When faced with SCARCITY of resources, decisions have to be made about how to use those resources

Production Possibilities Curve (Frontier)

When faced with SCARCITY of resources, decisions have to be made about how to use those resources

Trade-offsOpportunity Costs1Trade-OffsThis is the decision making process that is occurring in your mind right now! Am I going to pay attention to what Mr. Nagelhout 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 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.2Opportunity CostThe price you pay for each decision you make is called the OPPORTUNITY COST.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 service3The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production Possibilities CurveThe 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 GoodsGoods that satisfy our wants DIRECTLY. Instant Gratification

Lesson 1 Act 1

4Production Possibilities Curve (Frontier)Constructing the PPC.Horizontal axis is labeled Consumer GoodsVertical axis is labeled Capital GoodsConsumer GoodsCapital Goods5Production Possibilities Curve (Frontier)If this economy allocated ALL of its productive resources to the production of Capital Goods it could produce 100 Capital GoodsConsumer GoodsCapital Goods01006Production Possibilities Curve (Frontier)If this economy allocated ALL of its productive resources to the production of Consumer Goods it could produce 1000 Consumer GoodsConsumer GoodsCapital Goods010010007Production Possibilities Curve (Frontier)Connect the two points.This line represents an economys Production Possibilities of Capital and Consumer goods.Consumer GoodsCapital Goods010010008Production Possibilities Curve (Frontier)Notice the line is straight.It has a constant slope.Lets calculate the ratios between Capital and Consumer goods.This gives us our opportunity costs of producing capital and consumer goods. Consumer GoodsCapital Goods010010009Production Possibilities Curve (Frontier)An economy that produces ALL capital goods and no consumer goods is a boring place to be. People want to have fun, and consumer goods make life worth livingConsumer GoodsCapital Goods0100100010Production Possibilities Curve (Frontier)In order to get some consumer goods, the economy must give up the production of some quantity of capital goods. Remember ALL resources are limited!

Consumer GoodsCapital Goods0100100011Production Possibilities Curve (Frontier)Lets number our axis and connect the points. Each point represents production possibilities for this economy.

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I12Production Possibilities Curve (Frontier)At point A we give up the production of 10 capital goods in order to obtain 100 units of consumer goods.

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I13Production Possibilities Curve (Frontier)What is the opportunity cost of producing at point A?In terms of Consumer Goods

100 Consumer Goods = 10 Capital Goods.

1 Consumer Good = 10 Capital Goods/100

1 Consumer Good = .10 Capital Goods Each Consumer Good costs one tenth of a Capital Good.

If the economy wants 1 consumer good, it must give up the production of .10 of a capital good.

This is the opportunity cost of consumer goods.Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I14Production Possibilities Curve (Frontier)What is the opportunity cost of producing at point A?In terms of Capital Goods

10 Capital Goods = 100 Consumer Goods.

1 Capital Good = 100 Consumer Goods/10

1 Capital Good = 10 Consumer Goods Each Capital Good costs ten Consumer Goods.

If the economy wants 1 Capital good it must give up the production of 10 Consumer goods.

This is the opportunity cost of capital goods.

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I15Production Possibilities Curve (Frontier)What is the practical application of this model?Absolute and Comparative Advantage. Forms the basis for International Trade.Who can produce Absolutely more relative to another country.Who can produce at a lower opportunity cost relative to another country. In other words, who has the Comparative Advantage.We will examine this later!Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I16Comparative and Absolute AdvantageDo what you do best and trade for the rest

Comparative Advantage is the Round-about wayTo produce goods and services

17Comparative AdvantageBasic Premise:I could be a teacher AND grow my own food.You could be a farmer AND home-school your children.

I have a college degree and a knack for teaching Economics but I tend to kill most things I grow.You have a green thumb and can grow anything, but you hate economics.

