CHAPTER TWO
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PRODUCTION
POSSIBILITIES
FRONTIERS
CHOICES
Choices involve the balancing of having
more of one thing against having less of
another
 Arriving at the best balance possible within
your limits is called OPTIMIZING

Exhibit 1 Production by Elizabeth and Brian
COMPARATIVE ADVANTAGE
a basis for trade exists when each of
two countries, both capable of
producing the same two goods,
specialize in the good that is
relatively cheaper to produce
MAIN IDEA
COMPARATIVE ADVANTAGE
is a situation where a country can
produce a good at a lower opportunity
cost than another country.
Opportunity Cost and
Comparative Advantage
Elizabeth: the opportunity cost of producing
one loaf of bread is one apple
 Brian: the opportunity cost of producing
one loaf of bread is three apples
 Elizabeth can produce bread at a lower
opportunity cost than Brian can

SPECIALIZATION
Elizabeth produces only bread and produces
20 loaves of bread
 Brian produces only apples and produces 30
apples
 Decide to trade 8 loaves of bread for 12
apples
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Exhibit 2 Consumption for Elizabeth and Brian with and
without Specialization and Trade
MAIN FACTS ABOUT THE
PPF

Production Possibilities Frontier (or PPF)
– A graph of the combinations of various goods
that the economy can possibly produce with its
resources and technology
ASSUMPTIONS OF THE PPF
Fixed amount of resources
 Constant level of technology
 Full employment of resources
 Efficient Production

MAIN FACTS ABOUT THE
PPF

Points on the PPF
– Each point on the PPF shows one combination
of goods
– All points under the PPF are also possible
– Points above the PPF are impossible
MAIN FACTS ABOUT THE
PPF
DOWNWARD SLOPE OF
THE PPF
implies:
scarcity
 opportunity cost
 choice

MAIN FACTS ABOUT THE
PPF

Technical Efficiency
– Points on the PPF are technically efficient
combinations of output
Means that it is impossible to produce more of one
good without producing less of another
 The economy does not waste resources

MAIN FACTS ABOUT THE
PPF

Technical Inefficiency
– Points under the PPF indicate technically
inefficient production

Means that the economy could alter its use of
resources so that it produces more output of some
good without producing less of anything else
EXPLANATION AND
EXAMPLES

Steve's PPF
EXPLANATION AND
EXAMPLES

When is the PPF a Straight Line?
– The PPF is a straight line if the opportunity cost
of producing each good is independent of its
level of production
– Resources are equally well suited for producing
both goods
PPF (Example)
Compact Disc (CD): $10 each
 Cassette Tape (CT): $5 each
- Opportunity cost of one CD?
- Opportunity cost of one CT?
- Your resources: $100
- Draw PPF of CD and CT

EXPLANATION AND
EXAMPLES

When is the PPF Curved?
– The PPF is curved when the opportunity cost of
producing each good in the graph depends on
the amount produced
EXPLANATION AND
EXAMPLES
LAW OF INCREASING
COSTS

Because resources are not completely
adaptable to alternative uses, the
opportunity cost increases as society wants
an increasing amount of a particular product
SHIFTS IN THE PPF

When does the PPF Shift?
– The PPF shifts whenever the economy's
resources change, or when technology changes
SHIFTS IN THE PPF
SHIFTS IN THE PPF

Economic Growth
– Refers to an increase in the economy's output of
goods and services per person

A growing economy's PPF expands faster than its
population grows
– Occurs when the economy either gains new
resources or discovers better technologies
SHIFTS IN THE PPF
DEPRECIATION - THE
PORTION OF THE CAPITAL
STOCK THAT IS WORN OUT IN
THE PRODUCTION OF THIS
YEAR’S OUTPUT
If capital production is greater
than depreciation, the PPF
grows
If capital production is less
than depreciation, the PPF
shrinks
CHAPTER 2 continued
ECONOMIC SYSTEMS
CAPITALISM AND
SOCIALISM
These are the two basic economic
structures society uses to answer
the basic economic questions.
ECONOMIC POLICY GOALS
Full Employment
 Price Stability
 Economic Growth
 Increase the Well-Being of the Members of
Society
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TYPES OF ECONOMIC
SYSTEMS
Decentralized
Pure Capitalism
Mixed
economies
Centralized
Socialism
TYPES OF ECONOMIC
SYSTEMS
DECENTRALIZED - a system in which
individuals own the factors of production
and decide individually how to use them.
 CENTRALIZED - a system in which the
government controls the factors of
production and makes decisions on their use
 MIXED SYSTEM - the government and
individuals are both involved.

BASICS OF CAPITALISM
The interaction of individual buyers
and sellers pursuing their own self
interests address the questions of
what, how, and for whom.
ELEMENTS OF CAPITALISM
Private Property
 Market Allocation
 Competition
 Freedom of Enterprise
 Freedom of Choice
 Limited Government

ARGUMENTS FOR PURE
CAPITALISM
EFFICIENCY - competition leads
individual to seek the least expensive
production techniques
 SELF INTEREST - private ownership will
lead individuals to get the highest value
from their resources.
 INDIVIDUAL FREEDOM
 GROWTH

BASICS OF SOCIALISM
Individuals only control their labor
while capital and land are
controlled by the government.
Central planners address the
questions of what, how and for
whom to produce.
ELEMENTS OF SOCIALISM
Government ownership of resources
 Centralized allocation of resources
 Prices set by planners
 Emphasis on equitable distribution of
income
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ARGUMENTS FOR
SOCIALISM
EXTERNALITIES - a command system
can force price adjustments for compensate
for external costs or benefits.
 PUBLIC GOODS - certain goods are better
provided collectively (national defense).
 EQUITABLE DISTRIBUTION OF
INCOME
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TWO VISIONS OF THE
MARKET
Capitalist thinkers believe markets, in
general, are efficient and effective
allocation mechanisms while
socialist thinkers see several
problems inherent in a market
system.
PRICES
Capitalist thinkers believe that prices ration
goods and services, convey information,
and serve as incentives.
 Socialist thinkers view prices as being set
by greedy businesses with vast economic
power.

COMPETITION
Capitalist thinkers believe that is a strength
that is omnipresent in the market.
 Socialist thinkers view the market as being
dominated by big businesses which dictate
prices and manipulate consumers.

PRIVATE PROPERTY
Capitalist thinkers believe that private
property encourages individuals to make the
most efficient use of the resources they
own.
 Socialist thinkers believe that those with
property have greater political power and
use their power to take advantage of those
without property.

EXCHANGE
Capitalist thinkers see exchange as a
mutually beneficial action between
concenting parties.
 Socialist thinkers would often see exchange
as benefitting one person at the expense of
the other.

ROLE OF GOVERNMENT
Capitalist thinkers tend to be wary of the
government’s ability to protect the interests
of society as a whole.
 Socialist thinkers see government decisions
as promoting the best interest of society as a
whole.
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ANY QUESTIONS?