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Slide 1
Slide 2
When faced with SCARCITY of resources, decisions have to be
made about how to use those resources Trade-offs Opportunity
Costs
Slide 3
Trade-Offs This 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.
Slide 4
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. 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
Slide 5
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: 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 Lesson 1 Act
1
Slide 6
Production Possibilities Curve (Frontier) Constructing the PPC.
Horizontal axis is labeled Consumer Goods Vertical axis is labeled
Capital Goods Consumer Goods Capital Goods
Slide 7
Production Possibilities Curve (Frontier) If this economy
allocated ALL of its productive resources to the production of
Capital Goods it could produce 100 Capital Goods Consumer Goods
Capital Goods 0 100
Slide 8
Production Possibilities Curve (Frontier) If this economy
allocated ALL of its productive resources to the production of
Consumer Goods it could produce 1000 Consumer Goods Consumer Goods
Capital Goods 0 100 1000
Slide 9
Production Possibilities Curve (Frontier) Connect the two
points. This line represents an economys Production Possibilities
of Capital and Consumer goods. Consumer Goods Capital Goods 0 100
1000
Slide 10
Production 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 Goods
Capital Goods 0 100 1000
Slide 11
Production 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
living Consumer Goods Capital Goods 0 100 1000
Slide 12
Production 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 Goods Capital Goods 0 100 1000
Slide 13
Production Possibilities Curve (Frontier) Lets number our axis
and connect the points. Each point represents production
possibilities for this economy. Consumer Goods Capital Goods 0 100
1000 10 20 30 40 50 60 7 0 80 90 100 200 300 400 500 600 700 800
900.A.B.C.D.E.F.G.H.I
Slide 14
Production 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 Goods Capital Goods 0 100 1000 10 20 30 40
50 60 7 0 80 90 100 200 300 400 500 600 700 800
900.A.B.C.D.E.F.G.H.I
Slide 15
Production 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
Goods Capital Goods 0 100 1000 10 20 30 40 50 60 7 0 80 90 100 200
300 400 500 600 700 800 900.A.B.C.D.E.F.G.H.I
Slide 16
Production 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 Goods Capital Goods 0
100 1000 10 20 30 40 50 60 7 0 80 90 100 200 300 400 500 600 700
800 900.A.B.C.D.E.F.G.H.I
Slide 17
Production 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
Goods Capital Goods 0 100 1000 10 20 30 40 50 60 7 0 80 90 100 200
300 400 500 600 700 800 900.A.B.C.D.E.F.G.H.I
Slide 18
Comparative and Absolute Advantage Do what you do best and
trade for the rest Comparative Advantage is the Round-about way To
produce goods and services
Slide 19
Comparative Advantage Basic 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?
Slide 20
Comparative Advantage We 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.
Slide 21
Assume 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 Wine Country ACountry
B Cloth Wine Cloth Wine Assume 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
10 15 20
Slide 22
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Which 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?)
Slide 23
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Which 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.
Slide 24
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Lowest
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 = 1Cloth Who has the
Comparative Advantage in the Production of Cloth?
Slide 25
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Lowest
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 = 1Cloth Who has the
Comparative Advantage in the Production of Wine?
Slide 26
Country ACountry B Cloth Wine Cloth Wine 10 15 20 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
Slide 27
Comparative Advantage Who should export Cloth? Who should
import Cloth? Who should export Wine? Who should import Wine?
Slide 28
Comparative Advantage Terms of Trade We 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 trade Simply what is the
price
Slide 29
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Lowest
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 Cloth
Country A specializes and produces 15 Wines Country B specializes
and produces 20 Cloths If country A wants some cloth they must give
up some wine If country B wants some wine they must give up some
cloth What are acceptable terms of trade to close this deal!!
Slide 30
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Lowest
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 Cloth
Lets say A trades 2 wines with B for 4 cloths Now A consumes 13
Wines AND 4 Cloths Is this a good deal for A? Graph and see! Terms
of Trade in this case 2 Wines = 4 Cloths 1 Wine = 2 Cloths 13 5 4
7.5 10 Lets say B trades 4 cloth with A for 2 Wines Now B consumes
16 cloths AND 2 Wines Is this a good deal for B? Graph and see!
