Module 3
The Economizing Problem
I. Trade-offs: The Production Possibilities Curve
I. Trade-offs: The Production Possibilities Curve
A. Efficiency
B. Opportunity Cost
C. Economic Growth
Production Possibilities Model
Production Possibilities Model
All models have simplifying assumptions:
Available supply of resources is fixed in quantity
and quality at this point in time.
Technology is constant during analysis.
Economy produces only two types of products
Create a PPC
PPC
UNATTAINABLE
EFFICIENT
INEFFICIENT
A. Efficiency
A. Efficiency
1. Points on the curve represent maximum possible combinations of Pizza and
Bulldozers given resources and technology. At point E, given the decision
to produce 20 Bulldozers, the most Pizzas that could be made are 160.
2. Points inside the curve represent underemployment or idle resources. At
point I, if 20 Bulldozers are being made, we are only making 80 Pizzas
rather than 160. We are not at our full productive potential.
3. Points outside the curve are unattainable. We do not have the resources or
technology to produce at point U.
All points along the curve are efficient in production. We cannot increase pizza
production without giving up some bulldozer production.
Efficient in allocation refers to the point that this society wants above all
others. If society wishes to have more bulldozers than pizza, then a point
like E would be efficient in production but not in allocation.
B. Opportunity Cost
B. Opportunity Cost
What is the opportunity cost (trade-off) between Pizza and Bulldozers?
2:1
To gain 20 bulldozers, we give up 40 pizzas. Or to gain 1 bulldozer, we
give up 2 pizzas.
To gain 40 pizzas, we give up 20 bulldozers. Or to gain 1 pizza, we
give up ½ a bulldozer.
B. Opportunity Cost
B. Opportunity Cost
Tip: The opportunity cost of the good graphed on the x-axis is always the slope
of the PPC.
The opportunity cost of the good on the y-axis is always the inverse of the
slope of the PPC.
It doesn’t matter the initial point on the PPC, the opportunity cost of one more
pizza (or bulldozer) is always the same.
Notice that the slope (opportunity cost) is constant. What does this tell you
about the substitutability of the resources used to produce Pizza and
bulldozers?
They must be perfectly substitutable! Is this reasonable?
PPC
UNATTAINABLE
EFFICIENT
INEFFICIENT
Economic Growth
Not every sector of
the economy grows at
the same rate.
•
In this historic example,
productivity increases
were more dramatic for
corn than for wheat over
the 50-year period.
Production Possibilities
D.
Optimal or best
product-mix:
1. It will be some
point on the
curve.
2. The exact point
depends on
society; this is a
normative
decision.
Production Possibilities
E. Law of increasing opportunity costs:
1. The amount of other products that must be
foregone to obtain more of any given product is
called the opportunity cost.
2. Opportunity costs are measured in real terms
rather than money (market prices are not part of
the production possibilities model).
3. The more of a product produced the greater is its
(marginal) opportunity cost.
4. The slope of the production possibilities curve
becomes steeper, demonstrating increasing
opportunity cost. This makes the curve appear
bowed out, concave from the origin.
Production Possibilities
A TO B
Imagine you have lined up the labor from the
worst pizza maker to the best (Papa John
himself).
Who do you release from the kitchen to the
bulldozer factory?
The worst pizza maker.
Since there are only two skills in this economy,
the worst pizza maker should be the best
manufacturing worker.
Big gain in bulldozers comes at a small
opportunity cost in pizzas.
As you produce more and more bulldozers, you
keep releasing the next best pizza maker to
go work in the factory. Finally, you get to
the end of the line and you are left with Papa
John, the best pizza maker in all the land!
Production Possibilities
C TO D
When you send Papa John to the
factory to make bulldozers, you
gain very little bulldozer
production.
After all, he is likely the worst
manufacturing worker left;
otherwise you would have sent
him to the factory a long time ago.
Since he’s the best pizza maker, you
lose many pizzas.
Small gain in bulldozers comes at a
very high opportunity cost in
pizzas.
PPC: Applied
At the beginning of world war II, the
U.S. moved from the interior of
their production possibility frontier
to the boundary. In the graph
above, this is represented by a
move from point A to point B.
What is the opportunity cost to the
U.S. of making that decision?
Answer?
Since the U.S. could have
moved to point C rather than
point B, the opportunity cost of
moving to point B is the loss in
potential consumption equal to
the horizontal distance C1 C2.
APE U1 L2 A2 PPC
Figure 2.1
12
10
Good B
Figure 2.1 PPC 1
A. The OC of increasing production of
Good A from 0 units to one unit is
2
the loss of ______
unit(s) of Good
B.
B. The OC of increasing production of
Good A from 1 unit to 2 units is the
loss of ______
unit(s) of Good B.
