Production possibilities
Assumptions
1. All resources are fixed in quantity
2. All resources are fully employed
3. Existing technology is fixed.
4. You have a choice of 2 goods to produce
Production possibilities
Table
Pizzas (10,000)
Road Pavers
Opportunity Costs?
A to B?
B to C?
C to D?
D to E?
0
10
1
9
2
7
+ Pizza ___ , - Pavers ___
+ Pizza ___ , - Pavers ___
+ Pizza ___ , - Pavers ___
+ Pizza ___ , - Pavers ___
3
4
4
0
Production possibilities
10
9
Result of combination:
A- Future Growth
A
D
7
Capital good
Road Pavers
Curve (or Frontier)
0
B
C
4
B-
Less Growth
C-
Unemployment
D- Use up resources
1
2
3
Pizzas
Consumer good
4
Production Possibilities Curve
for Susan’s grades in English and Economics (10 hrs of study)
• Susan has 10 hours of
study to divide between
Economics and English.
• If she spends most of her
time studying economics,
she can earn an A in
economics … and a D in
English.
• If she splits her time
between the two, she can
earn a B in Economics
… and a B in English.
• If she spends most of her
time studying English, she
can earn a D in Economics
… and an A in English.
Expected
grade in
Economics 101
Production Possibilities
Curve ( PPC )
A
B
C
D
F
Expected
grade in
English 101
F
D
C
B
A
• Mapping out all the possibilities of
how Susan can divide her time
(limited resources) between these
activities shows us her Production
Possibilities Curve ( PPC ).
Production Possibilities Curve
for a nation’s economy (given limited resources)
• An economy with limited resources
has to divide production between
clothing and food.
• If it allocates all of its resources
toward the production of clothing,
then it can produce at point S.
• If the it allocates all of its resources
toward the production of food, then
it can produce at point T.
• Mapping out all the possibilities of
gives us the economy’s
Production Possibilities Curve.
• Output combinations A, B, & C are
all on the PPC and are, therefore,
efficient allocations of resources.
Only clothing
is produced
Production Possibilities
Curve ( PPC )
Output
of clothing
S
A
D
- Inefficiency -
B
All output
combinations
on the frontier
curve are
efficient.
C
Only food
is produced
T
• D is within the PPC and represents
an inefficient resource allocation.
Combination B delivers more food
with the same output of clothing.
Output
of food
Investment and Production
Possibilities in the Future
Investment
goods
• The long-term benefits of
investment goods now include
greater output in the future.
The decisions we make today
regarding how much to save
(investment) and consume
determine the shape of the
PPC 10 years from now.
• If we choose to produce a
mixture of consumption and
investment goods which
corresponds to bundle A …
then the future PPC might
move out to PPC 2010 with A
– due to the new buildings,
equipment, training, and
other forms of investment
goods that IA represents.
PPC 2010 with A
PPC 2000
IA
A
CA
Consumption
goods
Investment and Production
Possibilities in the Future
Investment
goods
PPC 2010 with A
PPC 2000
• If we choose to produce a
mixture of consumption and
investment goods which
corresponds to bundle B,
with fewer consumption
goods (CB < CA) and more
investment (IB > IA) …
then the future PPC might
move out to PPC 2010 with B
instead.
• The level of investment
(savings) in an economy is
only one determinant of
the movement outward (or
inward) of the production
possibilities curve.
PPC 2010 with B
IB
IA
B
A
CB CA
Consumption
goods
Shifting the Production
Possibilities Curve Outward
• An increase in the economy’s resource base
would expand our ability to produce goods and
services. (More workers, ores...)
• Advancements in technology can expand the
economy’s production possibilities.
• An improvement in the rules (laws,
institutions, and policies) of the economy can
increase output. (Oil drilling, logging)
• By working harder and giving up current
leisure, we could increase our production
of goods and services. (Longer work week)
• This requires us to give up something else we
value: leisure.
1.
Point
a.
b.
c.
d.
A is
unattainable.
inefficient.
efficient.
preferable
to point B.
2.
Which of the following is true?
a.
If the economy operates at point A, it is impossible to
produce more of both food and clothing.
b.
If the economy operates at point B, it is impossible to
increase the output of clothing without giving up food production.
c.
If the economy operates at point A, resources are being
used efficiently.
d.
If the economy operates at point B, resources are being
used inefficiently.
1. Comparative Advantage
The joint output of trading partners will
be greatest when each good is produced
by the low opportunity cost producer.
• Trading partners can gain by specializing
in the production of goods they can
produce at a relatively low cost and
trade for goods they could only produce
at a relatively high cost.
• It applies across individuals, firms,
regions and countries.
Areca
Guns
12
8
4
0
Butter
0
2
4
6
Bonsai
Guns
16
12
8
4
0
Butter
0
1
2
3
4
Bonsai
Areca
Guns
12
8
4
0
Butter
0
2
4
6
Guns
16
12
8
4
0
Butter
0
1
2
3
4
Production Possibilities - Mexico
Product
A
B
C
D
E
Avocados
0
20
24
40
60
Soybeans
15
10
9
5
0
Production Possibilities - US
Product
A
B
C
D
E
Avocados
0
30
33
60
90
Soybeans
30
20
19
10
0
1 S = __ A
1 A = __ S
1 S = __ A
1 A = __ S
Absolute advantage? US should produce?
Mexico should produce?
