Lecture 2 - PPF Production Possibility Curve PDF

Lecture II. Production Possibility Curves – Opportunity Costs and Efficiency I. Production Possibility Frontiers A. Defining the PPF Production: combining resources (inputs) to produce commodities (output). Production Possibility Frontier (PPF) – a graph that shows th...

Lecture II. Production Possibility Curves – Opportunity Costs and Efficiency I. Production Possibility Frontiers A. Defining the PPF Production: combining resources (inputs) to produce commodities (output). Production Possibility Frontier (PPF) – a graph that shows the combinations of two commodities that can be produced given a fixed level of technology and resources being used efficiently at a fixed pointing time. 1. Why would a business or economy operate WITHIN its frontier rather than ON the frontier? 2. How does an economy get the maximum output? 3. Why does an economy make choices? 4. Can an economy get beyond the frontier? 5. How does an economy expand the frontier? DRAW A PPF efficient – get as much output from as few inputs as possible (productive efficiency) B. Opportunity Costs -- A constant slope PPF implies constant opportunity costs -- A changing slope implies changing (nonconstant) opportunity costs The law of increasing marginal opportunity costs – as an economy produces more of a good, the opportunity cost of an additional unit, expressed in terms of other goods sacrificed, will increase WHY? All resources are not equally efficient or suitable for producing all outputs. Some resources are better suited to make some goods and other resources are not. Example: Robinson Crusoe lives alone on an island He has some resources at his disposal: Land: Some of the land is rocky and better suited for raising sheep. Other parts of the land are better suited for growing wheat Sheep: up to 10 hours a day of light for working Robinson – produces cloth and he grows wheat to produce bread. Possibility Bread Cloth (Loaves per Month) (Yards per Month) A 20 0 B 18 1 C 15 2 D 11 3 E 6 4 F 0 5 II. Economic Growth The PPF is not static – it is constantly changing and it can shift inward and outward implying a reduction or an increase in our production possibilities 1. Natural and unnatural occurrences – drought, plague, war Both X and Y are affected Y PPF0 to PPF2 – a positive shock PPF0 to PPF1 – a negative shock PPF1 0 2 X Only Y is affected Y PPF0 PPF1 X 2. Capital Accumulation – using time and resources to build tools, acquire an education, building a factory, doing R & D to find a new invention takes resources away from current production (opp. cost of economic growth), but significantly increases production possibilities in the future Economic growth is Growth in Productivity Y PPF0 before investment PPF1 during investment PPF2 after investment PPF1 0 2 X Does economic growth eliminate scarcity? No – economic growth has an opp. cost in forgone production 3. Technological progress or innovation  Discovering new technologies better ways of doing things, more efficient, allows us to get more out of a given amount of resources Not usually in a negative direction except on the planet of the apes 4. Give up leisure time III. Specialization and Exchange A. History and Perspective Self-sufficient – produces all that one needs to survive, does not depend on anyone else Division of labor: breaking a task into smaller parts for greater overall production GAINS FROM TRADE What things did people specialize in? Initially people traded what they produced. If you needed to see the doctor, you might pay for those services with a chicken. What is the direct exchange of goods and services called? BARTER Are there any drawbacks of a barter economy? Mutual Coincidence of Wants If you are a farmer and you produce wheat and you want to buy candles, you must find a candle maker who needs wheat. What happened to remedy this barter economy dilemma? Mediums of Exchange Precious Metal Money Pelts Currency This made it much easier to specialize and exchange so that we may enjoy the gains from trade. B. Comparative and Absolute Advantage Comparative Adv. – if you have the lowest opp. cost of producing something Absolute Adv. – if you have a productive advantage at producing all goods Law of comparative advantage – we can gain by producing goods for which we have the lowest opp. costs and then trading