Lecture 3: Production, Growth, and Trade Define production possibility frontier Define production efficiency Choosing Production Mixes An introduction.

Lecture 3:Production, Growth,

and Trade Define production possibility frontier Define production efficiency Choosing Production Mixes An introduction to Growth Work for the Weekend

Read Chapters 3 and 4 Work EIA Chapter 3

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Here are some of the issues we will address

Economic growth has made us richer than our grandparents.

Why must we still deal with scarcity? Why are there no “free lunches?” Why is there so much specialization

and trade in the world economy?

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The ProductionPossibility Frontier

Production is the conversion of land, labor, capital, and entrepreneurial ability into goods and services.

The production possibilities frontier (PPF) marks the boundary between those combinations of goods and services that can be produced and those that cannot-given available resources.

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Tapes Soda(millions (millions of bottles

Possibility per month) per month)

Production Possibilities Frontier

a 0 and 15

b 1 and 14c 2 and 12 d 3 and 9e 4 and 5f 5 and 0

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Production Possibilities Frontier

Tapes (millions per month)

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

0 1 2 3 4 5

5

10

15

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

bS

oda

(mil

lion

s of

bot

tles

per

mon

th)

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15 b

c

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)a

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

eSod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

10

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Production Possibilities Frontier

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

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Production Possibilities Frontier

Attainable

Unattainable

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

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Production Possibilities Frontier

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

Attainable

Unattainable

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

z

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Opportunity Costs

Tradeoff Tradeoffs exist when we must give up

something to get something else.

Opportunity Cost All tradeoffs involve a cost — an

opportunity cost.

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Opportunity Costs

An opportunity cost is the highest valued alternative foregone.

Opportunity costs increase as we desire to produce more tapes.

This explains the shape of the PPF — it is bowed outward.

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Opportunity Costs

Increasing Opportunity Cost Opportunity costs tend to increase

because not all resources are equally productive in all activities.

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Using Resources Efficiently

Marginal cost The opportunity cost of producing one

more unit of a good or service.

The marginal cost of an additional tape is the quantity of soda that must be given up to get one more tape — the opportunity cost.

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Opportunity Cost and Marginal Cost

Tapes (millions per month)

5

10

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

0 1 2 3 4 5

5

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Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

0 1 2 3 4 5

5

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Opportunity Cost and Marginal Cost

a

Tapes (millions per month)0 1 2 3 4 5

5

10

15 b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)Increasing opportunity cost of tapes...

0 1 2 3 4 5

5 MACRO HAPPENS

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Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

0 1 2 3 4 5

5

Opportunity Cost and Marginal Cost

Increasing opportunity cost of tapes...

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Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

f

0 1 2 3 4 5

5Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)Increasing opportunity cost of tapes...

e MACRO HAPPENS

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Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

5

10

15a

b

c

d

e

f

0 1 2 3 4 5

5Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)Increasing opportunity cost of tapes...

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Opportunity Cost and Marginal Cost

Tapes (millions per month)0 1 2 3 4 5

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)

1

2

3

4

5…means increasingmarginal cost of tapes.

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Tapes (millions per month)0 1 2 3 4 5

1

2

3

4

5MC

Opportunity Cost and Marginal Cost

Sod

a (m

illi

ons

of b

ottl

es p

er m

onth

)…means increasingmarginal cost of tapes.

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Where Should we Produce on a PPF

Any point on the curve is efficient Some choices has implications for

economic well being How should we choose? What Choices are best for Economic

Growth?

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The Cost of Shiftingthe Frontier

If society chooses to allocate resources toward capital investment, fewer goods and services are available for consumption today.

However, more goods and services will be produced in the future.

In General what determines how this choice is made?

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Factors That Influence Economic Growth

Technological progress is the development of new and better ways of producing goods and services.

Capital accumulation is the growth of capital resources.

does education play a role? does tax policy play a role?

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