Review
Economy
Economics
Microeconomics
Macroeconomics
Because of scarcity and opportunity costs we need to take
optimal decisions: WHWWW?
Who makes the Decisions? HH, Firm, Govt
Where do they make these decisions? Market
Product Market (Prices) vs Factor Market (Rent, Wages,
Interest, Profit)
How do they make these decisions? RIM
MB = MC
allocative efficiency vs Produvtive
vs. Equity
Opportunity cost
• From our definition of economics, we know
that when we make choices, we face costs
• Definition: Opportunity cost is the cost in
choosing in the face of scarcity - it is the
value of the benefit that is forgone by
choosing one alternative rather than
another.
Opportunity Cost II
• Note:
1) Opportunity cost is NOT money cost
2) Opportunity cost includes the value of time
3) Opportunity cost does not always remain the same
Note: The principle of substitution states that, as
opportunity costs change, individuals may choose
to substitute one action for another action that has
a lower opportunity cost.
Production
• 2 types of production - goods and services
Total Production
Goods
Services
Capital
Durable
Consumer
Non-Durable
How can we better illustrate this trade off?
Production Possibilities: An example
• Assumptions made:
1) only 2 goods produced (all the rest held
constant by ceteris paribus condition)
2) A fixed level of technology and fixed
amount of the factors of production are
present.
• Suppose this firm (Firm A) can produce either
cars or SUVs at the following ratio:
CARS
SUVs
A. 0
100
B. 50
75
C. 100
50
D. 150
25
E. 200
0
• These figures represent the maximum quantities
of each combination.
Cars
200
100
0
E
PPF for Firm A
C
50
A
100
SUVs
PPF and Opportunity Cost
• Here, we see that we have a linear PPF this implies a constant slope of the PPF.
• Slope = (D cars)/ (D SUV)
= (-50)/ 25 = -2cars/SUV
• Question: How do we show opportunity
cost from this?
Opportunity Cost
• Opportunity cost = “Give up”
“Get”
• So, if company moves production from E
=> D, what is the opportunity cost of:
• 1) SUVs in terms of cars?
• 2) cars in terms of SUVs?
Specialization and the PPF
• By specialization, we mean that these factors are
relatively more productive in some activity than
others
• PPF are not always linear - can be “bowed
outward”
Cars
Increasing Cost PPF
Z
Y
X
0
SUVs
Efficiency and the PPF
• Definition A certain allocation is
“technically efficient” if there is no way for
one good to be increased in quantity without
lowering the other good.
• How does this relate to the PPF?
• Is point X efficient? Is point Y efficient?
Efficient Production
• Thus, we could say that points ON the PPF are
characterized by
• 1) full utilization of the factors of production
• 2) factors are being used efficiently
• A violation of either of these 2 properties will
result in a combination that lies INSIDE of the
PPF.
Economic Growth
Shifting of the PPF
Cars
How can we get to point Z from a production standpoint?
Z
Y
X
0
SUVs
Economic Growth
• Recall, economic growth - this can be shown by
an outward shift of the PPF
2 key factors of economic growth 1) Technical Progress
2) Capital accumulation
**Capital goods vs. consumption goods trade-off
• What would a shift inward of the PPF represent???
• What might cause this??
Multiple Plant Production
• Suppose the firm producing cars/SUVs has another
plant(plant B). It employs the same amount of resources as
does the first plant (plant A we talked about earlier) and
follows this production schedule:
CARS
0
25
50
25
100
SUVs
100
75
50
75
0
Which plant has the lowest cost of producing (additional) SUVs?
Of producing (additional) cars?
From plant A:
• Opportunity cost of SUV: 2 cars
• Opportunity cost of car: 1/2 SUV
In plant B:
• Opportunity cost of SUV: 1 car
• Opportunity cost of car: 1 SUV
Thus, lowest cost of SUV ------ PLANT B
Lowest cost of car------- PLANT A
If I want to produce 125 SUVs, which plant should produce
how much??? What if I want to produce 125 cars???
Comparative Advantage
• This difference in costs leads to the notion
of comparative advantage
Definition:
A person has a comparative advantage in an activity if she can
perform that activity for a lower cost than any other person.
This applies to nations, firms, economies, etc. and the activity
is usually production.
Thus, in our case, Plant_____has a comparative advantage in the
production of cars and Plant ____ has a comparative advantage in the
production of SUVs.
Comp Adv. And Specialization
• If production is efficient, then comparative
advantage leads to specialization in production
Examples:
Adam Smith’s pin factory
Assembly-line at auto plant
Nations: Nepal vs. United States
• Specialization leads to greater quantities produced
• Specialization can be seen in the PPF as well.