1. To solve economic problems, 3 core issues must be resolved:
WHAT to produce with our limited resources.
HOW to produce the goods and services we select.
FOR WHOM goods and services are produced; that is, who should get them.
LO2

2. Economic systems
The way a society organizes to produce, distribute, and consume goods.
Economic systems try to prevent surpluses (having too much of a good or service)
Economic systems try to avoid shortages (having too little of a good or a service)
The four types of economic systems are: traditional, market, command, and mixed.

3. Command economy
The government or other central authority makes all economic decisions, including the price of goods and services
Resources are owned by the government
There is no competition; the purpose of business is to provide goods and services, not to make a profit
Factories are concerned with quotas
Consumers have few, if any, choices in the market place

4. The Production Possibilities Frontier/Curve (PPF/PPC)
The production possibilities frontier is a graph that shows the combinations of output that an economy can possibly produce given:
The available resources -factors of production. Fully employed and used efficiently
The available production technology.

5. Law of Increasing Opportunity Costs
Resources do not transfer perfectly from the production of one good to another.
Increasing quantities of any good can be obtained only by sacrificing ever-increasing quantities of other goods.
Resources used to produce trucks aren’t ideally suited for producing tanks.

6. Efficiency
Efficiency means getting the maximum output of a good from the resources used in production. Full Employment.
Allocative efficiency- production is such that marginal benefit is equal to marginal cost. Goods and services that are most highly valued.
Every point on a production possibilities frontier curve is efficient.

7. Inefficiency
A production possibilities frontier curve shows potential output, not necessarily actual output.
If we are inefficient- attainable, actual output will be less than the potential output.

8. Inefficiency
Countries may end up inside their production possibilities frontier curve if resources are inefficiently combined.
Such inefficiencies plagued centrally planned economies.

9. Unemployment
Countries may end up inside their production possibilities frontier curve if all available resources are not used.

10. PPF Graph Law of Increasing Opportunity Costs
Step 1: give up one truck 5 B 4
Step 3: give up another truck
Step 2: get two tanks C 3
OUTPUT OF TRUCKS
Step 4: get one more tank D 2 E 1 F 1 2 3 4 5
OUTPUT OF TANKS

11. PPF Graph Unemployment5 B 4 Y C 3
OUTPUT OF TRUCKS
Unemployment 2 1 1 2 3 4 5
OUTPUT OF TANKS

12. Economic Growth A X 5 Currently not attainable B 4 C 3
OUTPUT OF TRUCKS 2 1 1 2 3 4 5
OUTPUT OF TANKS

13. Economic Growth
A point outside the production possibilities frontier curve suggests that we could get more goods than we are capable of producing!
Economic growth is an increase in output (real GDP) – an expansion of production possibilities.

14. Production Possibilities Model
Society uses scarce resources to produce goods and services.
Illustrates production choices
Assumptions:
Full employment- use of all resources
Unemployment – Not using all resources
Fixed resources (# of factors of production-land, labor, capital, is fixed). Change can cause a shift inward. Natural disaster.
Fixed technology
Two goods (hypothetical; economy is producing only two goods, one consumer, one capital. Cell phone - Factory
The production possibilities model shows the maximum combinations of two goods that can be produced with the resources available today.
Full-employment means that we are using all available resources, and they are being used to their potential.
Using two goods is a simplification. You will still see the concepts shown by the PPC without making it any more complicated. Often times, the two goods are general categories of two goods rather than specific goods, so that the PPC shows the tradeoff between choosing those goods.
LO5
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15. Production Possibilities Frontier - Curve
Q: Are we good with opportunity cost, scarcity, incentives, and marginal cost/benefit?
4 categories of SCARCE resources:
Land
Labor
Capital
Entrepreneurship
Society must decide what combination of goods/services to produce because SCARCITY necessitates CHOICE.
SCARCITY, CHOICE, AND OPPORTUNITY COSTS (Trade-Off) ARE REPRESENTED IN THE PPF.
3 Essential Questions Every Economic System must answer:
What Goods/Services will be produced?
How will they be produced?
How will these Goods and Services be distributed?

16. Externalities
An externality is a cost or benefit accruing to a third party external to the market transaction
Positive externalities
Too little is produced
Demand-side market failures
Negative externalities
Too much is produced
Supply-side market failures
Positive externalities occur when a third person, or persons, is affected by the transaction in a positive way. The good is underproduced when positive externalities are present. The equilibrium output will be smaller than the efficient output because the consumer is willing to pay a price equal to the consumer’s individual marginal benefit, but no more. Since social benefits exist in addition to the private benefit, the government must either aid the producer to encourage more output, or engage in its own production of the item with the external benefits.
Negative externalities occur when a third person, or persons, external to the transaction is affected from the transaction in a negative way. The good is overproduced and the equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level, which would exist if true costs were reflected in the production decision.
LO4

17. Economic Growth
Economic growth results in an outward shift of the PPF because production possibilities are expanded.