What are we to do?18Comparative AdvantageWe should specialize in what we do best and trade with each other. To determine what we are best at doing, we need to consider our opportunity costs. We want to specialize in the activity that is least costly to us in terms of opportunity costs.19Assume Country A utilizes ALL of its productive resources (Productive Efficiency) to produce either Cloth or Wine. If it allocates all its resources to the production of Cloth it can produce 10 yards or Cloth. If it allocates all its resources to the production of Wine it can produce 15 gallons WineCountry A Country BClothWineClothWineAssume Country B utilizes ALL of its productive resources (Productive Efficiency) to produce either Cloth or Wine. If it allocates all its resources to the production of Cloth it can produce 20 yards or Cloth. If it allocates all its resources to the production of Wine it can produce 20 gallons Wine

1015202020Country A Country BClothWineClothWine10152020Which country has the ABSOLUTE ADVANTAGE in the production of Cloth? (Who can absolutely produce more Cloth?)Which country has the ABSOLUTE ADVANTAGE in the production of Wine ?(Who can absolutely produce more WIne?)21Country A Country BClothWineClothWine10152020Which Country has the Comparative Advantage in the production of Cloth? (Who can produce at the LOWEST OPPORTUNITY COST, or in other words, who gives up the LEAST in terms of production of the other GOOD.

22Country A Country BClothWineClothWine10152020Lowest Opportunity Cost determines Comparative Advantage Cloth Opportunity Cost Wine Opportunity Cost

Country A 10 10Cloths = 15Wines 15 15Wines = 10Cloths or or 1Cloth = 15cloths/10 1Wine = 10Cloths/15 or or 1Cloth = 1.5Wines 1Wine = .67Cloths

Country B 20 20Cloths = 20Wines 20 20WInes = 20Cloths or or 1Cloth = 20Wines/20 1Wine = 20Cloths/20 or or 1Cloth = 1Wine 1Wine = 1ClothWho has the Comparative Advantage in the Production of Cloth? 23Country A Country BClothWineClothWine10152020Lowest Opportunity Cost determines Comparative Advantage Cloth Opportunity Cost Wine Opportunity Cost

Country A 10 10Cloths = 15Wines 15 15Wines = 10Cloths or or 1Cloth = 15cloths/10 1Wine = 10Cloths/15 or or 1Cloth = 1.5Wines 1Wine = .67Cloths

Country B 20 20Cloths = 20Wines 20 20WIne = 20Cloths or or 1Cloth = 20Wines/20 1Wine =20Cloths/20 or or 1Cloth = 1Wine 1Wine = 1ClothWho has the Comparative Advantage in the Production of Wine? 24Country A Country BClothWineClothWine10152020 Bottom Line Country B has to give up 1 Cloth when they produce1 Wine, but Country A has to give up 1.5 Cloths to produce 1 Wine. Country B has to give up less relative to country A to produce Cloth. Country B should specialize in the production of Cloth.

Country A has to give up .67 Wine when they produce 1 Cloth, but Country B has to give up 1 Wine to produce 1 Cloth. Country A has to give up less relative to country B to produce Wine. Country A should specialize in the production of Wine.Lowest Opportunity Cost determines Comparative Advantage

25Comparative AdvantageWho should export Cloth? Who should import Cloth?

Who should export Wine?Who should import Wine?26Comparative AdvantageTerms of TradeWe have established that nations should produce the good/service that they have the comparative advantage in.How do we then trade?We have to determine what are acceptable terms of tradeSimply what is the price27Country A Country BClothWineClothWine10152020Lowest Opportunity Cost determines Comparative Advantage Cloth Opportunity Cost Wine Opportunity Cost

Country A 10 1Cloth = 1.5 Wines 15 1 Wine = .67 Cloths Country B 20 1Cloth = 1 Wine 20 1 Wine = 1 ClothCountry A specializes and produces 15 WinesCountry B specializes and produces 20 Cloths

If country A wants some cloth they must give up some wineIf country B wants some wine they must give up some cloth

What are acceptable terms of trade to close this deal!!28Country A Country BClothWineClothWine10152020Lowest Opportunity Cost determines Comparative Advantage Cloth Opportunity Cost Wine Opportunity Cost

Country A 10 1Cloth = 1.5 Wines 15 1 Wine = .67 Cloths Country B 20 1Cloth = 1 Wine 20 1 Wine = 1 ClothLets say A trades 2 wines with B for 4 clothsNow A consumes 13 Wines AND 4 ClothsIs this a good deal for A? Graph and see!

Terms of Trade in this case2 Wines = 4 Cloths1 Wine = 2 Cloths13547.51010Lets say B trades 4 cloth with A for 2 WinesNow B consumes 16 cloths AND 2 WinesIs this a good deal for B? Graph and see!

