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Unit 1: Basic Economic Concepts

Production Possibilities Curve

&

Absolute and Comparative Advantage

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Society has unlimited wants but limited resources

The Problem of…

Scarcity

WE HAVE A CONCERN!!

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The Production Possibilities Curve (PPC)

Using Economic Models…

Step 1: Explain concept in words

Step 2: Use numbers as examples

Step 3: Generate graphs from numbers

Step 4: Make generalizations using graph

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What is the Production Possibilities Curve?

A production possibilities graph (PPG) is a model that shows alternative ways that an economy/entity can use its scarce resources to produce goods and services.
This model graphically demonstrates scarcity, opportunity cost, efficiency and inefficiency.
A combination of goods being produced.

4 Key Assumptions

Only two goods can be produced
Full employment of resources available
Fixed Resources (Ceteris Paribus)
Fixed Technology (Ceteris Paribus)

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Opportunity Cost

The opportunity cost is the most desirable alternative being given up when making a decision.

It can measure what an economy/entity will give up to produce a certain quantity of goods.

Ex. If you are accepted into 5 colleges, you will pick one and it may not be necessarily the one that you really wanted to go to for various reason. The college that you did not choose is your Opportunity Cost.

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Bikes

Computers

NOW GRAPH IT: Put bikes on y-axis and computers on x-axis

Production “Possibilities” Table

Each point represents a specific combination of goods that can be produced given full employment of resources.

a

b

c

d

e

14

12

9

5

0

2

4

6

8

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Bikes

Computers

14

12

10

8

6

4

2

0

0 2 4 6 8 10

A

B

C

D

E

G

Inefficient/ Unemployment

Impossible/Unattainable

(given current resources)

Efficient

Production Possibilities

How does the PPG graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency?

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2 Bikes

2.The opportunity cost of moving from b to d is…

4.The opportunity cost of moving from f to c is…

3.The opportunity cost of moving from d to b is…

7 Bikes

4 Computers

0 Computers

5.What can you say about point G?

Unattainable

1. The opportunity cost of moving from a to b is…

Example:

Opportunity Cost

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The Production Possibilities Curve (or Frontier)

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PIZZA 0 1 2 3 4

CALZONES 4 3 2 1 0

List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e.
Constant Opportunity Cost- Resources are easily adaptable for producing either good.
Result is a straight line PPC (not common)

Production Possibilities

A B C D E

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PIZZA 20 19 16 10 0

ROBOTS 0 1 2 3 4

List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e.
Increasing Opportunity Cost-

As you produce more of any good, the opportunity cost (forgone production of another good) will increase.
Why? Resources are NOT easily adaptable to producing both goods.

Result is a bowed out (Concave) PPC

A B C D E

Production Possibilities

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Constant vs. Increasing Opportunity Cost

Corn

Wheat

Cactus

Pineapples

Identify which product would have a straight line PPC and which would be bowed out?

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Production Possibilities Curve ……...in 60 seconds

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1 Bike

2.The PER UNIT opportunity cost of moving from b to c is…

4.The PER UNIT opportunity cost of moving from d to e is…

3.The PER UNIT opportunity cost of moving from c to d is…

1.5 (3/2) Bikes

2 Bikes

2.5 (5/2) Bikes

= Opportunity Cost

Units Gained

1. The PER UNIT opportunity cost of moving from a to b is…

Example:

PER UNIT Opportunity Cost

How much each marginal unit costs

NOTICE: Increasing Opportunity Costs

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Shifting the Production Possibilities Curve

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4 Key Assumptions Revisited

Only two goods can be produced
Full employment of resources
Fixed Resources
Fixed Technology

What if there is a change?

3 Shifters of the PPC

1. Change in resource quantity or quality

2. Change in Technology

3. Change in Trade

Production Possibilities

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Robots

Pizzas

What happens if there is an increase in population?

Production Possibilities

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Robots

Pizzas

What happens if there is an increase in population?

Production Possibilities

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Robots

Pizzas

What if there is a technology improvement in pizza ovens

Production Possibilities

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Robots

Pizzas

What if there is a technology improvement in pizza ovens

Production Possibilities

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Canada – Favors Consumer Goods

Cuba – Favors Capital Goods

Consumer goods

Capital Goods

Current

PPC

Future

PPC

Consumer goods

Capital Goods

Future

PPC

Current

PPC

Capital Goods and Future Growth

Cuba

Canada

Countries that produce more capital goods will have more growth in the future.

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PPC Practice

Draw a PPC showing changes for each of the following:

Pizza and Robots (3)

1. New robot making technology

2. Decrease in the demand for pizza

3. Mad cow disease kills 85% of cows

Consumer goods and Capital Goods (4)

4. BP Oil Spill in the Gulf

5. Faster computer hardware

6. Many workers unemployed

7. Significant increases in education

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New robot making technology

Q

Robots

Pizzas

Question #1

A shift only for Robots

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Decrease in the demand for pizza

Q

Robots

Pizzas

Question #2

The curve doesn’t shift!

A change in demand doesn’t shift the curve

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Mad cow disease kills 85% of cows

Q

Robots

Pizzas

Question #3

A shift inward only for Pizza

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BP Oil Spill in the Gulf

Q

Capital Goods (Guns)

Consumer Goods (Butter)

Question #4

Decrease in resources decrease production possibilities for both

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Faster computer hardware

Q

Capital Goods (Guns)

Consumer Goods (Butter)

Question #5

Quality of a resource improves shifting the curve outward

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Many workers unemployed

Q

Capital Goods (Guns)

Consumer Goods (Butter)

Question #6

The curve doesn’t shift!

Unemployment is just a point inside the curve

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Significant increases in education

Q

Capital Goods (Guns)

Consumer Goods (Butter)

Question #7

The quality of labor is improved. Curve shifts outward.

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Best Buy, Walmart, Lowes

Nike, Apple, GE

You and me

Land, Labor, Capital

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Trade

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What is �Absolute Advantage?

A country’s ability to produce more goods using fewer resources than the country with which it trades

*

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What is �Comparative Advantage?

A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.

*

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INPUT

Example, 2 people, 2 jobs, time required

*

Job A (cars) Job B (bikes)

Judy

Sam

60 min.

75 min

90 min

150 min

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In the table, Judy has absolute advantag at both tasks, but what is her comparative advantage?

What is Sam’s comparative advantage?

*

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Judy’s comparative advantage is at job B, and Sam’s comparative advantage is at job A

To see why, Sam gives up ⅗ the time of Job B when he performs Job A. Judy on the other hand gives up ⅘ the time of Job B when performing Job A.

So Sam’s comparative advantage is less than Judy’s for the same job, so Judy should perform Job B

*

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OUTPUT

Example, 2 people, 2 jobs, items produced

*

Job A (cars) Job B (bikes)

Judy

Sam

6

12

15

9

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In the table, Judy has absolute advantag at Job B, and Sam has absolute Advantage at Job A, but what is her comparative advantage?

What is Sam’s comparative advantage?

*

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Judy’s comparative advantage is at job B (bikes), and Sam’s comparative advantage is at job A (cars)

To see why, look at the ratios in the table- Judy would either give up ½ car or 2 bikes. so she’s better off producing bikes. Sam would either give up 1⅔ car or ⅗ bike, so he should produce cars.

*

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Theory of comparative advantage

Argues that output is greater when resources tend to specialize in their greatest comparative advantages

*