18. Trade-offs: The Production Possibility FrontierX

19. Increasing Opportunity Cost

20. Production Possibilities Model
Production Alternatives
Type of Product A B C D E
Pizzas
(in hundred thousands) 1 2 3 4
Industrial Robots
(in thousands) 10 9 7 4
Plot the Points to Create the Graph…
LO5
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21. Production Possibilities Model14 13 12 11 10 9 8 7 6 5 4 3 2 1
The law of
increasing
opportunity costs makes
the PPC concave. A B
Unattainable C
Industrial Robots U D
Attainable E
Pizzas
LO5
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22. Test # 2 End of notes

23. A Growing Economy Economic Growth Now Attainable Unattainable14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’
Unattainable A
Economic
Growth B C’ C
Industrial Robots D’ D
Now Attainable
Attainable E E’
Pizzas
LO6
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24. Present Choices, Future Possibilities
Compare Two Hypothetical Economies
Future
Curve
Future
Curve F
Goods for the Future
Goods for the Future P
Current
Curve
Current
Curve
Goods for the Present
Goods for the Present
Presentville
Futureville
LO6
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25. Set of institutional arrangements in response to economizing problem.
Economic Systems
Set of institutional arrangements in response to economizing problem.
Differences in systems exist by:
Who owns the factors of production?
What method is used to motivate, coordinate, and direct economic activity?
Economic systems are a set of institutional arrangements and a coordinating mechanism to solve economic problems. Economic systems differ in two important ways: Who owns the factors of production and the method used to coordinate economic activity.
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LO1

26. Externalities
An externality is a cost or benefit accruing to a third party external to the market transaction
Positive externalities
Too little is produced
Demand-side market failures
Negative externalities
Too much is produced
Supply-side market failures
Positive externalities occur when a third person, or persons, is affected by the transaction in a positive way. The good is underproduced when positive externalities are present. The equilibrium output will be smaller than the efficient output because the consumer is willing to pay a price equal to the consumer’s individual marginal benefit, but no more. Since social benefits exist in addition to the private benefit, the government must either aid the producer to encourage more output, or engage in its own production of the item with the external benefits.
Negative externalities occur when a third person, or persons, external to the transaction is affected from the transaction in a negative way. The good is overproduced and the equilibrium output will be greater than the efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level, which would exist if true costs were reflected in the production decision.
LO4

27. Problem Set # 1 A society can make either guns or butter
Put guns on the x-axis and butter on the y-axis
Label the following points:
Point
Guns
Butter A 5 3 B 9 C 1 15 X Y
What is the opportunity cost of 1 gun?
What is the opportunity cost of 1 butter?
What is the problem at point X?
What is the problem at point Y?

28. Problem Set # 2
A society can make either Jeeps (x-axis) or Cars (y-axis)
If the economy makes 100 cars, it can’t make any jeeps
If the economy makes 200 jeeps, it can’t make any cars
What is the opportunity cost of 1 gun?
What is the opportunity cost of 1 butter?
What is the problem at point X?
What is the problem at point Y?

29. Problem Set #3 - Exploring the Essential Question
Imagine that a new society, Paternoville, produces only two items: Footballs and Peachy Paterno Ice Cream.
Use the information on the table below to construct a Production Possibilities Frontier with Footballs on the x-axis and Peachy Paterno Ice Cream on the y-axis.
Footballs
Peachy Paterno Ice Cream (gallons)
100 90 4 75 8 50 12 16
If the economy is currently producing 90 footballs, what is the opportunity cost of producing 10 additional footballs?
What is the opportunity cost of increasing the annual output of Peachy Paterno Ice Cream from 8 to 12 gallons?
If there were a labor shortage or some other event that effects production, where would the output of Paternoville production appear on the graph?
What would happen to Paternoville’s PPF if a technological advancement improved production across the board?

30. Continuing Debates
The core of most debates is some variation of the WHAT, HOW, or FOR WHOM questions.
Conservatives favor Adam Smith’s laissez-faire approach.
Liberals tend to think government intervention is likely to improve the answers.
Some intervention: Keynes
Complete coordination: Marx
LO3

31. Concepts Illustrated by the Production Possibilities Frontier
Efficiency
Tradeoffs
Opportunity Cost
Economic Growth 21

32. Figure 3 A Shift in the Production Possibilities Frontier
Quantity of
Computers
Produced
4,000
3,000
1,000
2,100
750 E
2,000
700 A
Quantity of
Cars Produced
Copyright © South-Western

33. 1. The Command System Known as socialism or communism
Government ownership of means to production.
Decisions made by a central planning board.
Include production goals, resource usage, consumer vs. capital goods production, etc.
North Korea and Cuba.
Resources are owned by government and economic activity is coordinated by a central planning board. This means that what is produced, how much is produced and the prices that are charged for the output are determined by the central planning board.
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LO1

34. Private ownership of resources
2. The Market System
Known as capitalism
Private ownership of resources
Use of markets and prices to coordinate economic activity.
Laissez-Faire vs. Government involvement.
Decisions based on markets
USA, Australia, Switzerland, U.K.
With a market system, resources are owned by private individuals and institutions. Markets and prices coordinate and direct economic activity. Each participant acts in his or her own self-interest and in pure capitalism the government plays a very limited role. In the U.S. version of capitalism, the government plays a substantial role.
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LO1