bah - macroprinciples 02 opportunity costs and the ppc

8/13/2019 Bah - MacroPrinciples 02 Opportunity Costs and the PPC

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Opportunity Costs and the PPCOpportunity Costs and the PPC

ECN 211ECN 211

Fall, 2007Fall, 2007

ELEL--HADJ BAHHADJ BAH

Chapter 2Chapter 2

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Cost of attending collegeCost of attending college

Question:

Af ter you at tend col lege fo r 1 year,youll get $20,000.

College tuition cost $5000/year

Will you attend college?

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Opportunity CostOpportunity Cost

Opportunity cost: the value of thehighest-valued alternative that mustbe forgone when a choice is made.

Forgone alternative: giving up oneactivity (or good) in order to dosomething else.

Highest valued alternative: the bestalternative possible.

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ExamplesExamples

Opportunity cost of being in class.

Opportunity cost building the lightrail Phoenix-Mesa..

Opportuni ty cost of a tax cut..

Opportunity cost of going to themovies.


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Example: Opportunity cost ofExample: Opportunity cost of

going to collegegoing to college Benefit of g oing t o college $20,000 per year

College tuitio n cos t $5000/year

Work ful l tim e and earn $25,000/year

Opportunity cost of attending college =../year

Do you attend coll ege ?

Work part-time and during the summer and earn$10,000/year

Opportunity cost of attending college =../year

Do you attend coll ege ?

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Test questionTest question

You can consume either 2 apples, 3oranges or 1 candy bar.

Whats the opportunity cost of thecandy bar?

Whats the opportunity cost of 1apple?.

Whats the opportunity cost of 1orange?

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TradeoffsTradeoffs

A tradeoffmeans giving up one goodor activity in order to get some othergood or activity.

Every time you make a decision, youhave to make a tradeoff.

Whats the dif ference betweentradeoff and opportunity cost?

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Production Possibilities CurveProduction Possibilities Curve

The production possibilities cu rve(PPC) shows the maximum quantityof goods and services that can beproduced using the limited resourcesto the fullest extent possible.


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ProductionProduction

PossibilitiesPossibilities

Underutilized

(Inefficient)

Nondefense Goods

B1

F1C1

D1

Only nondefensegoods produced

E1

Only defensegoods produced

A1

EfficientCombinations

Defense Goods

Impossible

200

175

150

125

100

75

0

7525 50

G1

100 125

75200G1

25130F1

1600E1

15070D1

125130C1

75175B1

0200A1

Non-defenseDefense

15010

Points inside the PPCPoints inside the PPC

A point ly ing ins ide the PPCindicates resources are not beingefficiently or fully used.

It is possible to move from a pointinside the PPC to the frontier byeither using more resources or byusing the same resources efficiently.

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Shifts of the PPCShifts of the PPC

The PPC can move outward as the result of: Increased resources

Larger labor force

Change in labor force participation

Change in labor-leisure decision

Improved technology (innovation)

Expansion of capital stock

An improvement in the rules (laws, institutions,and policies) of the economy

The PPC can also move inward. Why?

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A Shift of the PPCA Shift of the PPC

Nondefense Goods

B1

C1

D1

E1

A1Defense Goods 200

175

150

125

100

75

07525 50

B2

100 125 150

225 A2

C2

D2

E2

F2

1650F2

16070E2

150130D2

120175C2

75200B2

0225A2

Non-defenseDefense


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Marginal Opportunity CostMarginal Opportunity Cost

Marginal benefits and costs: the benefitsand (opportunity) costs associated withone additional unit of the good.

The marginal opportunity cost is theamount of one good or service that mustbe given up to obtain one additional unitof another good or service.

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Marginal Opportunity costMarginal Opportunity cost

15075G

1750H

125125F

100155E

75175D

50188C

25195B

0200A

NondefenseGoods

MC(defensegoods forgoneper 25 units ofnondefensegoods

DefenseGoods

Combination

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Marginal CostsMarginal Costs

To increase its production of

nondefense goods, society is

must give up ever-increasing

amounts of defense goods.

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Opportunity cost and the PPCOpportunity cost and the PPC

The shape of the PPC illustratesthe relative cost of movingproductive resources from oneactivity to another.

The PPC bows outward becausethere are ever-increasing marginalopportunity costs to the

production of any good.


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Decision MakingDecision Making

Principle: Decision making is done atthe margin.

Decision makers evaluate a fixed arrayof alternatives.

Decision makers compare the marginalcosts to marginal benefits to determinethe best alternative.

This is economic decision making.

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SpecializationSpecialization

Economic agents (individuals, firms, nations)will be better off if they choose to producethose things for w hich they have the lowestopportunity costs, and trade for those withhigher costs.

This is called specialization .

We say that the agent specializes in a specificactivity because the agent enjoys a comparativeadvantage in it.

Agents do this because such cho ices involvegiving up the least amount of other things.

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Specialization & TradeSpecialization & Trade

Comparative Advantage: the abilityto produce a good or service at alower opportunity cost than someoneelse.

Law of comparative advantage: proposition that the joint output of trading

partners will be greatest when each good isproduced by the low opportunity costproducer.

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Benefits of TradeBenefits of Trade

500

1000

5 10

500

1000

5 10

Trade Gain

Trade Gain

Health

Care

Food Food

Health

Care100100

53007500

050001000

FoodHealth

Care

FoodHealth

Care

HaitiDominicanRepublic


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Example 1Example 1

246Ohio

9612Iowa

ChiliesCookies

Output per Hour

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Example 1Example 1

Opportunity costs of Chili in Ohio and Iowa:

Cookies in Ohio and Iowa:

Who has comparative and advantageand who specialize in: Cookies

Chili

Prices

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Example 2Example 2

15002000F

1202016040E

904012080D

606080120C

308040160B

01000200A

FoodCarsFoodCars

Country YCountry Xchoice

Production possibilities

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Example 2Example 2

Opportunity costs

Marginal Opportunity costs

Comparative advantage andspecialization

Gains from trade

Prices


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Private Property RightsPrivate Property Rights

The rights of ownership

Laws, courts and police to ensureownership

Necessary for t rade

Private property rights that countsnot public property rights.

bah - macroprinciples 02 opportunity costs and the ppc

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