3 QUESTIONS AND TRADEOFFS

Circular Flow Model, Production Possibility Frontiers

The 3 questions

People seek to answer 3 questions when producing… What do we produce? How do we produce? For whom do we produce?

WHAT and How

Land Labor Capital Entrepreneurship

What: Goods and Services

How: Factors of Production

WHAT? Top Services and Goods

For Whom?

Land rent Labor wages Capital interest Entrepreneurship

profit/loss

FOPs are paid income.Functional distribution of income

Personal Distribution of Income

The Circular Flow Model

A model of the economy that shows: the circular flow of expenditures and

incomes that result from decision makers’ choices and

the way those choices interact in markets to determine what, how, and for whom goods and services are produced.

Households and Firms

Households Individuals or people living together as

decision-making units.

Firms Institutions that organize production of

goods and services.

Markets

Markets A market is any arrangement that brings

buyers and sellers together and enables them to get information and do business with each other.

Factor markets are markets in which factors of production are bought and sold.

Goods markets are markets in which goods and services are bought and sold.

Real Flows

In factor markets:• Households supply factors of

production

• Firms hire factors of production.

• Firms supply goods and services produced.

• Households buy goods and services.

In goods markets:

Money FLOWS

Firms pay households incomes for the services of factors of production.

Money Flows

• Households pay firms for the goods and services they buy.

What are the possible decisions a firm can make?

PRODUCTION POSSIBILITIES

Production Possibilities Frontier A curve showing the combinations between

two goods that can be produced using all available resources.

Figure 3.1 shows thePPF for bottled water and CDs.

Each point on the graph represents a column of the table.

The line through the points is the PPF.

PRODUCTION POSSIBILITIES

The PPF separates attainable combinations from unattainable combinations.

Points outside the PPF such as point G are unattainable.

We can produce at any point inside the PPF or on the frontier.

PRODUCTION POSSIBILITIES

1. When production is on the PPF, such as at point E or D, production is efficient.

2. If production were inside the PPF, such as at point H, more could be produced of both goods without forgoing either good. Production is inefficient.

PRODUCTION POSSIBILITIES

Moving from E to F, 1 bottle of water costs 5 CDs.

OPPORTUNITY COST

How do you shift the curve?

Improvements in productivity New technology Novel techniques

An increase in the factors of production An increase in the workforce Rise in the amount of capital

“Shift it to the right productivity or novelty,

Shift it to the left inefficiency”

Draw the following situation… Costa Rica can produce bananas and

coffee. During the last month, the country has made technological advances that led to a new, efficient method of planting crops. Draw and explain the impact of this advancement on both bananas and coffees.