2
C. The OC of increasing production of
Good A from 2 units to 3 units is
2
the loss of ______
unit(s) of Good
B.
Constant
D. This an example of ___________
OC per unit for Good A.
8
6
4
2
0
1
2 3 4
Good A
5
6
APE U1 L2 A2 PPC
Figure 2.2
12
10
8
Good B
Figure 2.2 PPC 2
A.
The OC of increasing production of
Good A from 0 units to one unit is the
2
loss of ______
unit(s) of Good B.
B.
The OC of increasing production of
Good A from 1 unit to 2 units is the
4
loss of ______
unit(s) of Good B.
C.
The OC of increasing production of
Good A from 2 units to 3 units is the
6
loss of ______
unit(s) of Good B.
INCREASING
D.
This an example of _____________
OC per unit for Good A.
6
4
2
0
1
Good A
2
3
APE U1 L2 A2 PPC
Good B
Part B: Figure 2.3 PPC 3
Increasing OC per unit of Good B
Good A
APE U1 L2 A2 PPC
Good B
Part B: Figure 2.4 PPC 4
ZERO OC per unit of Good B
Good A
APE U1 L2 A2 PPC
Good B
Part B: Figure 2.4 PPC 4
CONSTANT OC per unit of Good B
Good A
APE U1 L2 A2 PPC
Capital Goods
A B
C
Figure 2.6 PPP: Capital Goods and
Consumer Goods
3. Technological breakthrough in
the consumer-goods industry?
BD
4. Forbidden use of automation?
AA
5. New oil & coal sources &
technological innovation?
A B D C
Consumer Goods
CC
6. If BB is a country’s PPC what can be said about point X?
It is impossible by itself to attain w/ existing resources & tech.
7. If BB is a country’s current PPC what can be said about point Y?
The economy is not fully using existing resources & technology.
The Great Depression of the 1930’s is an example.
APE U1 L2 A2 PPC
Y
Capital Goods
Part D: PPC:
Capital Goods & Consumer Goods
8. What changes could cause the
PPC to shift from XX ot YY?
New resources and/or new tech.
9. Under what conditions might an
economy be at point Z?
Resources are not fully employed.
10. Why might a government want
to move from B to A?
The govt might want to emphasize
the production of capital goods
so the economy would grow
more in the future. This would
shift the PPC outward in the
future.
A
X
B
Z
X
Y
Consumer Goods
APE U1 L2 A3
You Don’t Have to Spend a Buck to Have a Cost
Explicit
Implicit
A. Decide to go to
college
Tuition, books, travel
Income not earned,
less job experience
B. Take a job after
school
Work clothes, meals,
transportation
Less study and
social time.
C. Study & take an
AP Econ Test(s)
Cost of test & books
D. A stay at home
Dad returns to
work
Work clothes, taxes,
child-care expenses
Money earned from parttime job, less social time,
less study time for other
courses.
Less time with family,
less time for
recreation.
APE U1 L2 A3
You Don’t Have to Spend a Buck to Have a Cost
Explicit
E. Family members
work in their parents
restaurant: Child’s
Point of view.
Parents’ (employer)
viewpoint
Taxes, work clothes
Payroll taxes, wages
for child
Implicit
Lower pay than
elsewhere, less time
for study, less
recreation time.
Less flexibility for
hiring and firing,
more complex
relationship w/ child
APE U1 L2 A3
You Don’t Have to Spend a Buck to Have a Cost
2. Pick one of the situations in #1 and explain why the decision maker
must have decided that the benefits received exceeded, equaled or
fell short of the opportunity costs to engage in the activity.
A. You decide to go to college:
Future consumption and status vs. current consumption.
B. You take a job after school:
More disposable income. Choice of hours however can make the
benefits exceed the cost. Total benefits may exceed total costs,
even when the cost of an additional hour of work per week exceeds
the benefit of the additional hour. But the economic way of thinking
causes the person to adjust work so the extra hour just matches the
extra cost. If this extra hour causes the worker to earn a lower
grade in class total benefits of work may exceed total costs of work;
but the marginal costs of that extra hour of work greatly exceed the
MB of extra income.
APE U1 L2 A3
You Don’t Have to Spend a Buck to Have a Cost
2. Pick one of the situations in #1 and explain why the decision
maker must have decided that the benefits received
exceeded, equaled or fell short of the opportunity costs to
engage in the activity.
C. Study for and take AP Economics exam:
The cost may be scores on any other AP tests. Management of
study time is vital for mastery of all tests.
D. A stay-at-home dad returns to work:
Working exceeded the costs of staying home.
E. Family members work in their parents’ restaurant:
Family decision making is often closer to tradition than market
criteria. A student may work in a family business “just
because.” Depends on the foreseen benefit of working there.
