Production Possibilities and Opportunity Costs
Principles of Economics
2nd edition by Fred M Gottheil
PowerPoint Slides prepared by
Ken Long
©1999 South-Western College Publishing
1

What is a Production
Possibilities Frontier (PPF)?
A graph that shows the maximum combinations of goods that can be produced when resources and technology are used efficiently
©1999 South-Western College Publishing
2

For simplicity, lets take a world with only 2 products
Lets use beer and pizza (a typical college campus?)
3

A typical PPF has the following shape: .
The curve has a negative slope.
The curve is concave to the origin.
Pizza
4

All points on the curve correspond to full use of resources.
A
B
Pizza
5

Points outside the the PPF are not feasible with existing resources.
.
A
Pizza
6

Periods of unemployment or inefficiency in production correspond to points under the
PPF.
.
A
Pizza
7

Shape of the PPF? Why
Concave?
If PPF a straight line, we have constant opportunity costs
If PPF concave, we have increasing opportunity costs
8

Beer
Consider a straight line PPF
Beer given up, the opportunity cost, remains constant
Pizza
9

Concave shape, increasing opportunity costs.
Beer given up, the opportunity cost, is increasing
Pizza
10

What is the Law of
Increasing Costs?
The opportunity cost of producing a good increases as more of the good is produced
©1999 South-Western College Publishing
11

Why does the Law of
Increasing Opportunity costs hold?
Because resources are not perfectly adaptable to all products
12

How do we have more of everything?
By increasing our resources
©1999 South-Western College Publishing
13

Economic growth indicates an increase in the total output of an economy.
The PPF shifts to the right !
.
A
Pizza
14

Causes of rightward shifts in PPF’s?
Increase in resources
Increased productivity
Improved technology
15

Can a PPF shift inward
(to the left)?
YES!! For just the opposite reasons as an outward shift such as a loss of resources
16

Economic growth and the Capital
Consumer goods tradeoff:
A
From which point would an economy grow faster,
A or B?? Answer is A, with more capital goods
B
Consumer goods
17

What should a country specialize in producing?
In those goods and services that it has a comparative advantage
©1999 South-Western College Publishing
18

What is
Comparative Advantage?
A country’s ability to produce a good at a lower opportunity cost than the country which it trades
©1999 South-Western College Publishing
19

What is
Absolute Advantage?
A country’s ability to produce a good using fewer resources than the country with which it trades
©1999 South-Western College Publishing
20

Example, 2 people, 2 jobs, time required
Judy
Job A
60 min.
Job B
75 min
Sam 90 min 150 min
21

In the table, Judy is absolutely advantaged at both tasks, but what is her comparative advantage? What is
Sam’s comparative advantage?
22

Judy’s comparative advantage is at job B, and Sam’s comparative advantage is at job
A
To see why, look at the ratios in the table- Judy can do job A in
2/3 the time of Sam, but she can do job B in ½ the time, so she is relatively more efficient at job B.
23

Theory of comparative advantage
Argues that output is greater when resources tend to specialize in their greatest comparative advantages
24

Problem
With the same quantity of resources,
Euphoria can produce 100 barrels of beer to Extasia’s 50 barrels, and
Euphoria can produce 150 pizzas to
Extasia’s 100. According to comparative advantage, what product should Extasia tend to specialize in?
What about Euphoria?
25

ANSWER:
Extasia should specialize in pizzas, Euphoria in beer production
26

• What are Factors of Production?
•
What is Production Possibilities?
•
Why does division of labor increase productivity?
•
What is an Opportunity Cost?
• What is Comparative Advantage?
• What is Absolute Advantage?
27