Chapter 2 - Production possibilities. After studying this chapter, you should be able to: Explain the importance of models in economics, describe the production possibilities model, illustrate the use of the production possibilities model, calculate opportunity costs of production,...
Introduction to Economics: Social Issues and Economic Thinking Wendy A Stock Chapter production possibilities Copyright © 2013 John Wiley & Sons, Inc / Photo Credit: Pedro Portal/©AP/Wide World Photos PowerPoint Prepared by Z Pan After studying this chapter, you should be able to: Ø Ø Ø Ø Ø Explain the importance of models in economics Ø Describe the production possibilities model Illustrate the use of the production possibilities model Ø Apply the concept of comparative advantage to demonstrate the benefits of specialization and trade Discuss the difference between positive and normative economics Calculate opportunity costs of production Define the concept of comparative advantage Copyright © 2013 John Wiley & Sons, Inc MODELS IN ECONOMICS Ø Ø Models are used in economics and most other sciences to represent reality Like a map, a Model is a simplification that captures the most important features of something but does not include each and every detail Copyright © 2013 John Wiley PRODUCTION POSSIBILITIES MODEL Ø Production Possibilities Model Combinations of goods or services that can be produced by an individual, a group, or an entire economy given the resources available and the state of technology Copyright © 2013 John Wiley Production possibility frontier Ø Production Possibilities Frontier (PPF) maximum amount of output that can be produced with a given set of resources and technology, ceteris paribus Copyright © 2013 John Wiley A hypothetic example Copyright © 2013 John Wiley What’s in a PPF? Ø The production possibilities model shows some important relationships that represent the choices facing an individual, a firm or an entire economy Copyright © 2013 John Wiley Some important economic relationships implied in PPF Ø Scarcity and Tradeoffs Ø Attainable and Unattainable Choices Ø q Points on or inside the PPF are attainable q Points outside the PPF are unattainable Efficiency and Inefficiency Combinations of output that lie on the PPF represent efficient choices q Combinations of output that lie inside the PPF represent inefficient choices q Copyright © 2013 John Wiley Some important economic relationships implied in PPF Ø Economic Growth: the ability to produce goods has increased (caused by increased resources) Copyright © 2013 John Wiley Some important economic relationships implied in PPF Ø Economic Growth: the ability to produce goods has increased (caused by technological change) Copyright © 2013 John Wiley 10 Some important economic relationships implied in PPF Ø Opportunity Cost The slope of the PPF equals the opportunity cost of producing one more unit of the good measured on the X-axis Copyright © 2013 John Wiley 11 Increasing Costs and Specialized Resources Copyright © 2013 John Wiley 12 Absolute & comparative advantage Ø Ø Absolute Advantage: the ability to produce something with fewer resources or to produce more with the same resources as another producer Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than another producer Copyright © 2013 John Wiley 13 Absolute & comparative advantage Copyright © 2013 John Wiley 14 comparative advantage Ø For Dan: The opportunity cost of producing pint of yogurt is bagels per day: 1Y=5B The opportunity cost of producing bagel is 1/5 pint of yogurt: 1B = 1/5Y Ø For Betty: The opportunity cost of producing pint of yogurt is bagels per day: 1Y=3B The opportunity cost of producing bagel is 1/3 pint 15 Copyright © 20131B John= Wiley of yogurt: 1/3Y Gains from specialization & trade Ø Ø Because Betty can produce yogurt at a lower opportunity cost (3B) than Dan(5B), she has comparative advantage relative to him in producing yogurt Because Dan ’s cost of producing bagel (0.2Y) is lower than Betty ’s (0.33Y), Dan has comparative advantage relative to Betty in producing bagels Copyright © 2013 John Wiley 16 Gains from specialization & trade Ø Ø Ø Dan will specialize in producing bagels, he will produce 300 bagels and no yogurt Betty will specialize in producing yogurt She will produce 40 pints of yogurt and no bagels The mutually beneficial terms of trade is 3B < 1Y < 5B Assuming: 1Y = 4B e.g Dan trades 100 bagels to Betty at this price, he will receive 25 pints of yogurt in return Copyright © 2013 John Wiley 17 Gains from specialization & trade Assuming: 1Y = 4B Dan trades 100 bagels to Betty at this price, he will receive 25 pints of yogurt in return Copyright © 2013 John Wiley 18 Positive vs normative economics Ø Ø Normative Economics deals with value judgments and decisions regarding how things should be Positive Economics is more objective and provides descriptions of how things are Copyright © 2013 John Wiley 19 three basic economic questions The three basic economic questions regarding resource allocation are: Ø What to produce? Ø How to produce it? Ø For whom to produce? Copyright © 2013 John Wiley 20 Questions/Discussions Which of the following is true of production possibility frontiers (PPFs)? A B C D The slope of the PPF reflects the opportunity costs of producing different combinations of two goods Combinations of goods can be produced inside or outside the PPF, ceteris paribus Points inside the PPF boundary are attainable and efficient Only points along the frontier line are attainable and efficient Copyright © 2013 John Wiley 21 Key Concepts • Production possibilities model • Production possibilities frontier • Attainable choices • Unattainable choices • Efficient choices • Inefficient choices • Slope of the PPF • Absolute advantage • Comparative advantage ã Normative economics Copyright â 2013 John Wiley ã 22 ... concept of comparative advantage Copyright © 20 13 John Wiley & Sons, Inc MODELS IN ECONOMICS Ø Ø Models are used in economics and most other sciences to represent reality Like a map, a Model is... important economic relationships implied in PPF Ø Economic Growth: the ability to produce goods has increased (caused by increased resources) Copyright © 20 13 John Wiley Some important economic. .. X-axis Copyright © 20 13 John Wiley 11 Increasing Costs and Specialized Resources Copyright © 20 13 John Wiley 12 Absolute & comparative advantage Ø Ø Absolute Advantage: the ability to produce something