Chapter 2 PRODUCTION POSSIBILITIES AND OPPORTUNITY COSTS Gottheil — Principles of Economics, 7e ©...

Chapter 2Chapter 2

PRODUCTION PRODUCTION POSSIBILITIES AND POSSIBILITIES AND OPPORTUNITY COSTSOPPORTUNITY COSTS

Gottheil — Principles of Economics, 7e© 2013 Cengage Learning1

Economic PrinciplesEconomic Principles

© 2013 Cengage Learning Gottheil — Principles of Economics, 7e2

Factors of production

Production possibilities

Opportunity cost

The law of increasing costs

Economic PrinciplesEconomic Principles


Technological change and economic growth

Division of labor and specialization

Absolute and comparative advantage

Factors of ProductionFactors of Production


Factors of production

• Any resource used in a production process.



These resources include:

• Labor• Land• Capital• Entrepreneurship



Labor

• Labor is the physical and intellectual effort of people engaged in producing goods and services.



Land

• Land is a natural-state resource such as real estate, grasses and forests, and metals and minerals.



Capital

• Capital includes the manufactured goods used to make and market other goods and services.



Human capital

• Human capital is the knowledge and skills acquired by labor, principally through education and training.



Entrepreneurship

• Entrepreneurship describes the people who alone assume the risks and uncertainties of a business.

Production PossibilitiesProduction Possibilities


Production possibilities

• The various combinations of goods that can be produced in an economy when it uses its available resources and technology efficiently.


EXHIBIT 1 PRODUCTION POSSIBILITIES FRONTIER


Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier

1. What do points A, B, C, and D represent in Exhibit 1?

• They represent four consumption and capital goods possibilities when resources are used efficiently.



2. What does the curve that passes through points A, B, C, and D represent?

• The curve represents all of the possible combinations of consumption goods and capital goods.



3. Why does the curve have a balloon-like shape?

• The law of increasing costs accounts for the balloon-like shape of the production possibilities curve.



4. If a production possibilities frontier was a downward-sloping straight line, would the law of increasing costs still hold?

• No.



5. What would cause a production possibilities frontier to be a downward-sloping straight line?

• Resources are not specialized.



1. Is an economy operating on its production possibilities frontier if there is a high rate of unemployment?

• No. In this case the economy is operating inside its production possibilities frontier.



2. How can an economy produce a combination of goods outside its production possibilities frontier?

• If more resources become available, or if existing resources become more productive.


Evaluating Production Evaluating Production PossibilitiesPossibilities

1. Two things to keep in mind when evaluating production possibilities:

• Opportunity cost

• The law of increasing costs



Opportunity cost

• The quantity of other goods that must be given up to obtain a good.



Opportunity cost is typically subjective. One must rely on calculating expected gains and expected opportunity costs of choices made.



Law of increasing costs

• The opportunity of producing a good increases as more of the good is produced.



The law of increasing costs is based on two facts:• Not all resources are suited to the

production of all goods.

• The order of use of a resource in producing a good goes from the most productive resource unit to the least.



Relationship between opportunity cost and law of increasing costs:A) The opportunity cost of producing a good

increases as more of a good is produced.

B) The negative slope of the production possibilities curve illustrates the fact that any increase in capital goods production must come at the cost of consumption goods production.

EXHIBIT 2 SHIFTS IN THE PRODUCTION POSSIBILITIES FRONTIER


Exhibit 2: Shifts in the Production Exhibit 2: Shifts in the Production Possibilities FrontierPossibilities Frontier


1. What will cause the production possibilities frontier to shift to the right?

• Investing in capital today expands the resource base of later periods, therefore allowing more capital and consumption goods in the future.


EXHIBIT 3 COMPARATIVE ECONOMIC GROWTH

Exhibit 3: Comparative Exhibit 3: Comparative Economic GrowthEconomic Growth


1. If an economy chooses to produce at point C, why does the production possibilities curve shift to the right?

A) The economy produced a mixture of consumption and capital goods.



1. If an economy chooses to produce at point C, why does the production possibilities curve shift to the right?

B) Therefore, capital goods have been added to the resource base for future production.



