The Production Possibilities Curve and Economic Reasoning

1. The Production Possibilities Curve and Economic Reasoning • The choices made by society are often presented in terms of a production possibility curve. • The production possibilities curve shows the trade-offs among choices we make.

2. The Production Possibility Table • A production possibility table lists the maximum combination of outputs that can be obtained from a given number of inputs.

3. The Production Possibility Curve • A production possibility curve plots the maximum combination of outputs that can be achieved from a given number of inputs. • It slopes downward from left to right.

4. The Production Possibility Curve • The production possibility curve not only demonstrates the opportunity cost concept, it also measures the opportunity cost.

5. The Production Possibility Curve • 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.

6. 20 hours of economics 0 hours of history A 100 B 88 Economics grade C 70 20 hours of history 0 hours of economics D 46 E 40 58 66 78 94 98 History grade The Production Possibility Curve Fig. 2-1 (a and b), p 33 Hours of study Grade in Hours of study Grade in in history history in economics economics 20 98 0 40 19 96 1 43 18 94 2 46 17 92 3 49 16 90 4 52 15 88 5 55 14 86 6 58 13 84 7 61 12 82 8 64 11 80 9 67 10 78 10 70 9 76 1 1 73 8 74 12 76 7 72 13 79 6 70 14 82 5 68 15 85 4 66 16 88 3 64 17 91 2 62 18 94 1 60 19 97 0 58 20 100

7. Increasing Marginal Opportunity Cost • The production possibility curve is generally bowed outward since some resources are better suited for the production of some goods.

8. Increasing Marginal Opportunity Cost • The concept of 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.

9. Y 10 If the slope of the production curve is -2 at A, the opportunity cost of 1X is 2Y. 9 8 A 2Y 7 . 6 5 1X 4 3 2 1 0 1 2 3 4 5 6 7 8 9 X Increasing Marginal Opportunity Cost, p 33

10. Increasing Marginal Opportunity Cost • The principle of increasing 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.

11. A Production Possibility Table, Fig. 2-2a, p 34 % of resources % of resources devoted to devoted to production production Number Number of burgers of DVDs of DVDs Row of burgers 0 0 100 15 A 20 4 80 14 B 40 7 60 12 C 60 9 40 9 D 80 1 1 20 5 E 100 12 0 0 F

12. 1 DVD 2 DVDs 5 DVDs 4 burgers 3 burgers 1 burger A Production Possibility Curve, Fig. 2-2b, p 34 A 15 B 14 C 12 D 9 DVDs E 5 F 4 7 9 11 12 Burgers 0

13. Slope is flat at A. Low opportunity cost of burgers. A DVDs Slope is steep at B. High opportunity cost of burgers. B Burgers Increasing Marginal Opportunity Cost, p 35

14. Efficiency • In our production, we would like to have productive efficiency—achieving as much output as possible from a given amount of inputs or resources.

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

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

17. Unattainable point, given available technology, resources and labor force 10 8 C D Efficient points 6 DVDs B 4 A Inefficient point 2 0 2 4 6 8 10 Burgers Efficiency and Inefficiency, Fig. 2-3a, p 36

18. 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.

19. Shifts in the Production Possibility Curve • An outward shift in the production possibility curve indicates more output that can be produced with given inputs.

20. C D Shifts in the Production Possibility Curve, Fig. 2-3b, p 36 Neutral Technological Change DVDs A 0 B Burgers

21. C Shifts in the Production Possibility Curve, Fig. 2-3c, p 36 Biased Technological Change DVDs B 0 A Burgers

22. Distribution and Production Efficiency • The production possibilities curve focuses on productive efficiency and ignores distribution. • An increase in output that goes to one person and not to anyone else would not necessarily be efficient in some societies.

23. Distribution and Production Efficiency • Economists often talk about efficiency as if it means productive efficiency and achieving society's goals. • In our society, more is generally preferred to less and many policies have relatively small distributional effects.

24. If more inputs are available for the production of X and Y equally, the PPC shifts out along both X and Y axes. If fewer inputs are available for the production of X and Y equally, the PPC shifts in along both X and Y axes. Examples of Shifts in the Production Possibility Curve

25. Examples of Shifts in the Production Possibility Curve • If more inputs are available for good X only, the PPC shifts out on the X axis only. • If more inputs are available for good Y only, the PPC shifts out on the Y axis only.

26. Examples of Shifts in the Production Possibility CurveFig. 2-4, p 37 (b) (d) (a) (c)

27. Comparative Advantage, Specialization, and Trade • The production possibility curve becomes bowed out when individuals specialize in the production of goods for which they have a comparative advantage and trade with others.

28. Comparative Advantage, Specialization, and Trade • The comparative advantage argument used to explain the bowed-out shape of the production possibilities curve can be used to show how trade makes society better off.

29. Comparative Advantage, Specialization, and Trade • Collaboration and specialization can make society better off. • Total production can rise.

30. Comparative Advantage, Specialization, and Trade • The outward bow graphically represents the potential gains from trade.

31. The Gains From Trade • Sunder can either write one economics paper or four creative writing papers in a day. • Ti can either write one creative writing paper or four economics papers in a day.

32. The Gains From Trade • Sunder has a comparative advantage in creating writing and Ti has a comparative advantage in economics.

33. The Gains From Trade • The following table and production possibility curves demonstrate how output increases when two individuals collaborate and specialize in the activity for which each has a comparative advantage.

34. The Gains From Trade, Fig. 2-6a, p 41

35. The Gains From Trade, Fig. 2-6b, p 41

36. The Gains From Trade • Each individual's PPC is drawn by connecting the number of papers each can write in a day on a graph.

37. The Gains From Trade,Fig. 2-6c, p 41 5 4 Economics 3 2 (a) Ti (b) Sunder 1 1 2 3 4 5 Creative writing

38. The Gains From Trade • The combined PPC curve is drawn by finding three points and connecting them.

39. The Gains From Trade, Fig. 2-6c, p 41 A (c) Combined with trade 5 B 4 Economics 3 2 (a) Ti (b) Sunder 1 C 1 2 3 4 5 Creative writing

40. The Gains From Trade • Point A: This is the combined number of economics papers they both can write in a day. • If economics papers are on the Y axis, it is point 0,5.

41. The Gains From Trade • Point B: This is the combined number of creative papers they both can write in a day. • If economics papers are on the Y axis, it is point 5,0.

42. The Gains From Trade • Point C: This is where each is focusing on that activity for which he or she has a comparative advantage. • Sunder writes four creative papers and Ti writes four economics papers. • This is the coordinates 4,4.

43. The Gains From Trade • The combined PPC is bowed out because of comparative advantage and specialization.

44. The Division of Labor • Markets allow specialization and the division of labor. • They allow individuals to develop their comparative advantages, thereby increasing the production possibilities of society.

45. Markets, Specialization, and Growth • Markets and specialization have led to growth.

46. Markets, Specialization, and Growth • The growth in per capita income (constant 1990 dollars) in the past 2 millennia has been astonishing. • This owes largely to the introduction of markets and democracy.

47. Markets, Specialization, and Growth • As people are allowed to compete and specialize, they get better at what they do, develop new technologies and the market grows ever larger.

48. col17930_0207.eps $6,000 $5,000 $4,000 Per capita income (in 1990 international dollars) $3,000 $2,000 $1,000 0 500 1000 1500 2000 Growth in the Past Two Millennia Fig. 2-7, p 42

49. The Economic Organization Of Society End of Chapter 2