3. CHAPTER. Economic Problem and the PPF. 1. 2. 3. 4. C H E C K L I S T. When you have completed your study of this chapter, you will be able to. Use the production possibilities frontier to illustrate the economic problem. Calculate opportunity cost.
Economic Problem and the PPF
Calculate opportunity cost.
Explain what makes production possibilities expand.
Figure 3.1 shows the
PPF for bottled water and CDs.
The line through the points is the PPF.
Attainable and unattainable combinations
We can produce at any point inside the PPF or on the frontier.
Points outside the PPF such as point G are unattainable.
Efficient and inefficient production
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, production is inefficient.
Tradeoffs and free lunches
3. When production is on the PPF, we face a tradeoff. There’s no free lunch.
4.If production were inside the PPF, there would be a free lunch.
Moving from A to B, 1 bottle of water costs 1 CD.
Moving from B to C, 1 bottle of water costs 2 CDs.
Moving from C to D, 1 bottle of water costs 3 CDs.
Moving from D to E, 1 bottle of water costs 4 CDs.
Moving from E to F, 1 bottle of water costs 5 CDs.
The marginal benefit curve passes through points A, B, C, and D.
The line through points A, B, C, D, and E is the marginal cost curve.
1. Production efficiency occurs at all points on the PPF.
Allocative efficiency occurs at the intersection of the marginal benefit curve (MB) and the marginal cost curve (MC).
Only one point (point B) on the PPF is a point of allocative efficiency.
Figure 3.9 shows how production possibilities expand.
If we produce at point L, we produce water and no bottling plants.
And every year, consumption remains at 5 million bottles of water.
But if we cut production of water to 3 million bottles this year, we can produce 2 bottling plants at point K.
Then next year, our PPF shifts outward because we have more capital.
We can consume at a point outside our original PPF, such as K'.