2. If an economy chooses to produce at point A on the Production Possibilities Curve, how will its economy compare to the first economy?

• Over time, the production gap between the two economies will widen.

Productive Power of Advanced Productive Power of Advanced TechnologyTechnology


Innovation

• Innovation is an idea that eventually takes the form of new, applied technology.


EXHIBIT 4 PRODUCTION POSSIBILITIES GENERATED BY SPEAR AND NET TECHNOLOGIES

Exhibit 4: Production Possibilities Exhibit 4: Production Possibilities Generated by Spear and Net Generated by Spear and Net

TechnologiesTechnologies


A) The “new” technology of the fishing net uses a different combination of land and labor.

1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?




1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?

B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.




2. Relationship between technology and economic growth:

A) Innovation makes the creation of even more advanced technology possible.

B) Innovation expands the growth potential of our economy.


EXHIBIT 5 INWARD AND OUTWARD SHIFTS OF THE PRODUCTION POSSIBILITIES CURVE

Exhibit 5: Inward and Outward Shifts Exhibit 5: Inward and Outward Shifts of the Production Possibilities Curveof the Production Possibilities Curve


1. What could cause the production possibilities curve to shift inward in Exhibit 5?

• The destruction of capital goods and the disruption of people’s lives can cause the production possibilities curve to shift inward.



2. After shifting inward, what can explain the curve’s shift back to its original position and beyond?

• While capital goods can be destroyed, ideas are far more durable.



• Resources can be rebuilt and advanced technologies can be applied to recoup or even surpass the economy’s levels of production previously attained.

2. After shifting inward, what can explain the curve’s shift back to its original position and beyond?


EXHIBIT A National Security, Conventional War and Terrorism

Exhibit A: National Security, Exhibit A: National Security, Conventional War and TerrorismConventional War and Terrorism


• Yes, as shown in the move from a to b along the production possibilities curve of panel a in Exhibit A.

1. The more national security goods a country, chooses to produce—subject to the law of increasing cost—the more national security it acquires?



• AGG’s national security remains Unchanged. DEF’s response results in both having less of other goods and no increase in national security.

2. panel b depicts an Aggressive nation (AGG) and a Defensive one (DEF). If the AGG nation’s initial move from a to b causes the DEF nation to move from x to y, what happens?



• Yes. Its national security edge increases by a factor of 4. DEF’s response results in both having less of other goods and no increase in national security.

3. In panel c, AGG’s targets DEF’s resource base, destroying its defenses and ability to produce goods. Does AGG’s first strike pay off?



• DEF cannot respond to the terrorism itself, but might to the state supporting it. If it does, AGG’s own national security becomes once again compromised.

4. If AGG chooses to become a terrorist-supporting state, it can remain at a—no notable shift of resources to terrorist-mode security goods—yet force DEF to move from x' to y' or z', or even w', in panel d. Why?

Possibilities, Impossibilities, Possibilities, Impossibilities, and Less than Possibilitiesand Less than Possibilities


Two possible states of an economy

A) Underemployed resources

B) Economic efficiency



Underemployed resources

• The less than full utilization of a resource’s production capabilities.



Economic efficiency

• The maximum possible production of goods and services generated by the fullest employment of the economy’s resources.


EXHIBIT 6 POSSIBLE, IMPOSSIBLE, AND LESS THAN POSSIBLE

Exhibit 6: Possible, Impossible, Exhibit 6: Possible, Impossible, and Less than Possibleand Less than Possible


1. What point in Exhibit 6 reflects underemployed resources?

• Point U reflects underemployed resources. This point, as well as all others inside the curve, describe an economy with inefficient production.

Exhibit 6: Possible, Impossible, Exhibit 6: Possible, Impossible, and Less than Possibleand Less than Possible


2. What point reflects a currently unattainable production possibility?

• Point E and all other points located outside of the production possibilities curve represent impossible production combinations. These points are unattainable with the resources and technology currently available.

Production Possibilities and Production Possibilities and Economic StabilizationEconomic Stabilization


Labor specialization

• The division of labor into specialized activities that allow individuals to be more productive.