Terms of Trade in this case 4 cloths = 2 wines 1 cloths =.5 wines
16 2 BAD DEAL FOR COUNTRY B NO TRADE!!! A produces Wine B produces
Cloth
Slide 31
Country ACountry B Cloth Wine Cloth Wine 10 15 20 Lowest
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 Cloth
Lets say A trades 5 wines with B for 4 cloths Now A consumes 10
Wines AND 4 Cloths Is this a good deal for A? Graph and see! Terms
of Trade in this case 5 Wines = 4 Cloths 1 Wine =.8 Cloths 5 7.5 10
Lets say B trades 4 cloth with A for 5 Wines Now B consumes 16
cloths AND 5 Wines Is this a good deal for B? Graph and see! Terms
of Trade in this case 4 cloths = 5 wines 1 cloths = 1.25 wines A
produces Wine B produces Cloth 10 16 4 5 TRADE should occur! BOTH
now Consume beyond Their PPCS!
Slide 32
Production Possibilities Curve (Frontier) This straight line
PPC represents Constant Opportunity Costs The Trade-off as we move
along the PPC are constant Consumer Goods Capital Goods 0 100 1000
10 20 30 40 50 60 7 0 80 90 100 200 300 400 500 600 700 800
900.A.B.C.D.E.F.G.H.I
Slide 33
Production 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 Goods Capital Goods 0 100 1000 10 20 30 40 50 60 7
0 80 90 100 200 300 400 500 600 700 800 900.A.B.C.D.E.F.G.H.I
Slide 34
Production 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 Goods
Capital Goods 0 100 1000 10 20 30 40 50 60 7 0 80 90 100 200 300
400 500 600 700 800 900
Slide 35
Production 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 goods 1 Consumer good = 10
Capital goods/400 1 Consumer good =.025 Capital good Consumer Goods
Capital Goods 0 100 1000 10 20 30 40 50 60 7 0 80 90 100 200 300
400 500 600 700 800 900.A.B.C.D
Slide 36
Production 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 goods 1 Consumer good = 10
Capital goods/200 1 Consumer good =.05 Capital good Consumer Goods
Capital Goods 0 100 1000 10 20 30 40 50 60 7 0 80 90 100 200 300
400 500 600 700 800 900.A.B.C.D
Slide 37
Production 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 Goods Capital Goods 0 100 1000 10 20
30 40 50 60 7 0 80 90 100 200 300 400 500 600 700 800
900.A.B.C.D
Slide 38
Production Possibilities Curve (Frontier) Lets take a closer
look at the PPC. What do the different points on the PPC represent?
Consumer Goods 0 100 1000 100 200 300 400 500 600 700 800
900.A.B.C.D
Slide 39
Production 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
Goods 0 100 1000 100 200 300 400 500 600 700 800 900.A.B.C.D
Slide 40
Production Possibilities Curve (Frontier) The WHOLE PPC
represents FULL PRODUCTION Productive Efficiency Full-Employment of
Resources Consumer Goods 0 100 1000 100 200 300 400 500 600 700 800
900.A.B.C.D
Slide 41
Production Possibilities Curve (Frontier) Do economys always
produce on the PPC? No! Often they operate inside their production
possibilities Consumer Goods 0 100 1000 100 200 300 400 500 600 700
800 900.A.B.C.D E
Slide 42
Production 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 Goods Consumer Goods 0 100 1000 100 200 300 400 500 600
700 800 900.A.B.C.D.E
Slide 43
Production 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 Goods 0 100 1000 100 200 300
400 500 600 700 800 900.A.B.C.D.E
Slide 44
Production 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 Goods
0 100 1000 100 200 300 400 500 600 700 800 900.A.B.C.D E.F
Slide 45
Production Possibilities Curve The 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 available Robotics (Capital Good) Compact Discs (Consumer
Good) B C E F A G How do we get to point G?? 1. Technological
advancement which increases Productivity 2. Discover new resources
3. Take resources (War) 4. Trade for Resources D OUR ECONOMY IS
DRIVEN BY TECHNOLOGICAL ADVANCEMENT
Slide 46
Production Possibilities Curve The 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 available Robotics (Capital Good) Compact Discs (Consumer
Good) B C E F A G How do we get to point G?? 1. Technological
advancement which increases Productivity 2. Discover new resources
3. Take resources (War) 4. Trade for Resources D OUR ECONOMY IS
DRIVEN BY TECHNOLOGICAL ADVANCEMENT
Slide 47
P ossibilities -A, B, C, D, & E Impossibility Impossibility
[more/better resources, better technology] Economic resources are
not completely adaptable to alternative uses. curvechanging
trade-off. The curve indicates a changing trade-off. more of one
good giving up Obtaining more of one good requires giving up larger
amounts of the alternative good.
Slide 48
So, How Is Economic Growth Demonstrated on a PPC Graph?
Economic Growth e [Ability to produce a larger total output over
time] Capital Goods C 0 Consumer Goods a d f b