Chapter 2
Production
Possibilities and
Opportunity Cost
©2002 South-Western College Publishing
What are the three
fundamental economic
questions?
What to produce?
How to produce?
For whom to produce?
What is
opportunity cost?
The best alternative
sacrificed for a
chosen alternative
What opportunity cost am
I experiencing now?
The most money that you
could be making if you were
somewhere else instead of
studying these slides
Can opportunity cost
be something other
than money?
Yes! That most desired
activity that you are
presently giving up
is considered an
opportunity cost
What is
marginal analysis?
An examination of the
effects of additions to
or subtractions from a
current situation
What is an example of
marginal analysis?
When your benefit of
studying these slides
exceeds the opportunity
cost, you will spend time
studying these slides
What is a production
possibilities curve?
A curve that shows the
maximum combinations of
two outputs that an
economy can produce,
given its available
resources and technology
What is technology?
The body of knowledge
and skills applied to how
goods are produced
What assumptions
underlie the productions
possibilities model?
• Fixed resources
• Fully employed resources
• Technology unchanged
What is the conclusion
of the production
possibilities curve?
Scarcity limits an
economy to points on
or below its production
possibilities curve
What is the law of
increasing
opportunity costs?
The principle that the
opportunity cost
increases as
production of one
output expands
What is
economic growth?
The ability of an economy
to produce greater levels
of output, an outward
shift of its production
possibilities curve
What makes possible
economic growth?
Research and development
of new technologies
Increase production in
excess of worn out capital
What happens when a
country does not invest in
new technology?
Everything else being equal,
the country will not grow
What is investment?
The accumulation of
capital, such as factories,
machines, and inventories,
that is used to produce
goods and services
What is the opportunity
cost of investment?
The consumer goods that
could have been
purchased with the
money spent for plants
and other capital
What does an increase
in investments make
possible in the future?
Economic growth and
more goods and
services
What conclusion can we
make about investments?
A nation can accelerate
growth by increasing
production of capital
goods in excess of the
capital being worn out
Key Concepts
• What are the three fundamental economic
questions?
• What is opportunity cost?
• Can opportunity cost be something other
than money?
• What is marginal analysis?
• What is a production possibilities curve?
• What three assumptions underlie the
productions possibilities curve model?
• What is the conclusion of the production
possibilities curve?
• What is the opportunity cost of investment?
• What does an increase in investments make
possible in the future?
• What conclusion can we make about
investments?
Summary
24
Thee fundamental economic
questions facing any economy are
What, How, and For Whom to
produce goods. The What question
asks exactly which goods are to be
produced and in what quantities. The
How question requires society to
decide the resource mix used to
produce goods. The For Whom
problem concerns the division of
output among society’s citizens.
25
Opportunity cost is the best
alternative foregone for a chosen
option. This means no decision
can be made without cost.
26
Marginal analysis examines the
impact of changes from a current
situation and is a technique used
extensively in economics. The basic
approach is to compare the
additional benefits of a change with
the additional cost of the change.
27
A production possibilities curve
illustrates an economy’s capacity to
produce goods, subject to the
constraint of scarcity. The
production possibilities curve is a
graph of the maximum possible
combinations of two outputs that
can be produced in a given period
of time, subject to three conditions:
28
(1) All resources are fully employed
(2) The resource base is not allowed
to vary during the time period.
(3) Technology, which is the body of
knowledge applied to the production
of goods, remains constant.
29
Inefficient production occurs at any
point inside the production
possibilities curve. All points along
the curve are efficient points
because each point represents a
maximum output possibility.
30
The law of increasing opportunity
costs states that the opportunity
cost increases as the production of
an output expands. The explanation
for the law of increasing opportunity
costs is that the suitability of
resources declines sharply as
greater amounts are transferred
from producing one output to
producing another output.
31
Investment means that an
economy is producing and
accumulating capital. Investment
consists of factories, machines,
and inventories (capital) produced
in the present that are used to shift
the production possibilities curve
outward in the future.
32
Economic growth is represented
by the production possibilities
curve shifting outward as the
result of an increase in resources
or an advance in technology.
33
END