Economics 2010 Lecture 3 The Economic Problem Rober Martinez-Espineira

 Any questions on the course outline?

 The fundamental economic problem is to decide which of our wants to satisfy and to which extent, how and when

Production and Cost  Some definitions  Production possibility frontier  Production efficiency  Opportunity cost  Increasing opportunity cost

Some definitions  Production is making wealth, valuable things by using productive resources. The greater the value, the greater is production

Some definitions  Natural resources are called Land  Human resources are called Labor  Capital resources are called Capital  Human capital: the skill and knowledge of people. It comes from education, on the job training, and work experience  Productive resources are organized by entrepreneurial ability

Some definitions  Goods (material wealth) and services (immaterial wealth): things that people value  They fall into two categories: £ Consumption goods and services £ Capital goods

Production Possibility Frontier  The production possibility frontier (PPF) is the boundary between those production levels that can be produced and those that cannot  The PPF depends on the quantities of productive resources and on the state of technology

Production Possibility Frontier  Jones Inc. can produce two types of goods: computers and stereos  Using all its resources to produce computers, it can produce 50 a week  Using all its resources to produce stereos, it can also produce 50 a week  Similarly, Mark produces trousers, western cuts and/or baggys

Production Possibility Frontier

Production Efficiency  Production efficiency is achieved when it is not possible to produce more of one good without producing less of another good

Production Efficiency  Production efficiency occurs at all points on the PPF  Possible production points inside the PPF such as point z are inefficient

Opportunity Cost  The opportunity cost of an action is the best alternative foregone

Increasing Opportunity Cost  Almost every productive resource is better at producing some things than others  For example: most capital is custom designed to do a small range of jobs

Increasing Opportunity Cost  At one point on the PPF, every productive resource is being used in its most productive way  And as the economy moves from that point, in either direction, the opportunity cost of producing more of a good increases

Increasing Opportunity Cost  The PPF in this figure illustrates increasing opportunity cost

Increasing Opportunity Cost  Suppose that Initially, production is at e  If production moves toward a, the opportunity cost of missiles increases

Increasing Opportunity Cost  The first 1,000 games cost 200 missiles  The second 1,000 games cost 300 missiles

Increasing Opportunity Cost  The more games we produce, the greater is the opportunity cost of a game

Increasing Opportunity Cost  Similarly, the more missiles we produce, the greater is the opportunity cost of a missile

Increasing Opportunity Cost  Increasing opportunity cost is shown by the outward bow of the PPF  We measure opportunity cost as the decrease in the quantity of what we give up divided by the increase in the quantity of what we get  Opportunity cost is a ratio--the decrease in the quantity of one good divided by the increase in the quantity of another good

Increasing Opportunity Cost  Increasing opportunity cost is everywhere in the real world

Next  Economic Growth  Gains from Trade  The Evolution of Trading Arrangements