1. Choice, Opportunity Costs and Specialization
Chapter Two
Choice,
Opportunity Costs and Specialization

2. Introduction
An economic system has to solve three coordination problems:
What, and how much, to produce.
How to produce it.
For whom to produce it.

3. Introduction
All economic knowledge can be boiled down to a single phrase:
There ain’t no such thing as a free lunch.

4. Introduction
Every decision has an opportunity cost – the cost in foregone opportunities.

5. Opportunity Cost
Opportunity cost: the value of the highest-valued alternative that must be forgone when a choice is made. It is the evaluation of a trade-off.
Marginal benefits and costs: the benefits and opportunity costs associated with one additional unit of the good.

6. Introduction
A production possibility curve is used to illustrate opportunity cost.

7. The Production Possibilities Model
The production possibilities curve shows the trade-offs among choices we make.

8. The Production Possibility Table
A production possibility table lists a choice's opportunity costs by summarizing what alternative outputs you can achieve with your inputs.

9. The Production Possibility Table
Output – an output is simply a result of an activity.
Input – an input is what you what you put into a production process to achieve an output.

10. The Production Possibility Curve for an Individual
A production possibility curve measures the maximum combination of outputs that can be achieved from a given number of inputs.
It slopes downward from left to right.

11. The Production Possibility Curve for an Individual
The production possibility curve not only represents the opportunity cost concept, it also measures the opportunity cost.

12. The Production Possibility Curve for an Individual
The production possibility curve demonstrates that:
There is a limit to what you can achieve, given the existing institutions, resources, and technology.
Every choice made has an opportunity cost—you can get more of something only by giving up something else.

13. A Production Possibility Curve for a Society
The production possibility curve is generally bowed outward.
Some resources are better suited for the production of some goods than others.

14. A Production Possibility Curve for a Society10 9 8 6 5 4 3 2 1 . 2Y 1X A X
If the slope of the production curve is -2 at A, the opportunity cost
of 1X is 2Y. 7
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

15. A Production Possibility Curve for a Society
Comparative advantage explains why opportunity costs increase as the consumption of a good increases.
Some resources are better suited for the production of some goods than to the production of other goods.

16. A Production Possibilities Table and Curve
% of resources
devoted to
production
of guns
Number
of butter
Pounds
Row 20 40 60 80
100 4 7 9 1 12 15 14 5 A B C D E F
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

17. A Production Possibilities Table and Curve
4 guns
1 pound of butter 15 B 14
3 guns
2 pounds of butter C 12 D 9
Butter E 5
1 gun
5 pounds of butter F 4 7 9 11 12
Guns
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

18. Marginal Opportunity Cost
The Production Possibilities Curve (PPC) illustrates the concept of opportunity cost. Each point on the PPC means that every other point is a forgone opportunity.
The PPC bows outward because there are ever-increasing marginal opportunity costs to the production of any good.

19. Increasing Marginal Opportunity Cost
The principle of increasing marginal opportunity cost states that opportunity costs increase the more you concentrate on an activity.
In order to get more of something, one must give up ever-increasing quantities of something else.
This principle is discussed but Not Named in the Boyes Text

20. Increasing Marginal Opportunity Cost
Butter
Slope is flat at A. Low opportunity cost of guns.
Slope is steep at B. High opportunity cost of guns.
Guns B A

21. Specialization
Economic agents (individuals, firms, nations) will be better off if they choose to produce those things for which they have the lowest opportunity costs, and trade for those with higher costs.
Agents do this because such choices involve giving up the least amount of other things.

22. Specialization & Trade
Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than someone else.
Law of comparative advantage:
proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer.

23. Efficiency
In production, we’d like to have productive efficiency – achieving as much output as possible from a given amount of inputs or resources.

24. Efficiency
Efficiency involves achieving a goal as cheaply as possible.
Efficiency has meaning only in relation to a specified goal.

25. Efficiency
Any point within the production possibility curve represents inefficiency.
Inefficiency – getting less output from inputs which, if devoted to some other activity, would produce more output.

26. Efficiency
Any point outside the production possibility curve represents something unattainable, given present resources and technology.

27. Efficiency and Inefficiency
Guns 10 8 6 4 2
Butter C D A B
Unattainable point,
given available technology,
resources and labor force
Efficient
points
Inefficient
point

28. Production Possibilities Curve
The production possibilities curve shows the maximum quantity of goods and services that can be produced when the existing resources are used fully and efficiently.

29. Production Possibilities
Defense
Non-defense A1
200 B1
175 75 C1
130
125 D1 70
150 E1
160 F1 25 G1
Only defense goods produced
Defense Goods A1
200 G1
Impossible B1
175
150
Efficient
Combinations C1 F1
125
Underutilized
(Inefficient)
100
Only nondefense
goods produced 75 D1 E1 25 50 75
100
125
150
Nondefense Goods

30. Shifts in the Production Possibility Curve
Society can produce more output if:
Technology is improved.
More resources are discovered.
Economic institutions get better at fulfilling our wants.

31. Growth The PPC moves outward (growth occurs) as the result of:
Increased resources
Larger labor force
Change in labor force participation
Chance in labor-leisure decision
Improved technology (innovation)
Expansion of capital stock
An improvement in the rules (laws, institutions, and policies) of the economy

32. A Shift of the PPC
Defense
Non-defense A2
225 B2
200 75 C2
175
120 D2
130
150 E2 70
160 F2
165
225 A2
Defense Goods A1 B2
200 B1
175 C2
150 C1 D2
125
100 D1 E2 75 E1 F2 25 50 75
100
125
150
Nondefense Goods

33. Shifts in the Production Possibility Curve
More output is represented by an outward shift in the production possibility curve.

34. Shifts in the Production Possibility Curve
Neutral Technological Change
Butter C D A B
Guns

35. Shifts in the Production Possibility Curve
Biased Technological Change
Butter C B A
Guns

36. Distribution and Production Efficiency
The production possibilities curve focuses on productive efficiency and ignores distribution.

37. Distribution and Production Efficiency
In our society, more is generally preferred to less and many policies have relatively small distributional effects.

38. Examples of Shifts in the Production Possibility Curve

39. Finagle A Bagel
Specialization