2 1 The Production Possibilities Curve and Economic

2 -1 The Production Possibilities Curve and Economic Reasoning The choices made by society are often presented in terms of a production possibility curve. u The production possibilities curve shows the trade-offs among choices we make. u © 2003 Mc. Graw-Hill Ryerson Limited

2 -2 The Production Possibility Table u A production possibility table lists the maximum

2 -3 The Production Possibility Curve A production possibility curve plots the maximum combination of outputs that can be achieved from a given number of inputs. u It slopes downward from left to right. u © 2003 Mc. Graw-Hill Ryerson Limited

2 -4 The Production Possibility Curve u The production possibility curve not only demonstrates

2 -5 The Production Possibility Curve u The production possibility curve demonstrates that: l There is a limit to what you can achieve, given the existing institutions, resources, and technology. l Every choice made has an opportunity cost —you can get more of something only by giving up something else. © 2003 Mc. Graw-Hill Ryerson Limited

2 -6 The Production Possibility Curve Fig. 2 -1 (a and b), p 33 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 Grade in history 98 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 64 62 60 58 Hours of study in economics 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Grade in economics 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 100 20 hours of economics 0 hours of history 100 A Economics grade Hours of study in history 88 B C 70 46 40 58 66 D 20 hours of history 0 hours of economics E 78 94 98 History grade © 2003 Mc. Graw-Hill Ryerson Limited

2 -7 Increasing Marginal Opportunity Cost u The production possibility curve is generally bowed outward since some resources are better suited for the production of some goods. © 2003 Mc. Graw-Hill Ryerson Limited

2 -8 Increasing Marginal Opportunity Cost u The concept of comparative advantage explains why opportunity costs increase as the consumption of a good increases. l Some resources are better suited for the production of some goods than to the production of other goods. © 2003 Mc. Graw-Hill Ryerson Limited

2 -9 Increasing Marginal Opportunity Cost, p 33 Y 10 9 8 7 6 5 4 3 2 1 0 If the slope of the production curve is -2 at A, the A opportunity cost of 1 X is 2 Y. 1 X 1 2 3 4 5 6 7 8 9 X © 2003 Mc. Graw-Hill Ryerson Limited

2 - 10 Increasing Marginal Opportunity Cost The principle of increasing opportunity cost states that opportunity costs increase the more you concentrate on an activity. u In order to get more of something, one must give up ever-increasing quantities of something else. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 11 A Production Possibility Table, Fig. 2 -2 a, p 34 % of resources devoted to production Number of burgers of DVDs Row of burgers of DVDs 0 20 40 60 80 100 0 4 7 9 11 12 100 80 60 40 20 0 15 14 12 9 5 0 A B C D E F © 2003 Mc. Graw-Hill Ryerson Limited

2 - 12 A Production Possibility Curve, Fig. 2 -2 b, p 34 DVDs

2 - 13 Increasing Marginal Opportunity Cost, p 35 Slope is flat at A. Low opportunity cost of burgers. DVDs A B Slope is steep at B. High opportunity cost of burgers. Burgers © 2003 Mc. Graw-Hill Ryerson Limited

2 - 14 Efficiency u In our production, we would like to have productive

2 - 15 Efficiency u Any point within the production possibility curve represents inefficiency —getting less output from inputs which, if devoted to some other activity, would produce more output. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 16 Efficiency u Any point outside the production possibility curve represents something

2 - 17 Efficiency and Inefficiency, Fig. 2 -3 a, p 36 Unattainable point, given available technology, resources and labor force 10 DVDs 8 6 C Efficient points B 4 2 0 Inefficient point 2 4 D A 6 Burgers 8 10 © 2003 Mc. Graw-Hill Ryerson Limited

2 - 18 Shifts in the Production Possibility Curve u Society can produce more output if: l Technology is improved. l More resources are discovered. l Economic institutions get better at fulfilling our wants. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 19 Shifts in the Production Possibility Curve u An outward shift in the production possibility curve indicates more output that can be produced with given inputs. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 20 Shifts in the Production Possibility Curve, Fig. 2 -3 b, p