Terms of Trade? ___ A for ___ S
1. Which of the following sayings best reflects the concept of
opportunity cost?
a.“You can’t teach an old dog new tricks.”
b.“Time is money.”
c. “I have a baker’s dozen.”
d.“There’s no business like show business.”
2. The primary benefit that results when a nation employs its resources
in accordance with the principle of comparative advantage is
a. an expansion in investment resulting from a reallocation of resources
away from consumption.
b. a larger output resulting from a more efficient use of resources.
c. greater equality of income resulting from an increase in the number
of workers.
d. an increase in the profitability of business enterprises resulting from
an increase in investment.
3. If a firm or a nation desires to maximize its output, each
productive assignment should be carried out by those persons
who
a. have the highest opportunity cost.
b.
b. have a comparative advantage in the productive activity.
c. can complete the productive activity most rapidly.
d. least enjoy performing the productive activity.
Payments $$
Product/Goods and Services Markets
Businesses
Households
Factor/Resource Markets
Resources
Circular Flow Markets
1. Resource Market:
a. Business firms demand resources
b. Households supply labor and other resources
c. in exchange for income.
2. Goods and Services Market:
a. Businesses supply goods & services
b. Receive sales revenue.
c. Households, investors, governments, and
foreigners (net exports) demand goods.
Which
one?
a. A real flow through a product market?
b. A money flow through a product market?
c. A real flow through a resource market?
d. A money flow through a resource market?
1. Receiving a paycheck at the end of each month?
2. Delivering a specially ordered car to a buyer?
3. Receiving patient care in a hospital?
4. Using a credit card to buy a meal in a
restaurant?
5. Earning profit at your summer ice cream stand?
6. Obtaining college credits?
7. Working overtime?
a
d
b
c
Goods and Services Markets
Business
Taxes
Payments
Goods and
Services
Payments
and Legal
Resource Markets
Income
Taxes
Goods and
Services
Resources
Businesses
Goods and
Services
Payments $$
Resources
Households
Another
Circular
Flow
The Circular Flow Diagram
• Four key markets coordinate the
circular flow of income.
•1. the resource market coordinates
demand for factors of production
between businesses and households.
2. The goods & services market
coordinates the demand for output
between businesses and households.
3. The loanable funds market
directs household and foreign
investments to business and
government borrowers .
4. The foreign exchange market
coordinates demand for currencies
for export/import transactions
Another
Circular
Flow
1) BMW recently decided to build a manufacturing plant in Shenyang, China. At this
plant, BMW is able to take advantage of paying lower wages to its Chinese workers than
it pays its German workers, but it also sacrifices the high levels of technical training
possessed by its German workers. In deciding to open the Shenyang plant, BMW
A) faced no trade-offs because employing lower-wage workers increased efficiency.
B) faced a trade-off between higher cost and lower precision.
C) adopted a negative technological change because it replaced high-skilled workers with
low-skilled workers.
D) eroded some of its competitiveness in the luxury car market because of its decreased
cost of production.
2) The principle of opportunity cost is that
A) in a market economy, taking advantage of profitable opportunities involves some
money cost.
B) the economic cost of using a factor of production is the alternative use of that
factor that is given up.
C) taking advantage of investment opportunities involves costs.
D) the cost of production varies depending on the opportunity for technological
application.
3) The attainable production points on a production possibility curve are
A) the horizontal and vertical intercepts.
B) the points along the production possibilities frontier.
C) the points outside the area enclosed by the production possibilities frontier.
D) the points along and inside the production possibility frontier.
4)
A)
B)
C)
D)
Point A is
technically efficient.
unattainable with current resources.
inefficient in that not all resources are being used.
the equilibrium output combination.
5) This figure shows the production
possibilities frontier for Mendonca, an
agrarian nation that produces two goods,
meat and vegetables. What is the
opportunity cost of one pound of
vegetables?
A) ¾ pound of meat
B) 1.2 pounds of meat
C) 1 1/3 pounds of meat
D) 12 pounds of meat
6) An outward shift of a nation's production possibilities curve represents
A) economic growth.
B) rising prices of the two goods on the production possibilities frontier.
C) an impossible situation.
D) where a country produces more of one good and less of another.
Serena
Haley
Bracelets
8
9
Necklaces
16
12
7) The table shows the output per week of two jewelers, Serena and
Haley. They can either devote their time to making bracelets or
making necklaces. Which of the following statements is true?
A) Haley has a comparative advantage in making both products.
B) Serena has a comparative advantage in making both products.
C) Haley has a comparative advantage in making bracelets and Serena
in making necklaces.
D) Haley has a comparative advantage in making necklaces and Serena
in making bracelets.
8) Specializing in the production of a good or service in which one has
a comparative advantage enables a country to do all of the following
except
A) engage in mutually beneficial trade with other nations.
B) increase the variety of products that it can consume with no
increase in resources.
C) consume a combination of goods that lies outside its own production
possibilities frontier.
D) produce a combination of goods that lies outside its own production
possibilities frontier.
9)
A)
B)
C)
D)
An example of a factor of production is
stock issued by Dell.
the computers exported by Dell.
a computer produced by Dell.
a worker hired by Dell.
10) Which of the following statements about an entrepreneur is false?
A) organizes the other factors of production into a working unit
B) develops the vision for the firm and funds the producing unit
C) sells his entrepreneurial services in the output market
D) risks the personal funds provided
11) Households
A) have no influence on the circular flow in a market economy.
B) purchase resources in the factor market.
C) sell goods in the product market.
D) sell resources in the factor market.