Lecture Introduction to economics: Social issues and economic thinking: Chapter 2 - Wendy A. Stock

Introduction to
Economics:
Social Issues and
Economic
Thinking
Wendy A. Stock

Chapter 2

production possibilities
Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: Pedro Portal/©AP/Wide World Photos

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Prepared by
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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.

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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.

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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.

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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.

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A hypothetic example

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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.

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Some important economic relationships
implied in PPF
Ø

Scarcity and Tradeoffs

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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

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Some important economic relationships
implied in PPF
Ø

Economic Growth: the ability to produce goods has
increased. (caused by increased resources)

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Some important economic relationships
implied in PPF
Ø

Economic Growth: the ability to produce goods has
increased. (caused by technological change)

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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.

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Increasing Costs and Specialized Resources

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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.

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Absolute & comparative advantage

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comparative advantage
Ø

For Dan:

The opportunity cost of producing 1 pint of yogurt is
5 bagels per day: 1Y=5B
The opportunity cost of producing 1 bagel is 1/5 pint
of yogurt: 1B = 1/5Y
Ø

For Betty:

The opportunity cost of producing 1 pint of yogurt is
3 bagels per day: 1Y=3B
The opportunity cost of producing 1 bagel is 1/3 pint
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© 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 1 bagel (0.2Y)
is lower than Betty ’s (0.33Y), Dan has
comparative advantage relative to Betty in
producing bagels.

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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.
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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.

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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.

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three basic economic questions
The three basic economic questions regarding
resource allocation are:
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What to produce?

Ø

How to produce it?

Ø

For whom to produce?

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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.

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Key Concepts
•

Production possibilities model

•

Production possibilities frontier

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Attainable choices

•

Unattainable choices

•

Efficient choices

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Inefficient choices

•

Slope of the PPF

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Absolute advantage

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Comparative advantage

•

Normative economics

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© 2013 John Wiley
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