Benefits of Specialization:

A) Allows every entity—from individuals to nations—to do what they do best.

B) Leads to greater productivity.



Requirements of Specialization:

A) It requires an exchange system that allows each entity to exchange the goods it produces under specialization



Specialization is attractive because:

A) Those who specialize in what they do best will achieve greater material prosperity.

B) Everyone participating in the system produces more, exchanges more, and consumes more.

Specialization DecisionsSpecialization Decisions


Two types of production advantages:A) Absolute advantage

B) Comparative advantage

Absolute AdvantageAbsolute Advantage


Absolute advantage

• A country’s ability to produce a good using fewer resources than the country with which it trades.

Comparative AdvantageComparative Advantage


Comparative advantage

• A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.


EXHIBIT 7 PRODUCTION OF FISH AND SHIRTS PER EIGHT-HOUR DAY—ABSOLUTE ADVANTAGE

Exhibit 7: Production of FishExhibit 7: Production of Fishand Shirts—Absolute Advantageand Shirts—Absolute Advantage


1. In Exhibit 7, which country has an absolute advantage in producing fish?

• The Yakamaya Island

Exhibit 7: Production of FishExhibit 7: Production of Fishand Shirts—Absolute Advantageand Shirts—Absolute Advantage


2. In Exhibit 7, which country has an absolute advantage in producing shirts?

• The Crusoe Island


EXHIBIT 8 PRODUCTION PER EIGHT-HOUR DAY UNDERCONDITIONS OF FREE TRADE AND SPECIALIATION

Exhibit 8: Production per Eight-Exhibit 8: Production per Eight-Hour Day Under Conditions of Hour Day Under Conditions of Free Trade and SpecializationFree Trade and Specialization


What is the advantage of specialization for the islands?

A) Without specialization, total production on the islands is 5 shirts and 5 fish for an 8-hour workday.

B) If they specialize, total production is 8 shirts and 8 fish.


EXHIBIT 9 PRODUCTION OF FISH AND SHIRTS PER EIGHT-HOUR DAY—COMPARATIVE ADVANTAGE

Exhibit 9: Production of FishExhibit 9: Production of Fishand Shirts—Comparative Advantageand Shirts—Comparative Advantage


1. In Exhibit 9, which country should produce shirts and which country should produce fish?

A) To determine what each country should produce, opportunity costs must be compared.



B) When Crusoe Island produces 8 fish, they give up the opportunity to produce 8 shirts.




C) The opportunity cost of producing a shirt is 1 fish.




D) When Yakamaya Island produces 2 shirts, they give up the opportunity of producing 8 fish.




E) The opportunity cost of producing a shirt is 4 fish.




F) Crusoe Island holds a comparative advantage in shirts, so Yakamaya Island should produce fish.


Comparative Advantage Comparative Advantage Practice ProblemPractice Problem


If Jack can type 4 pages or file 4 legal briefs in a day, while Sara can type 6 pages or file 12 legal briefs in a day, what should Jack and Sara specialize in producing?

Comparative Advantage Practice Comparative Advantage Practice Problem: Breaking it DownProblem: Breaking it Down


1. What are Jack and Sara’s opportunity costs of typing one page?

A) Jack’s opportunity cost of one page of typing is one legal brief.




B) Sara’s opportunity cost of one page of typing is two legal briefs.



C) Jack has the smaller opportunity cost of one page of typing.




2. What are Jack and Sara’s opportunity costs of filing a legal brief?

A) Jack’s opportunity cost of filing a legal brief is one page of typing.



B) Sara’s opportunity cost of filing a legal brief is one-half page of typing.

2. What are Jack and Sara’s opportunity costs of filing a legal brief?



3. So what should Jack and Sara specialize in producing?

A) The Law of Comparative Advantage tells us that Jack should type and Sara should file legal briefs.

Date post:	16-Jan-2016
Category:	Documents
Upload:	veronica-owen
View:	219 times
Download:	0 times

Chapter 2 PRODUCTION POSSIBILITIES AND OPPORTUNITY COSTS Gottheil — Principles of Economics, 7e ©...

Documents