantage is at job B, and Sam’s comparative advantage is at job A To see why, look at the ratios in the table- Judy can do job A in 2/3 the time of Sam, but she can do job B in ½ the time, so she is relatively more efficient at job B.

24 Theory of comparative advantage Argues that output is greater when resources tend to specialize in their greatest comparative advantages

25 ProblemProblem With the same quantity of resources, Euphoria can produce 100 barrels of beer to Extasia’s 50 barrels, and Euphoria can produce 150 pizzas to Extasia’s 100. According to comparative advantage, what product should Extasia tend to specialize in? What about Euphoria?

26 ANSWER: Extasia should specialize in pizzas, Euphoria in beer production

27 What are Factors of Production? What is Production Possibilities? Why does division of labor increase productivity?Why does division of labor increase productivity? What is an Opportunity Cost? What is Comparative Advantage? What is Absolute Advantage?