chapter two choice, opportunity costs and specialization
TRANSCRIPT
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Chapter Two
Choice,
Opportunity Costs and Specialization
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Introduction
• An economic system has to solve three coordination problems:– What, and how much, to produce.– How to produce it.– For whom to produce it.
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Introduction
• All economic knowledge can be boiled down to a single phrase:
There ain’t no such thing as a free lunch.
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Introduction
• Every decision has an opportunity cost – the cost in foregone opportunities.
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Opportunity Cost• Opportunity cost: the value of the
highest-valued alternative that must be forgone when a choice is made. It is the evaluation of a trade-off.
• Marginal benefits and costs: the benefits and opportunity costs associated with one additional unit of the good.
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Introduction
• A production possibility curve is used to illustrate opportunity cost.
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The Production Possibilities Model
• The production possibilities curve shows the trade-offs among choices we make.
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The Production Possibility Table
• A production possibility table lists a choice's opportunity costs by summarizing what alternative outputs you can achieve with your inputs.
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The Production Possibility Table
• Output – an output is simply a result of an activity.
• Input – an input is what you what you put into a production process to achieve an output.
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The Production Possibility Curve for an Individual
• A production possibility curve measures the maximum combination of outputs that can be achieved from a given number of inputs.
• It slopes downward from left to right.
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The Production Possibility Curve for an Individual
• The production possibility curve not only represents the opportunity cost concept, it also measures the opportunity cost.
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The Production Possibility Curve for an Individual
• The production possibility curve demonstrates that:
– There is a limit to what you can achieve, given the existing institutions, resources, and technology.
– Every choice made has an opportunity cost—you can get more of something only by giving up something else.
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A Production Possibility Curve for a Society
• The production possibility curve is generally bowed outward.– Some resources are better suited for the
production of some goods than others.
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A Production Possibility Curve for a Society
Y
1098
6543210
.2Y
1X
A
X1 2 3 4 5 6 7 8 9
If the slope of the production curve is -2 at A, the
opportunity cost of 1X is 2Y.
7
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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A Production Possibility Curve for a Society
• Comparative advantage explains why opportunity costs increase as the consumption of a good increases.– Some resources are better suited for the
production of some goods than to the production of other goods.
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A Production Possibilities Table and Curve
% of resources devoted toproduction of guns
Number of guns
% of resources devoted toproduction of butter
Pounds of butter Row
0 20 40 60 80
100
0 4 7 9 11 12
100 80 60 40 20 0
15 14 12 9 5 0
A B C D E F
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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1211
A Production Possibilities Table and Curve
AB
utte
r
Guns4 7 90
1 gun
5 pounds of butter
5
9
15
3 guns
2 pounds of butter
B
C
D
E
F
14
12
4 guns
1 pound of butter
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Marginal Opportunity Cost • The Production Possibilities Curve (PPC)
illustrates the concept of opportunity cost. Each point on the PPC means that every other point is a forgone opportunity.
• The PPC bows outward because there are ever-increasing marginal opportunity costs to the production of any good.
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Increasing Marginal Opportunity Cost
• The principle of increasing marginal opportunity cost states that opportunity costs increase the more you concentrate on an activity.
• In order to get more of something, one must give up ever-increasing quantities of something else.
This principle is discussed but Not Named in the Boyes Text
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Increasing Marginal Opportunity Cost
But
ter
Slope is flat at A. Low opportunity cost of
guns.
Slope is steep at B. High opportunity cost of guns.
Guns
B
A
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Specialization• Economic agents (individuals, firms, nations)
will be better off if they choose to produce those things for which they have the lowest opportunity costs, and trade for those with higher costs.
• Agents do this because such choices involve giving up the least amount of other things.
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Specialization & Trade• Comparative Advantage: the ability to
produce a good or service at a lower opportunity cost than someone else.
• Law of comparative advantage: – proposition that the joint output of trading
partners will be greatest when each good is produced by the low opportunity cost producer.
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Efficiency
• In production, we’d like to have productive efficiency – achieving as much output as possible from a given amount of inputs or resources.
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Efficiency
• Efficiency involves achieving a goal as cheaply as possible.
• Efficiency has meaning only in relation to a specified goal.
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Efficiency
• Any point within the production possibility curve represents inefficiency.
• Inefficiency – getting less output from inputs which, if devoted to some other activity, would produce more output.
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Efficiency
• Any point outside the production possibility curve represents something unattainable, given present resources and technology.
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Efficiency and InefficiencyG
uns
10
8
6
4
2
0 2 4 6 8 10
Butter
C D
A
B
Efficientpoints
Inefficientpoint
Unattainable point, given available technology, resources and labor force
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Production Possibilities Curve• The production possibilities curve shows
the maximum quantity of goods and services that can be produced when the existing resources are used fully and efficiently.
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Production Possibilities
Underutilized(Inefficient)
Nondefense Goods
B1
F1
C1
D1
Only nondefense goods produced
E1
Only defensegoods produced
A1
Efficient Combinations
Defense Goods
Impossible
200
175
150
125
100
75
07525 50
G1
100 125
Defense Non-defense
A1 200 0
B1 175 75
C1 130 125
D1 70 150
E1 0 160
F1 130 25
G1 200 75
150
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Shifts in the Production Possibility Curve
• Society can produce more output if:– Technology is improved.– More resources are discovered.– Economic institutions get better at fulfilling our
wants.
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Growth• The PPC moves outward (growth occurs)
as the result of:– Increased resources
• Larger labor force• Change in labor force participation• Chance in labor-leisure decision
– Improved technology (innovation)– Expansion of capital stock– An improvement in the rules (laws, institutions,
and policies) of the economy
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A 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
Defense Non-defense
A2 225 0
B2 200 75
C2 175 120
D2 130 150
E2 70 160
F2 0 165
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Shifts in the Production Possibility Curve
• More output is represented by an outward shift in the production possibility curve.
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Neutral Technological Change
Butter
A
B Guns0
Shifts in the Production Possibility Curve
C
D
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Biased Technological Change
Shifts in the Production Possibility Curve
0
B
A
Butter
Guns
C
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Distribution and Production Efficiency
• The production possibilities curve focuses on productive efficiency and ignores distribution.
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Distribution and Production Efficiency
• In our society, more is generally preferred to less and many policies have relatively small distributional effects.
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(a) (c) (d)(b)
Examples of Shifts in the Production Possibility Curve
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Finagle A Bagel
SpecializationSpecialization