1. Copyright © 1999 Larry Reynolds The Circular-Flow Diagram The following two animated slides are courtesy of R. Larry Reynolds at Boise State University

2. Copyright © 1999 Larry Reynolds Q P Personal Cons Expenditure $ Goods and Services Households (Individuals) $income $ Expense Roles: A. Resource owners B. Consumers Business Firms Role: Producers hire resource Resource offered S D Resource hired Price Resource Resource Market (Mouse Click to advance) N P (Mouse Click to Advance) Circular Flow (Mouse Click to advance) S D Goods and services (Mouse Click to advance) Revenue $ (Mouse Click to advance) Mouse click for next slide © L Reynolds, 1999 Q P Goods Market

3. Copyright © 1999 Larry Reynolds Gov’t Purchases & transfers Gov’t Purchases & transfers Taxes Personal Cons Expenditure $ Goods and Services Households (Individuals) $income $ Expense Roles: A. Resource owners B. Consumers Business Firms Role: Producers hire resource Resource offered S D Resource hired Price Resource N P (Mouse Click to Advance) Circular Flow S Q P D Goods and services Revenue $ © L Reynolds, 1999 Government (Mouse Click to Advance) Finis Q P

4. Copyright © 1999 Larry Reynolds Production Possibilities Frontier The following six animated slides are courtesy of R. Larry Reynolds at Boise State University

5. Copyright © 1999 Larry Reynolds Example Production Possibilities Frontier There are two fields that can be used to grow two crops [these are the only outputs] Wheat [X] and Peanuts [Y] These two fields are of different soil types, so out put of Wheat [X] and Peanuts [Y] is different on each field Field A is more productive in Wheat [X], Field B is more productive in Peanuts [Y]

6. Copyright © 1999 Larry Reynolds 10 20 30 40 50 60 10 20 30 40 50 60 [Y] [X] Field A is more productive in growing Wheat [X] than peanuts [Y] These alternatives can be plotted on the graph,... If no Wheat is produced a maximum of 30 units of peanuts can be produced. If no peanuts are produced, 60 unit of wheat can be grown. This is because the land is better suited to growing Wheat [X] than [Y]. If the production relationship is linear, we can interpolate an infinite number of alternatives that lie along the line TM. T M © L Reynolds, 1999

7. Copyright © 1999 Larry Reynolds 10 20 30 40 50 60 10 20 30 40 50 60 [Y] [X] 70 80 Field B is more productive in growing Y than X These alternatives are plotted This relationship is represented by the line RS R S If you were producing Y on both fields and wanted some X, which field would you first grow X on? © L Reynolds, 1999

8. Copyright © 1999 Larry Reynolds Did you choose Field A? Why? If were producing all Y on both fields, you could produce 110 units of peanuts with no wheat. If you wanted a unit of Wheat [X] you would have to sacrifice [opportunity cost] 2.67 units of Y if you chose Field B. On Field A you would only sacrifice.5 units of Y. Therefore, X [wheat] would cost less if it were grown on Field A. You can produce up to 60 units of X at a cost of.5 Y per unit of X. To produce more than 60X, you will be required to sacrifice 2.67Y. If we combine the two fields to evaluate the alternatives we develop a “production possibilities frontier” [PPF] or a Transformation function. The PPF is a graphical representation [ model ] of the production alternatives available to the community or firm with the two fields, a given level of technology and other inputs [labour, kapital, entrepreneurial ability]. © L Reynolds, 1999

9. Copyright © 1999 Larry Reynolds 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 [Y] [X] 110 10 20 30 40 50 60 10 20 30 40 50 60 [Y] [X] 10 20 30 40 50 60 10 20 30 40 50 60 [Y] [X] 70 80 Production alternatives on Field A Field A Field B T M Production alternatives on Field B R S [T+R] S + M © L Reynolds, 1999

10. Copyright © 1999 Larry Reynolds 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 [Y] [X] 110 The production possibilities on the two fields are demonstrated as a PPF Production on Field A Production on Field B As the number of fields increases, or we break the two fields up into smaller homogeneous fields, the PPF will “smooth” out and can be represented by a curve or nonlinear function This transformation function or PPF demonstrates all production alternatives available given the inputs. The fact that it is “bowed out” (convex from above) demonstrates the problem that as we increase the output of X (or Y) we must sacrifice larger and larger amounts of Y (or X). © L Reynolds, 1999