1. Production possibilities and opportunity cost
P1Session 6-7
Production possibilities and opportunity cost

2. Key concepts Scarcity, choice and opportunity cost revisited
A graphical representation of an economy’s production possibilities
Concave versus linear frontiers: the “law” of increasing opportunity costs
Full employment and unemployment of resources
Marginal costs and marginal benefits
An introduction to productive & allocative efficiency
Capital formation, technological progress and economic growth
Production possibilities in rich and poor countries

3. Production Possibilities and Opportunity Cost
The production possibilities frontier (PPF)or production possibilities curve(PPC) is the boundary(locus) between those combinations of goods and services that can be produced(attainable combinations) and those that cannot(unattainable combinations).
To illustrate the PPF, we focus on two goods and hold the quantities of all other goods constant.
That is, we look at a model economy in which everything remains the same (ceteris paribus) except the two goods we’re considering.
The production possibility frontier (PPF) is the first economic model the students see. Your first challenge it to ensure that the students understand the mechanics of the model. You can provide some help in the classroom but you main goal must be to get the student working—to develop good work habits. Encourage them to work the end-of-chapter problems, study guide questions, and to work the Practice Problems in MyEconLab so that they are comfortable with the mechanics of this chapter.

4. Production Possibilities and Opportunity Cost-Assumptions
The economy has a given(fixed) stock of FOP’s(i.e. the PPF/PPC is a short-run view of economic capacity)
All resources are fully and efficiently employed( i.e. there is no unemployment, underemployment or misallocation of resources). This means that there is allocative efficiency (production of the welfare maximising bundle because each good is produced upto where P=MB=MC) and productive efficiency(P=MC=MinATC as any particular output bundle is produced at the lowest possible unit cost).
Technology(method/s of production) does not change(since this is a short-run view of an economy).
For simplicity there are only 2goods being produced.

5. Production Possibilities and Opportunity Cost
Frontier
Figure 2.1 shows the PPF for CDs and pizza, which stand for any
pair of goods and services.
Your second challenge is to help the students begin to use the PPF model and to start thinking like economists. Thinking about everyday events in terms of graphs and tables of numbers is hard for most students. You can help them to appreciate economic modes in general and the PPF model in particular by using the model to describe the tradeoff between studying and a social life faced every day by each student.
Why do some of the brightest students not get a mark of 80 per cent? After sleeping, attending classes, and performing the mundane tasks of life, a student has 8 hours a day available for study and recreation. Suppose that a bright student who spends all 8 hours studying gets a mark of 80 per cent.
The Economics of Campus Life 101. First, assume a constant opportunity cost of recreation equal to a 10 percentage points for each hour spent not studying. The highest possible mark is 80 per cent, the lowest is 0, and the negatively sloped PPF curve is a straight line.
Ask the students to draw the graph based on your description. Help them to interpret the PPF graph: the intercept points reveal the maximum mark and the maximum recreation hours possible, and the negative slope quantifies the tradeoff the student faces. Points on the curve represent production efficiency and points inside the curve represent a misallocation of the student’s time where opportunities for increases in recreation and/or marks are wasted.
Then show that the opportunity cost of each additional hour of recreation (lost marks) is constant. Ask the students why.

6. Production Possibilities and Opportunity Cost
Points on the frontier, such as points A, B, C, D, E and F and points inside the frontier, such as Z, are attainable.
Points outside the frontier are unattainable.

7. Production Possibilities and Opportunity Cost
Production Efficiency
We achieve production efficiency if we cannot produce more of one good without producing less of some other good.
Points on the frontier are efficient.

8. Production Possibilities and Opportunity Cost
Any point inside the frontier, such as point Z, is inefficient.
At such a point, it is possible to produce more of one good without producing less of the other good.
At Z, resources are either unemployed or misallocated.

9. Production Possibilities and Opportunity Cost
Trade-off Along the PPF
Every choice along the PPF involves a trade-off.
On this PPF, we must give up some CDs to get more pizza or give up some pizza to get more CDs.
NB: Resources can only be allocated to one use or another, but not both, hence the trade-off(i.e. a resource can only be allocated once)

10. Production Possibilities and Opportunity Cost
The PPF makes the concept of opportunity cost precise.
If we move along the PPF from C to D, the opportunity cost of the increase in pizza is the decrease in CDs.

11. Production Possibilities and Opportunity Cost
A move from C to D increases pizza production by 1 million.
CD production decreases from 12 million to 9 million, a decrease of 3 million.
The opportunity cost of 1 million pizza is 3 million CDs.
One pizza costs 3 CDs.

12. Production Possibilities and Opportunity Cost
A move from D to C increases CDs production by 3 million.
Pizza production decreases by 1 million.
The opportunity cost of 3 million CDs is 1 million pizza.
One CD costs 1/3 of a pizza.

13. Production Possibilities and Opportunity Cost
Increasing
opportunity cost
Because resources are not all equally productive in all activities, the PPF bows outward—is concave.
The outward bow of the PPF means that as the quantity produced of each good increases, so does its opportunity cost.

14. Production Possibilities and Opportunity Cost
Note that the opportunity cost of a CD is the inverse of the opportunity cost of a pizza.
One pizza costs 3 CDs.
One CD costs 1/3 of a pizza.

15. The PPF and Marginal Cost
Figure 2.2 illustrates the marginal cost of pizza.
As we move along the PPF in part (a), the opportunity cost and the marginal cost of pizza increases.

16. The PPF and Marginal Cost
In part (b) of Figure 2.2, the blocks illustrate the increasing opportunity cost of pizza.
The black dots and the line labelled MC show the marginal cost of pizza.

17. Preferences and Marginal Benefit
Preferences are a description of a person’s likes and dislikes. Economists use marginal benefit and the marginal benefit curve to describe them.
The marginal benefit of a good is the benefit received from consuming one more unit of it.
We measure marginal benefit by the amount that a person is willing to pay for an additional unit of a good or service.

18. Preferences and Marginal Benefit
It is a general principle that the more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay(or give up) for an additional unit of it.
We call this general principle the principle of decreasing marginal benefit.
The marginal benefit curve shows the relationship between the marginal benefit of a good and the quantity of that good consumed.

19. Preferences and Marginal Benefit
Figure 2.3 shows a marginal benefit curve.
The curve slopes downward to reflect the principle of decreasing marginal benefit.
At point A, with pizza production at 0.5 million, people are willing to pay 5 CDs per pizza.

20. Preferences and Marginal Benefit
At point B, with pizza production at 1.5 million, people are willing to pay 4 CDs per pizza.
At point E, with pizza production at 4.5 million, people are willing to pay 1 CD per pizza.

21. Using Resources Efficiently
Figure 2.4 illustrates allocative efficiency.
The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal cost.
This point is determined by the quantity at which the marginal benefit curve intersects the marginal cost curve.

22. Using Resources Efficiently
When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency, and we are producing at a point on the PPF.
When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency, and we are producing at the point on the PPF that we prefer above all other points.

23. Using Resources Efficiently
If we produce less than 2.5 million pizza, marginal benefit exceeds marginal cost. We get more value from our resources by producing more pizza.
On the PPF at point A, we are producing too many CDs, and we are better off moving along the PPF to produce more pizza.

24. Using Resources Efficiently

25. Using Resources Efficiently
If we produce more than 2.5 million pizza, marginal cost exceeds marginal benefit. We get more value from our resources by producing less pizza. On the PPF at point C, we are producing too much pizza, and we are better off moving along the PPF to produce less pizza.