1. 2 1. Reviewing the Basics 2. Production Possibilities Frontier 3. The Economic Problem 4. Comparative Advantage

2. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities What is Production? Production is the process by which resources are transformed into useful goods and services.Production is the process by which resources are transformed into useful goods and services. Resources (or inputs) refer to anything that can be used, directly or indirectly, to satisfy human wants.Resources (or inputs) refer to anything that can be used, directly or indirectly, to satisfy human wants. Natural resources [LAND] Natural resources [LAND] Human resources [LABOR] Human resources [LABOR] Capital resources [CAPITAL] Capital resources [CAPITAL]

3. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Three Basic Questions Decision-making in a larger economy is more complex, but the types of decisions that must be made are the same as individuals make for themselvesDecision-making in a larger economy is more complex, but the types of decisions that must be made are the same as individuals make for themselves All societies must decide:All societies must decide: What will be produced? What will be produced? How will it be produced? How will it be produced? Who will get what is produced? Who will get what is produced?

4. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Three Basic Questions

5. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Capital Goods vs. Consumer Goods Consumer Goods are goods produced for present consumption. (sometimes called “final goods”)Consumer Goods are goods produced for present consumption. (sometimes called “final goods”) Capital Goods are goods used to produce other goods or services over time.Capital Goods are goods used to produce other goods or services over time.

6. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Positive vs. Normative Positive Economic (focus: efficiency) Normative Economics (focus: equity)

7. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Weighing Present and Expected Future Costs and Benefits Investment: the process of using current resources to produce future benefitsInvestment: the process of using current resources to produce future benefits Because resources are scarce, the opportunity cost of any investment is forgone present consumption.Because resources are scarce, the opportunity cost of any investment is forgone present consumption.

8. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier The Production Possibility Frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently.The Production Possibility Frontier (ppf) is a graph that shows all of the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

9. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier The production possibility frontier curve has a negative slope that indicates the trade-off that a society faces between two goods.The production possibility frontier curve has a negative slope that indicates the trade-off that a society faces between two goods.

10. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier Points inside of the curve are inefficient.Points inside of the curve are inefficient. We refer to this situation as Underutilization.We refer to this situation as Underutilization. At point H, resources are either unemployed, or are being used inefficiently.At point H, resources are either unemployed, or are being used inefficiently.

11. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier Point F is desirable because it yields more of both goods,Point F is desirable because it yields more of both goods, However, it is not attainable given the amount of resources currently available in the economy.However, it is not attainable given the amount of resources currently available in the economy.

12. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.Point C is one of the possible combinations of goods produced when resources are fully and efficiently employed.

13. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Production Possibility Frontier A move along the curve illustrates the concept of opportunity cost.A move along the curve illustrates the concept of opportunity cost. In order to increase the production of capital goods, the amount of consumer goods will have to decrease.In order to increase the production of capital goods, the amount of consumer goods will have to decrease.

14. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Law of Increasing Opportunity Cost The concave shape of the production possibility frontier curve reflects the law of increasing costs.The concave shape of the production possibility frontier curve reflects the law of increasing costs. As we increase the production of one good, we sacrifice progressively more of the other.As we increase the production of one good, we sacrifice progressively more of the other.

15. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Economic Growth Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources.Economic growth is an increase in the total output of the economy. It occurs when a society acquires new resources, or when it learns to produce more using existing resources. The main causes of economic growth are capital accumulation and technological advances.The main causes of economic growth are capital accumulation and technological advances.

16. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Economic Growth To increase the production of one good without decreasing the production of the other, the PPF curve must shift outward.To increase the production of one good without decreasing the production of the other, the PPF curve must shift outward. From point D, the economy can choose any combination of output between F and G.From point D, the economy can choose any combination of output between F and G. Economic Growth is represented by an outward shift of the entire curveEconomic Growth is represented by an outward shift of the entire curve

17. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Economic Growth Every sector of the economy does not grow at the same rate.Every sector of the economy does not grow at the same rate. In this historic example, productivity increases were more dramatic for corn than for wheat over this 50-year period.In this historic example, productivity increases were more dramatic for corn than for wheat over this 50-year period.

18. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Economic Problem The ECONOMIC PROBLEM: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions?The ECONOMIC PROBLEM: Given scarce resources, how, exactly, do large, complex societies go about answering the three basic economic questions? Economic Systems are the basic arrangements made by societies to solve the economic problem. They include:Economic Systems are the basic arrangements made by societies to solve the economic problem. They include: Centrally-Planned Economy [aka. command system] Centrally-Planned Economy [aka. command system] Free Market Economy [aka. capitalist system] Free Market Economy [aka. capitalist system] Traditional Economy Traditional Economy Mixed systems Mixed systems

19. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities The Economic Problem In a centrally-planned economy, a central government either directly or indirectly sets output targets, incomes, and prices.In a centrally-planned economy, a central government either directly or indirectly sets output targets, incomes, and prices. In a free market economy, the policy is Laissez-Faire (literally from the French: “allow (them) to do”). Individual people and firms pursue their own self-interests without any central direction or regulation. This system is based on the existence of FREE MARKETS.In a free market economy, the policy is Laissez-Faire (literally from the French: “allow (them) to do”). Individual people and firms pursue their own self-interests without any central direction or regulation. This system is based on the existence of FREE MARKETS. A market is the institution through which buyers and sellers interact and engage in exchange. A market is the institution through which buyers and sellers interact and engage in exchange.

20. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Mixed Systems, Markets, and Governments Markets are not perfect, and governments play a major role in modern economic systems in order to: Minimize market inefficiencies Minimize market inefficiencies Provide public goods Provide public goods Redistribute income Redistribute income Stabilize the macroeconomy [“the big picture”] Stabilize the macroeconomy [“the big picture”] Promote low levels of unemployment Promote low levels of unemployment Promote low levels of inflation Promote low levels of inflation

21. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Specialization, Exchange and Comparative Advantage David Ricardo (British Economist) developed the theory of comparative advantage to explain the benefits of specialization and free trade. The theory is based on the concept of opportunity cost:David Ricardo (British Economist) developed the theory of comparative advantage to explain the benefits of specialization and free trade. The theory is based on the concept of opportunity cost: Opportunity cost is that which we give up or forgo, when we make a decision or a choice. Opportunity cost is that which we give up or forgo, when we make a decision or a choice.

22. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Specialization, Exchange and Comparative Advantage According to the theory of comparative advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers.According to the theory of comparative advantage, specialization and free trade will benefit all trading parties, even those that may be absolutely more efficient producers.

23. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Absolute Versus Comparative Advantage Which country has an absolute advantage?Which country has an absolute advantage? Country A, because it can produce more food and more clothing in one day than country B. Country A, because it can produce more food and more clothing in one day than country B. Which country has a comparative advantage in the production of Food?Which country has a comparative advantage in the production of Food? because a worker in country A can produce 6 times as many units of food as a worker in country B, but only 1.5 as many units of clothing. because a worker in country A can produce 6 times as many units of food as a worker in country B, but only 1.5 as many units of clothing. Output per Day of Work FoodClothing Country A 63 Country B 12

24. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Absolute Versus Comparative Advantage The opportunity costs can be summarized as follows:The opportunity costs can be summarized as follows: For food:For food: 1 unit of food costs country A ½ unit of clothing. 1 unit of food costs country A ½ unit of clothing. 1 unit of food costs country B 2 units of clothing. 1 unit of food costs country B 2 units of clothing. For clothing:For clothing: 1 unit of clothing costs country A 2 units of food. 1 unit of clothing costs country A 2 units of food. 1 unit of clothing costs country B ½ unit of food. 1 unit of clothing costs country B ½ unit of food. Output per Day of Work FoodClothing Country A 63 Country B 12

25. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Absolute Versus Comparative Advantage Conclusion: What will happen??? Each country should prefer to produce whichever has a LOWER opportunity cost to them.Each country should prefer to produce whichever has a LOWER opportunity cost to them. Country A will specialize in food, and Country B will specialize in clothing.Country A will specialize in food, and Country B will specialize in clothing. Specialization also works to develop skills and raise productivity.Specialization also works to develop skills and raise productivity. Output per Day of Work FoodClothing Country A 63 Country B 12

26. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Absolute & Comparative Advantage Example #1 - an OUTPUT problem In a given day, the US can produce 20 units of wheat or 10 units of corn. Canada can produce 20 units of wheat or 5 units of corn. Would the two trade? If so, what would this trade look like?In a given day, the US can produce 20 units of wheat or 10 units of corn. Canada can produce 20 units of wheat or 5 units of corn. Would the two trade? If so, what would this trade look like?WHEATCORN United States Canada O.C. of wheat O.C. of corn

27. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Absolute & Comparative Advantage Example #2 - an INPUT problem It costs the US 1 hour of labor per unit of wheat, or 2 hours of labor per unit of corn. It costs Canada 1 hour of labor per unit of wheat, or 4 hours of labor per unit of corn.It costs the US 1 hour of labor per unit of wheat, or 2 hours of labor per unit of corn. It costs Canada 1 hour of labor per unit of wheat, or 4 hours of labor per unit of corn. Would the two trade? If so, what would this trade look like?Would the two trade? If so, what would this trade look like?WHEATCORN United States Canada O.C. of wheat O.C. of corn

28. Mr. Chris MeierEconomics: Unit 1Opportunity Cost and Production Possibilities Practice

29. Practice