2 - 21 Shifts in the Production Possibility Curve, Fig. 2 -3 c, p

2 - 22 Distribution and Production Efficiency The production possibilities curve focuses on productive efficiency and ignores distribution. u An increase in output that goes to one person and not to anyone else would not necessarily be efficient in some societies. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 23 Distribution and Production Efficiency u Economists often talk about efficiency as if it means productive efficiency and achieving society's goals. u In our society, more is generally preferred to less and many policies have relatively small distributional effects. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 24 Examples of Shifts in the Production Possibility Curve If more inputs are available for the production of X and Y equally, the PPC shifts out along both X and Y axes. u If fewer inputs are available for the production of X and Y equally, the PPC shifts in along both X and Y axes. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 25 Examples of Shifts in the Production Possibility Curve If more inputs are available for good X only, the PPC shifts out on the X axis only. u If more inputs are available for good Y only, the PPC shifts out on the Y axis only. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 26 Examples of Shifts in the Production Possibility Curve Fig. 2 -4,

2 - 27 Comparative Advantage, Specialization, and Trade u The production possibility curve becomes bowed out when individuals specialize in the production of goods for which they have a comparative advantage and trade with others. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 28 Comparative Advantage, Specialization, and Trade u The comparative advantage argument used to explain the bowed-out shape of the production possibilities curve can be used to show trade makes society better off. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 29 Comparative Advantage, Specialization, and Trade Collaboration and specialization can make society

2 - 30 Comparative Advantage, Specialization, and Trade u The outward bow graphically represents

2 - 31 The Gains From Trade Sunder can either write one economics paper or four creative writing papers in a day. u Ti can either write one creative writing paper or four economics papers in a day. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 32 The Gains From Trade u Sunder has a comparative advantage in

2 - 33 The Gains From Trade u The following table and production possibility curves demonstrate how output increases when two individuals collaborate and specialize in the activity for which each has a comparative advantage. © 2003 Mc. Graw-Hill Ryerson Limited

2 - 34 The Gains From Trade, Fig. 2 -6 a, p 41 ©

2 - 35 The Gains From Trade, Fig. 2 -6 b, p 41 ©

2 - 36 The Gains From Trade u Each individual's PPC is drawn by

2 - 37 The Gains From Trade, Fig. 2 -6 c, p 41 Economics

2 - 38 The Gains From Trade u The combined PPC curve is drawn

2 - 39 The Gains From Trade, Fig. 2 -6 c, p 41 Economics

2 - 40 The Gains From Trade Point A: This is the combined number of economics papers they both can write in a day. u If economics papers are on the Y axis, it is point 0, 5. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 41 The Gains From Trade Point B: This is the combined number of creative papers they both can write in a day. u If economics papers are on the Y axis, it is point 5, 0. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 42 The Gains From Trade Point C: This is where each is focusing on that activity for which he or she has a comparative advantage. u Sunder writes four creative papers and Ti writes four economics papers. u This is the coordinates 4, 4. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 43 The Gains From Trade u The combined PPC is bowed out

2 - 44 The Division of Labor Markets allow specialization and the division of labor. u They allow individuals to develop their comparative advantages, thereby increasing the production possibilities of society. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 45 Markets, Specialization, and Growth u Markets and specialization have led to

2 - 46 Markets, Specialization, and Growth The growth in per capita income (constant 1990 dollars) in the past 2 millennia has been astonishing. u This owes largely to the introduction of markets and democracy. u © 2003 Mc. Graw-Hill Ryerson Limited

2 - 47 Markets, Specialization, and Growth u As people are allowed to compete and specialize, they get better at what they do, develop new technologies and the market grows ever larger. © 2003 Mc. Graw-Hill Ryerson Limited

col 17930_0207. eps 2 - 48 Per capita income (in 1990 international dollars) Growth in the Past Two Millennia Fig. 2 -7, p 42 $6, 000 $5, 000 $4, 000 $3, 000 $2, 000 $1, 000 0 500 1000 1500 2000 © 2003 Mc. Graw-Hill Ryerson Limited