production possibilities when faced with scarcity of resources, decisions have to be made about how...
TRANSCRIPT
When faced with SCARCITY of resources, decisions have to
be made about how to use those resources
Trade-offs
Opportunity Costs
Trade-Offs
• This is the decision making process that is occurring in your mind right now!
• Am I going to pay attention to what Mr. Hayward is saying, or am I going to daydream?
• Am I going to come to class or go buy a lottery ticket? • Am I going to stay in school or go find a full time job?• Each and every decision you make has a cost!! Not
necessarily a cost in dollar terms, but a cost in that you must give up something in order to get more of something else.
Opportunity Cost
• The “price you pay” for each decision you make is called the OPPORTUNITY COST.
• Opportunity cost is vital to the understanding of economics.
• “The amount of a product or service that must be forgone (given up) in order to obtain more of the next best alternative product or service”
Production Possibilities Frontier
• Used to illustrate:– Productive Capacity– Opportunity Costs– Efficiency
• Productive • Allocative
– Economic Growth/Decline– Vital Link to Aggregate Supply (short/long run)
Wheat
Rice
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Production Possibilities FrontierIncreasing Opportunity Costs
Wheat Rice
NOTE: The GAIN in Rice isCONSTANT while the LOSSIn Wheat is INCREASING each Time…What is going on???
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Production Possibilities FrontierIncreasing Opportunity Costs
• The type of land resource suitable for growing Wheat is DIFFERENT than the land resource for growing Rice.
• If a society wants MORE Rice, then as you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy) it will become MORE costly to do that, in terms of Wheat production
• We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat
Production Possibilities Frontier
• Economy’s produce MORE that just Wheat and Rice.
• We produce LOTS of goods of many different types.
• We can broadly categorize goods into TWO categories– Capital Goods and Consumer Goods
The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production
Possibilities Curve
The PPC shows the relationship between two goods:
1. Capital Goods (Investment Goods) Goods that satisfy our wants
INDIRECTLY and promote future growth or “happiness” – Delayed gratification.
2. Consumer GoodsGoods that satisfy our wants DIRECTLY. Instant Gratification
Lesson 1 Act 1
Capital Goods
Consumer Goods
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Capital Goods “Stuff you use to make other Stuff” Tools, equipment, factories, other infrastructure
Consumer Goods“Stuff” for immediate Consumption. Food, consumerElectronics, etc.
Allocative EfficiencyWhere a society decides to Produce on its PPF. A value Decision based on values/politics
Productive EfficiencyFull-employment of resources And producing at the lowest cost
.A
.B.C
.D
.E
Production Possibilities Frontier
Production Possibilities Curve (Frontier)
• The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.
• At Point “A” the economy gives up 10 capital goods in order to get 400 consumer goods.
• 400 Consumer goods = 10 Capital goods• 1 Consumer good = 10 Capital goods/400• 1 Consumer good = .025 Capital good
Consumer Goods
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Production Possibilities Curve (Frontier)
• The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.
• At Point “B” the economy gives up 10 Capital goods in order to get 200 more Consumer goods.
• 200 Consumer goods = 10 Capital goods
• 1 Consumer good = 10 Capital goods/200
• 1 Consumer good = .05 Capital good Consumer Goods
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Production Possibilities Curve (Frontier)
• The bowed nature of the PPC is due to INCREASING OPPORTUNITY COSTS
• Not all resources are adaptable to alternative uses.
• Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa)
• Marsh land suitable for growing rice could not easily be converted for use as a an airport. It would be much more costly than using farmland in Kansas.
Consumer Goods
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Production Possibilities Curve (Frontier)
• Lets take a closer look at the PPC.
• What do the different points on the PPC represent?
Consumer Goods
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Production Possibilities Curve (Frontier)
• Each point represents Productive Efficiency
• This means that this economy is allocating ALL of it productive resources in the least costly way
Consumer Goods
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Production Possibilities Curve (Frontier)
• There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency– This represents the
combination of Capital and Consumer Goods most desired by the society
Consumer Goods
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Production Possibilities Curve (Frontier)
• The WHOLE PPC represents
• “FULL PRODUCTION”– Productive Efficiency– Full-Employment of
Resources
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
No! Often they operate inside their production possibilities
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
Point “E” represents a point inside the PPC.
Notice that this point “E” represents a lower bundle of Capital and Consumer Goods
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
Point “E” represents a point inside the PPC.
