3'1 PRODUCTION POSSIBILITIES

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3.1 PRODUCTION POSSIBILITIES

• Production Possibilities Frontier
• Production possibilities frontier
• The boundary between the combinations of goods
  and services that can be produced and the
  combinations that cannot be produced, given the
  available factors of production and the state of
  technology.
• The PPF is a valuable tool for illustrating the
  effects of scarcity and its consequences.

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3.1 PRODUCTION POSSIBILITIES

• The PPF puts three features of production
  possibilities in sharp focus
• Attainable and unattainable combinations
• Full employment and unemployment
• Tradeoffs and free lunches

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3.1 PRODUCTION POSSIBILITIES

• Attainable and Unattainable Combinations
• Because the PPF shows the limits to production,
  it separates attainable combinations from
  unattainable ones.
• Figure 3.2 on the next slide illustrates the
  attainable and unattainable combinations.

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3.1 PRODUCTION POSSIBILITIES

• Full Employment and Unemployment
• Full employment occurs when all the available
  factors of production are being used.
• Unemployment occurs when some factors of
  production are not used.
• Figure 3.3 on the next slide illustrates full
  employment and unemployment.

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3.1 PRODUCTION POSSIBILITIES

• Tradeoffs and Free Lunches
• Tradeoff
• A constraint or limit to what is possible that
  forces an exchange or a substitution of one thing
  for something else.
• To emphasize that every choice involves a cost,
  economists say, There is no such thing as a free
  lunch.
• But there would be a free lunchsomething for
  nothingif we were not at a point on the PPF.

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3.2 OPPORTUNITY COST

• The Opportunity Cost of a Bottle of Water
• The opportunity cost of a bottle of water is the
  decrease in the quantity of CDs divided by the
  increase in the number of bottles of water as we
  move along the PPF
• Figure 3.5 illustrates the calculation of the
  opportunity cost of a bottle of water.

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3.2 OPPORTUNITY COST
Moving from A to B, 1 bottle of water costs 1 CD.
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3.2 OPPORTUNITY COST
Moving from B to C, 1 bottle of water costs 2 CDs.
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3.2 OPPORTUNITY COST
Moving from C to D, 1 bottle of water costs 3 CDs.
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3.2 OPPORTUNITY COST
Moving from D to E, 1 bottle of water costs 4 CDs.
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3.2 OPPORTUNITY COST
Moving from E to F, 1 bottle of water costs 5 CDs.
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3.2 OPPORTUNITY COST

• The Opportunity Cost of a CD
• The opportunity cost of a CD is the decrease in
  the quantity of bottles of water divided by the
  increase in the quantity of CDs as we move along
  the PPF.
• Figure 3.6 illustrates the calculation of the
  opportunity cost of a CD.

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3.2 OPPORTUNITY COST
Moving from F to E, the 1 CD costs 1/5 of a
bottle of water.
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3.2 OPPORTUNITY COST
Moving from E to D, the 1 CD costs 1/4 of a
bottle of water.
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3.2 OPPORTUNITY COST

• Opportunity Cost Is a Ratio
• The opportunity cost of a bottle of water is the
  quantity of CDs forgone divided by the increase
  in the quantity of water.
• The opportunity cost of a CD is the quantity of
  bottled water forgone divided by the increase in
  the quantity of CDs.
• When the opportunity cost of a bottle of water is
  x CDs, the opportunity cost of a CD is 1/x
  bottles of water.

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3.2 OPPORTUNITY COST

• Increasing Opportunity Cost
• The opportunity cost of a bottle of water
  increases as the quantity of bottled water
  produced increases.
• The opportunity cost of a CD increases as the
  quantity of CDs produced increases.
• The shape of the PPF is bowed outward because
  opportunity cost increase.

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3.2 OPPORTUNITY COST

• Increasing Opportunity Costs Are Everywhere
• Just about every activity that you can think of
  is one with an increasing opportunity cost.

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3.3 SPECIALIZATION AND EXCHANGE

• Comparative Advantage
• Comparative advantage
• The ability of a person to perform an activity or
  produce a good or service at a lower opportunity
  cost than someone else.
• Both Tom and Nancy produce bottles and water, but
  their opportunity costs differ.

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3.3 SPECIALIZATION AND EXCHANGE

• Achieving the Gains from Trade
• By specializing and trading with each other
• Tom doubles his production from 1,000 to 2,000
  bottles of water an hour.
• Nancy doubles her production from 1,000 to 2,000
  bottles of water an hour.
• Each gains 1,000 bottles of water as a result of
  the specialization and exchange.
• Both consume outside their PPFs.

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3.3 SPECIALIZATION AND EXCHANGE

• Absolute Advantage
• Absolute advantage
• When one person is more productive than another
  person in several or even all activities.
• Gain from specialization and trade are determines
  by comparative advantage, not absolute advantage.
• Comparative advantage results from opportunity
  costs that diverge.
• So when opportunity costs diverge, gains from
  specialization and trade are always available.

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3.4 EXPANDING PRODUCTION POSSIBILITIES

• During the past 30 years, production
  possibilities per person in the United States
  have doubled.
• Such a sustained expansion of production
  possibilities is called economic growth.
• Can economic growth enable us to overcome
  scarcity and avoid opportunity cost?
• It cannot.
• The faster we make our production possibilities
  expand, the greater is the opportunity cost of
  economic growth.

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3.4 EXPANDING PRODUCTION POSSIBILITIES

• The key factors that influence economic growth
  are
• Technological change
• Expansion of human capital
• Capital accumulation
• Technological change is the development of new
  goods and services and better methods of
  production.
• Expansion of human capital comes from education
  and on-the-job training.
• Capital accumulation is the increase in capital
  resources.

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3.4 EXPANDING PRODUCTION POSSIBILITIES

• Economic Growth in an Industry
• Instead of studying the PPF of bottled water and
  CDs, well hold the quantity of CDs produced
  constant and study the PPF for bottled water and
  water-bottling plants.
• The amount by which our production possibilities
  expands depends on the resources we devote to
  building new bottling plants and training people
  to operate them.

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