PRODUCTION,
GROWTH & TRADE 1
CHAPTER
Objectives
After studying this chapter, you will be able to:
▪ Define the production possibilities frontier and calculate
opportunity cost
▪ Distinguish between production possibilities and
preferences and describe an efficient allocation of
resources
▪ Explain how current production choices expand future
production possibilities
▪ Explain how specialization and trade expand our
production possibilities
▪ Explain why property rights and markets have evolved
Production Possibilities and Opportunity
Cost
The production possibilities frontier (PPF) is the
boundary between those combinations of goods and
services that can be produced and those that cannot.
To illustrate the PPF, we focus on two goods at a time and
hold the quantities of all other goods and services
constant.
That is, we look at a model economy in which everything
remains the same (ceteris paribus) except the two goods
we’re considering.
Production Possibilities and Opportunity
Cost
Production Possibilities
in millions
Frontier
CD Pizza
Table 2.1 shows the PPF
A 15 0
schedule for CDs and
pizza, which stand for any B 14 1
pair of goods and C 12 2
services. D 9 3
E 5 4
f 0 5
Production Possibilities and Opportunity
Cost
Production Possibilities
Frontier
Figure shows the PPF
diagram for CDs and
pizza, which stand for any
pair of goods and
services.
Production Possibilities and Opportunity
Cost
Points inside and on the
frontier, such as points A,
B, C, D, E, F, and Z are
attainable.
Points outside the frontier
are unattainable.
Production Possibilities and Opportunity
Cost
Production Efficiency
We achieve production
efficiency if we cannot
produce more of one good
without producing less of
some other good.
Points on the frontier are
efficient.
Production Possibilities and Opportunity
Cost
Any point inside the
frontier, such as point Z, is
inefficient.
At such a point it is
possible to produce more
of one good without
producing less of the other
good.
At Z, resources are either
unemployed or
misallocated.
Production Possibilities and Opportunity
Cost
Tradeoff Along the PPF
Every choice along the
PPF involves a tradeoff.
On this PPF, we must give
up some CDs to get more
pizza or give up some
pizza to get more CDs.
Production Possibilities and Opportunity
Cost
Opportunity Cost
The PPF makes the
concept of opportunity
cost precise.
If we move along the PPF
from C to D the
opportunity cost of the
increase in pizza is the
decrease in CDs.
Production Possibilities and Opportunity
Cost
A move from C to D,
increases pizza production
by 1 million.
CD production decreases
from 12 million to 9 million,
a decrease of 3 million.
The opportunity cost of 1
million pizza is 3 million
CDs.
One pizza costs 3 CDs.
Production Possibilities and Opportunity
Cost
A move from D to C,
increases CDs production
by 3 million.
Pizza production
decreases by 1 million.
The opportunity cost of 3
million CDs is 1 million
pizza.
One CD costs 1/3 of a
pizza.
Production Possibilities and Opportunity
Cost
Note that the opportunity
cost of CDs is the inverse
of the opportunity cost of
pizza.
One pizza costs 3 CDs.
One CD costs 1/3 of a
pizza.
Production Possibilities and Opportunity
Cost
Because resources are
not all equally productive
in all activities, the PPF
bows outward—is convex.
The outward bow of the
PPF means that as the
quantity produced of each
good increases, so does
its opportunity cost.
Economic Growth
The expansion of production possibilities—and increase in
the standard of living—is called economic growth.
Two key factors influence economic growth:
▪ Technological change
▪ Capital accumulation
Technological change is the development of new goods
and of better ways of producing goods and services.
Capital accumulation is the growth of capital resources,
which includes human capital.
Economic Growth
Figure illustrates the
tradeoff we face.
We can produce pizza or
pizza ovens along PPF0.
By using some resources
to produce pizza ovens,
the PPF shifts outward in
the future.
The Market Economy
Trade is organized using two key social institutions:
▪ Property rights
▪ Markets
Property Rights
Property rights are the social arrangements that govern
ownership, use, and disposal of resources, goods or
services.
Markets
A market is any arrangement that enables buyers and
sellers to get information and do business with each other.
The Market Economy
Circular Flows in the Market Economy
A circular flow diagram, like Figure, illustrates how
households and firms interact in the market economy.
The Market Economy
Goods and
services and
factors of
production flow
in one
direction.
And money
flows in the
opposite
direction.
THE END