The area between point “E” and the PPC represents underutilization of resources or under-employment of resources or unemployment. The economy is being inefficient.
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
Point “E” represents a point inside the PPC.
This economy could be doing better…
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
How about point “F”?
Point F is outside our PPC
It represents a combination of Capital and Consumer Goods that is currently not possible with this economies resources
Consumer Goods
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Production Possibilities Curve (Frontier)
Do economy’s always produce on the PPC?
How about point “F”?
Point F is outside our PPC
This point is desirable (more “stuff”) but currently not attainable.
Consumer Goods
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Capital Goods
Consumer Goods
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Capital Goods “Stuff you use to make other Stuff” Tools, equipment, factories, other infrastructure
Consumer Goods“Stuff” for immediate Consumption. Food, consumerElectronics, etc.
Allocative EfficiencyWhere a society decides to Produce on its PPF. A value Decision based on values/politics
Productive EfficiencyFull-employment of resources And producing at the lowest cost
.A
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Production Possibilities Frontier
Production Possibilities CurveThe PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully
employed (used) with the best technology currently available
Robotics(Capital Good)
Compact Discs (Consumer Good)
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How do we get to point G??1. Technological advancement which increases Productivity2. Discover new resources3. Take resources (War)4. Trade for Resources
D
“OUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT”
CAN YOU THINK OF AN EXAMPLE IN HISTORY WHEN WE WERE INSIDE THE PPC?
Production Possibilities CurveThe PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully
employed (used) with the best technology currently available
Robotics(Capital Good)
Compact Discs (Consumer Good)
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F
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How do we get to point G??1. Technological advancement which increases Productivity2. Discover new resources3. Take resources (War)4. Trade for Resources
D
“OUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT”
CAN YOU THINK OF AN EXAMPLE IN HISTORY WHEN WE WERE INSIDE THE PPC?
PPossibilitiesossibilities-A, B, C, D, & E-A, B, C, D, & E
ImpossibilityImpossibility[more/better resources, better technology]
Economic resources are not completely adaptable to alternative uses.The “curve”“curve” indicates a “changing trade-off.”“changing trade-off.”Obtaining more of one goodmore of one good requires giving upgiving up larger amounts of the alternative goodlarger amounts of the alternative good..
So, How Is So, How Is Economic GrowthEconomic Growth Demonstrated Demonstrated on aon a PPC Graph? PPC Graph?
Economic GrowthEconomic Growth
e
[Ability to produce a larger[Ability to produce a largertotal output over time]total output over time]
Cap
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Two Examples of Economic GrowthTwo Examples of Economic Growth
FAVORING PRESENT GOODSFAVORING PRESENT GOODS
Goods for the Present
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CONSUMPTIONCONSUMPTION
PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES
Two Examples of Economic GrowthTwo Examples of Economic Growth
FAVORING PRESENT GOODSFAVORING PRESENT GOODS
Goods for the Present
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CONSUMPTIONCONSUMPTION
PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES
Two Examples of Economic GrowthTwo Examples of Economic Growth
FAVORINGFAVORINGPRESENT GOODSPRESENT GOODS
FAVORINGFAVORINGFUTURE GOODSFUTURE GOODS
Goods for the Present
Go
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FUTUREFUTURECURVECURVE
CONSUMPTION
Goods for the Present
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PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES
Going to War (U.S.)Going to War (U.S.) When the U.S. entered WWI, we had severe unemployment. We were able to step up production of consumer goods and war materials simply by getting to full production. We went from 14.6% unemployment in 1940 to 1.2% in 1944. Over 7 million people went to work that were not working in 1940.
Going to War(Russia)Going to War(Russia). Russia, on the other hand, entered WWII at full capacity. So their preparedness entailed a shifting of resources from civilian goods and a drop in their standard of living.
The U.S. position was similar as we entered the Viet Nam War at full employment.We increased both military spending and domestic spending on the “War on Poverty.” Our attempt to achieve more “guns and butter” in a FE economy was doomed. We were trying to spend beyond capacity and ended up with double digit inflation in the 1970s.
Civilian GoodsCivilian Goods
FF
CC United StatesUnited States[Beginning of WWII][Beginning of WWII]
War GoodsWar Goods
Civilian GoodsCivilian Goods
War GoodsWar GoodsDD
CC RussiaRussia[Beginning of WWII][Beginning of WWII]