1. THE PRODUCTION POSSIBILITIES CURVE: SCARCITY, TRADE-OFFS, AND OPPORTUNITY COSTS AP Microeconomics Unit I – Basic Economic Concepts

2. When faced with SCARCITY of resources, decisions have to be made about how to use those resources Trade-offs Trade-offs Opportunity costs Opportunity costs

3. TRADE-OFFS This is the decision making process that is occurring in your mind right now! This is the decision making process that is occurring in your mind right now! Am I going to pay attention to what Mr. White is saying, or am I going to daydream? Am I going to pay attention to what Mr. White is saying, or am I going to daydream? Am I going to come to class or go buy a lottery ticket? Am I going to come to class or go buy a lottery ticket? Am I going to stay in school or go find a full time job? Am I going to stay in school or go find a full time job? Each and every decision you make has a cost!! Not necessarily a cost in dollar terms, but a cost in that you must give up something in order to get more of something else. Each and every decision you make has a cost!! Not necessarily a cost in dollar terms, but a cost in that you must give up something in order to get more of something else.

4. OPPORTUNITY COST The “price you pay” for each decision you make is called the OPPORTUNITY COST. The “price you pay” for each decision you make is called the OPPORTUNITY COST. Opportunity cost is vital to the understanding of economics. Opportunity cost is vital to the understanding of economics. “The amount of a product or service that must be forgone (given up) in order to obtain more of the next best alternative product or service” “The amount of a product or service that must be forgone (given up) in order to obtain more of the next best alternative product or service”

5. PRODUCTION POSSIBILITIES CURVE (SOMETIMES REFERRED TO AS A PRODUCTION POSSIBILITIES FRONTIER) Used to illustrate: Used to illustrate: Productive Capacity Productive Capacity Opportunity Costs Opportunity Costs Efficiency Efficiency Productive Productive Allocative Allocative Economic Growth/Decline Economic Growth/Decline Vital Link to Aggregate Supply (short/long run) Vital Link to Aggregate Supply (short/long run)

6. PRODUCTION POSSIBILITIES CURVE

7. The type of land resource suitable for growing Wheat is DIFFERENT than the land resource for growing Rice. The type of land resource suitable for growing Wheat is DIFFERENT than the land resource for growing Rice. If a society wants MORE Rice, then as you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy) it will become MORE costly to do that, in terms of Wheat production If a society wants MORE Rice, then as you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy) it will become MORE costly to do that, in terms of Wheat production We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat

8. PRODUCTION POSSIBILITIES CURVE Economies produce MORE that just Wheat and Rice. Economies produce MORE that just Wheat and Rice. We produce LOTS of goods of many different types. We produce LOTS of goods of many different types. We can broadly categorize goods into TWO categories We can broadly categorize goods into TWO categories Capital Goods Capital Goods Consumer Goods Consumer Goods

9. The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production Possibilities Curve The PPC shows the relationship between two goods: The PPC shows the relationship between two goods: 1.Capital Goods (Investment Goods): Goods that satisfy our wants INDIRECTLY and promote future growth or “happiness” – Delayed gratification. 2.Consumer Goods: Goods that satisfy our wants DIRECTLY. Instant Gratification

10. PRODUCTION POSSIBILITIES CURVE

11. The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. At Point A the economy gives up 10 capital goods in order to get 400 consumer goods. At Point A the economy gives up 10 capital goods in order to get 400 consumer goods. 400 Consumer goods = 10 Capital goods 400 Consumer goods = 10 Capital goods 1 Consumer good = 10 Capital goods/400 1 Consumer good = 10 Capital goods/400 1 Consumer good =.025 Capital good 1 Consumer good =.025 Capital good

12. PRODUCTION POSSIBILITIES CURVE The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. At Point B the economy gives up 10 Capital goods in order to get 200 more Consumer goods. At Point B the economy gives up 10 Capital goods in order to get 200 more Consumer goods. 200 Consumer goods = 10 Capital goods 200 Consumer goods = 10 Capital goods 1 Consumer good = 10 Capital goods/200 1 Consumer good = 10 Capital goods/200 1 Consumer good =.05 Capital good 1 Consumer good =.05 Capital good

13. PRODUCTION POSSIBILITIES CURVE The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. Not all resources are adaptable to alternative uses. Not all resources are adaptable to alternative uses. Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa) Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa) Marsh land suitable for growing rice could not easily be converted for use as a an airport. It would be much more costly than using farmland in Kansas. Marsh land suitable for growing rice could not easily be converted for use as a an airport. It would be much more costly than using farmland in Kansas.

14. PRODUCTION POSSIBILITIES CURVE Let’s take a closer look at the PPC Let’s take a closer look at the PPC What do the different points on the PPC represent? What do the different points on the PPC represent?

15. PRODUCTION POSSIBILITIES CURVE Each point represents Productive Efficiency Each point represents Productive Efficiency This means that this economy is allocating ALL of it productive resources in the least costly way This means that this economy is allocating ALL of it productive resources in the least costly way

16. PRODUCTION POSSIBILITIES CURVE There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency. There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency. This represents the combination of Capital and Consumer Goods most desired by the society This represents the combination of Capital and Consumer Goods most desired by the society

17. PRODUCTION POSSIBILITIES CURVE The whole PPC represents FULL PRODUCTION The whole PPC represents FULL PRODUCTION Productive efficiency Productive efficiency Full employment of resources Full employment of resources

18. PRODUCTION POSSIBILITIES CURVE Do economies always produce on the PPC? NO! Do economies always produce on the PPC? NO! Point E represents a point inside the PPC. Point E represents a point inside the PPC. The area between point E and the PPC represents underutilization of resources or under-employment of resources or unemployment. The economy is being inefficient. The area between point E and the PPC represents underutilization of resources or under-employment of resources or unemployment. The economy is being inefficient.

19. PRODUCTION POSSIBILITIES CURVE Do economies always produce on the PPC? NO! Do economies always produce on the PPC? NO! Point F represents a point outside the PPC. Point F represents a point outside the PPC. The area between point F and the PPC represents overutilization of resources The area between point F and the PPC represents overutilization of resources It represents a combination of Capital and Consumer Goods that is currently not possible with this economy’s resources It represents a combination of Capital and Consumer Goods that is currently not possible with this economy’s resources

20. DO ACTIVITY 1-2

21. SCARCITY IS THE FUNDAMENTAL ECONOMIC PROBLEM In order to solve the dilemma of scarce resources being needed to fulfill unlimited wants, we must be answer the 3 fundamental economic questions In order to solve the dilemma of scarce resources being needed to fulfill unlimited wants, we must be answer the 3 fundamental economic questions What to produce? What to produce? How to produce? How to produce? For whom to produce? For whom to produce?