Terms of Trade in this case4 cloths = 2 wines1 cloths = .5 wines162BAD DEAL FOR COUNTRY BNO TRADE!!!A produces WineB produces Cloth29Country A Country BClothWineClothWine10152020Lowest Opportunity Cost determines Comparative Advantage Cloth Opportunity Cost Wine Opportunity Cost

Country A 10 1Cloth = 1.5 Wines 15 1 Wine = .67 Cloths Country B 20 1Cloth = 1 Wine 20 1 Wine = 1 ClothLets say A trades 5 wines with B for 4 clothsNow A consumes 10 Wines AND 4 ClothsIs this a good deal for A? Graph and see!

Terms of Trade in this case5 Wines = 4 Cloths1 Wine = .8 Cloths57.51010Lets say B trades 4 cloth with A for 5 WinesNow B consumes 16 cloths AND 5 WinesIs this a good deal for B? Graph and see!

Terms of Trade in this case4 cloths = 5 wines1 cloths = 1.25 winesA produces WineB produces Cloth101645TRADE should occur!BOTH now Consume beyond Their PPCS!30Production Possibilities Curve (Frontier)This straight line PPC represents Constant Opportunity Costs

The Trade-off as we move along the PPC are constant Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I31Production Possibilities Curve (Frontier)What is the practical application of this model?

We want to use this model to examine an individual economy more closely.

THE PPC IS GOING TO GO THROUGH CHANGES FIRST

You didnt think it was going to be that easy, did you???

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90100 200 300 400 500 600 700 800 900 .A.B.C.D.E.F.G.H.I32Production Possibilities Curve (Frontier)A closer look at an individual economy is going to give different look to the PPC.

It is not going to be a straight line.

It is going to have a bowed look.

It is going to be convex from the origin.

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

33Production Possibilities Curve (Frontier)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.

400 Consumer goods = 10 Capital goods1 Consumer good = 10 Capital goods/4001 Consumer good = .025 Capital good

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A.B.C.D34Production Possibilities Curve (Frontier)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.

200 Consumer goods = 10 Capital goods1 Consumer good = 10 Capital goods/2001 Consumer good = .05 Capital good

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A.B.C.D35Production Possibilities Curve (Frontier)The bowed nature of the PPC is due to INCREASING OPPORTUNITY COSTS

Not all resources are adaptable to alternative uses.

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.

Consumer GoodsCapital Goods0100100010 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A.B.C.D36Production Possibilities Curve (Frontier)Lets take a closer look at the PPC.

What do the different points on the PPC represent?

Consumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.D37Production Possibilities Curve (Frontier)Each point represents Productive Efficiency

This means that this economy is allocating ALL of it productive resources in the least costly way Consumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.D38Production Possibilities Curve (Frontier)The WHOLE PPC represents FULL PRODUCTIONProductive EfficiencyFull-Employment of Resources

Consumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.D39Production Possibilities Curve (Frontier)Do economys always produce on the PPC?

No! Often they operate inside their production possibilitiesConsumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.DE40Production Possibilities Curve (Frontier)Do economys always produce on the PPC?

Point E represents a point inside the PPC.

Notice that this point E represents a lower bundle of Capital and Consumer GoodsConsumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.D.E41Production Possibilities Curve (Frontier)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.

This economy could be doing better

Consumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.D.E42Production Possibilities Curve (Frontier)Do economys always produce on the PPC?

How about point F?

Point F is outside our PPC

It represents a combination of Capital and Consumer Goods that is currently not possible with this economies resources

This point is desirable (more stuff) but currently not attainable.

Consumer Goods01001000100 200 300 400 500 600 700 800 900

.A.B.C.DE.F43Production Possibilities CurveThe PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully employed (used) with the best technology currently availableRobotics(Capital Good)Compact Discs (Consumer Good)BCEFAGHow do we get to point G??1. Technological advancement which increases Productivity2. Discover new resources3. Take resources (War)4. Trade for ResourcesDOUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT44Production Possibilities CurveThe PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully employed (used) with the best technology currently availableRobotics(Capital Good)Compact Discs (Consumer Good)BCEFAGHow do we get to point G??1. Technological advancement which increases Productivity2. Discover new resources3. Take resources (War)4. Trade for ResourcesDOUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT45

Possibilities-A, B, C, D, & E Impossibility[more/better resources, better technology]

Economic resources are not completely adaptable to alternative uses.The curve indicates a changing trade-off.Obtaining more of one good requires giving up larger amounts of the alternative good.

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So, How Is Economic Growth Demonstrated on a PPC Graph?Economic Growthe[Ability to produce a largertotal output over time]

Capital Goods

C0

Consumer Goodsa

df

b

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