Unemployment, Growth & the Future
A.Unemployment and
productive inefficiency
occur when the
economy is producing
less than full
production or inside
the curve (point U in
Figure 2-3).
Unemployment, Growth, & the Future
B. In a growing economy,
the production
possibilities curve shifts
outward
1. when resource
supplies expand in
quantity or quality.
2. when technological
advances are occurring.
Economic systems differ in two important ways: Who
owns the factors of production and the method used to
coordinate economic activity.
A.The market system:
1. There is private ownership of resources.
2. Markets and prices coordinate and direct
economic activity.
3. Each participant acts in his or her own selfinterest.
4. In pure capitalism the government plays a
very limited role (examples???).
5. In the U.S. version of capitalism, the
government plays a substantial role.
Three Basic Questions
Factors of production and the method
used to coordinate economic activity.
Command economy, socialism or
communism:
1. There is public (state) ownership of
resources.
2. Economic activity is coordinated by
central planning.
APE U1 L2 A5
The Circular Flow of Resources, Goods, Services & Money Payments
1. Give three examples of resource owners:
Answers can vary b/c resource owners are anyone who has land, labor,
capital, entrepreneurship to sell in the factor market.
2. Define business firm:
A bf buys resources and, in turn, sells goods and services to resource
owners.
3. What is a product market?
A market where finished goods and services are bought and sold.
4. Three examples of transactions you made this week in the product
market:
Any purchase of a good or service counts.
5. What is a factor market?
A market where the factors of production (L,L,C, EA) are bought and sold.
APE U1 L2 A5
The Circular Flow of Resources, Goods, Services & Money Payments
6. An example of a transaction you or your family made in the factor
market?
It probably would be wages for labor, although many other transactions
are possible.
7. How are businesses connected to factor and product markets?
They buy in the factor markets and sell in product markets.
8. What determines the price of land, labor, capital and
entrepreneurship?
Supply and demand.
9. Where do resource owners get the money to buy goods and
services in the product market?
From selling their resources in the factor markets.
APE U1 L2 A5
The Circular Flow of Resources, Goods, Services & Money Payments
10. Where do business firms get the money to pay resource owners for
their land, labor, capital and entrepreneurship?
From selling the goods and services they produce with the factors of
production.
11. Why is it important to know that a market economy is characterized
by interdependence?
Interdependence is important b/c people specialize and trade their
production in markets for other products they need. The circular
flow of income shows the interdependence of the economy.
Widgets & Whatsits Production
Needs:
A table or two desks for each group.
Two staplers for each group.
A stack of half-sheets of paper for each group.
A sheet of graph paper for each group.
Widgets & Whatsits
Set-up:
Each nation uses the resources to produce widgets and
whatsits.
A widget is a half-sheet of paper folded
twice into a rectangle and stapled.
A whatsit is a half-sheet of paper folded three times to form
a smaller rectangle and stapled.
A round of production lasts 30 seconds.
Widgets & Whatsits
Round 1:
All resources are used to produce widgets. At the end of the round,
each nation plots the output on the widget axis of the graph paper.
Round 2:
All resources are used to produce whatsits. At the end of the round,
each nation plots the output on the whatsit axis of the graph paper.
Round 3:
One person produces widgets, the rest of the group produces whatsits.
At the end of the round, each nation plots the combination of widget
and whatsit output on the graph paper.
Widgets & Whatsits
Round 4:
The labor is divided evenly between widget and whatsit
production. At the end of the round, each nation plots
the combination of widget and whatsit output on the
graph paper.
Round 5:
One person produces whatsits, the rest of the group
produces widgets. At the end of the round, each nation
plots the combination of widget and whatsit output on the
graph paper.
Each team should now have 5 points plotted on their PPC.
Widgets & Whatsits
The students are the labor and the staplers are the capital.
The paper represents natural resources. The human capital was the
way in which the students performed the production tasks. Discuss
specialization and division of labor to get more output in 30 seconds.
Each nation can now calculate the opportunity cost of producing more
whatsits (or widgets) with actual numbers. Were increasing
opportunity observed or were the opportunity costs relatively
How would the activity be modified to show economic growth? Maybe
a larger labor force or more staplers?
Maybe a new technology that used a fast machine that automatically
did the stapling, thus allowing more labor to be employed folding the
paper?
Main Idea Review
That sometimes a very simple model can be a powerful
way of explaining important economic concepts.
How the production possibilities model helps economists
think about the trade-offs every economy faces.
How the production possibilities model helps us understand
three important aspects of the real economy: efficiency,
opportunity cost, and economic growth.
MOD 3 Practice Quiz
Questions 2-6
Capital
Goods
F
A
B
C
E
Consumer
Goods
MOD 3 Practice Quiz
Questions 7-11