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Chapter 2

Chapter 2. Production Possibilities and Opportunity Costs. Economic Principles. Factors of production Production possibilities Opportunity cost The law of increasing costs. Economic Principles. Technological change and economic growth Division of labor and specialization

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Chapter 2

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  1. Chapter 2 Production Possibilities and Opportunity Costs Gottheil — Principles of Economics, 7e

  2. Economic Principles • Factors of production • Production possibilities • Opportunity cost • The law of increasing costs Gottheil — Principles of Economics, 7e

  3. Economic Principles • Technological change and economic growth • Division of labor and specialization • Absolute and comparative advantage Gottheil — Principles of Economics, 7e

  4. Factors of Production Factors of production • Any resource used in a production process. Gottheil — Principles of Economics, 7e

  5. Factors of Production These resources include: • Labor • Land • Capital • Entrepreneurship Gottheil — Principles of Economics, 7e

  6. Factors of Production Labor • Labor is the physical and intellectual effort of people engaged in producing goods and services. Gottheil — Principles of Economics, 7e

  7. Factors of Production Land • Land is a natural-state resource such as real estate, grasses and forests, and metals and minerals. Gottheil — Principles of Economics, 7e

  8. Factors of Production Capital • Capital includes the manufactured goods used to make and market other goods and services. Gottheil — Principles of Economics, 7e

  9. Factors of Production Human capital • Human capital is the knowledge and skills acquired by labor, principally through education and training. Gottheil — Principles of Economics, 7e

  10. Factors of Production Entrepreneurship • Entrepreneurship describes the people who alone assume the risks and uncertainties of a business. Gottheil — Principles of Economics, 7e

  11. Production Possibilities Production possibilities • The various combinations of goods that can be produced in an economy when it uses its available resources and technology efficiently. Gottheil — Principles of Economics, 7e

  12. EXHIBIT 1 PRODUCTION POSSIBILITIES FRONTIER Gottheil — Principles of Economics, 7e

  13. Exhibit 1: Production Possibilities 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. Gottheil — Principles of Economics, 7e

  14. Exhibit 1: Production Possibilities Frontier 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. Gottheil — Principles of Economics, 7e

  15. Exhibit 1: Production Possibilities Frontier 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. Gottheil — Principles of Economics, 7e

  16. Exhibit 1: Production Possibilities Frontier 4. If a production possibilities frontier was a downward-sloping straight line, would the law of increasing costs still hold? • No. Gottheil — Principles of Economics, 7e

  17. Exhibit 1: Production Possibilities Frontier 5. What would cause a production possibilities frontier to be a downward-sloping straight line? • Resources are not specialized. Gottheil — Principles of Economics, 7e

  18. Production Possibilities 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. Gottheil — Principles of Economics, 7e

  19. Production Possibilities 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. Gottheil — Principles of Economics, 7e

  20. Evaluating Production Possibilities 1. Two things to keep in mind when evaluating production possibilities: • Opportunity cost • The law of increasing costs Gottheil — Principles of Economics, 7e

  21. Evaluating Production Possibilities Opportunity cost • The quantity of other goods that must be given up to obtain a good. Gottheil — Principles of Economics, 7e

  22. Evaluating Production Possibilities Opportunity cost is typically subjective. One must rely on calculating expected gains and expected opportunity costs of choices made. Gottheil — Principles of Economics, 7e

  23. Evaluating Production Possibilities Law of increasing costs • The opportunity of producing a good increases as more of the good is produced. Gottheil — Principles of Economics, 7e

  24. Evaluating Production Possibilities 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. Gottheil — Principles of Economics, 7e

  25. Evaluating Production Possibilities 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. Gottheil — Principles of Economics, 7e

  26. EXHIBIT 2 SHIFTS IN THE PRODUCTION POSSIBILITIES FRONTIER Gottheil — Principles of Economics, 7e

  27. Exhibit 2: Shifts in the Production Possibilities 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. Gottheil — Principles of Economics, 7e

  28. EXHIBIT 3 COMPARATIVE ECONOMIC GROWTH Gottheil — Principles of Economics, 7e

  29. Exhibit 3: Comparative Economic 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. Gottheil — Principles of Economics, 7e

  30. Exhibit 3: Comparative Economic Growth 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. Gottheil — Principles of Economics, 7e

  31. Exhibit 3: Comparative Economic Growth 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. Gottheil — Principles of Economics, 7e

  32. Productive Power of Advanced Technology Innovation • Innovation is an idea that eventually takes the form of new, applied technology. Gottheil — Principles of Economics, 7e

  33. EXHIBIT 4 PRODUCTION POSSIBILITIES GENERATED BY SPEAR AND NET TECHNOLOGIES Gottheil — Principles of Economics, 7e

  34. Exhibit 4: Production Possibilities Generated by Spear and Net Technologies 1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology? A) The “new” technology of the fishing net uses a different combination of land and labor. Gottheil — Principles of Economics, 7e

  35. Exhibit 4: Production Possibilities Generated by Spear and Net Technologies 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. Gottheil — Principles of Economics, 7e

  36. Exhibit 4: Production Possibilities Generated by Spear and Net Technologies 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. Gottheil — Principles of Economics, 7e

  37. EXHIBIT 5 INWARD AND OUTWARD SHIFTS OF THE PRODUCTION POSSIBILITIES CURVE Gottheil — Principles of Economics, 7e

  38. Exhibit 5: Inward and Outward Shifts of 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. Gottheil — Principles of Economics, 7e

  39. Exhibit 5: Inward and Outward Shifts of the Production Possibilities Curve 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. Gottheil — Principles of Economics, 7e

  40. Exhibit 5: Inward and Outward Shifts of the Production Possibilities Curve 2. After shifting inward, what can explain the curve’s shift back to its original position and beyond? • Resources can be rebuilt and advanced technologies can be applied to recoup or even surpass the economy’s levels of production previously attained. Gottheil — Principles of Economics, 7e

  41. EXHIBIT A NationalSecurity, Conventional War and Terrorism Gottheil — Principles of Economics, 7e

  42. Exhibit A: National Security, Conventional War and Terrorism 1. The more national security goods a country, chooses to produce—subject to the law of increasing cost—the more national security it acquires? • Yes, as shown in the move from a to b along the production possibilities curve of panel a in Exhibit A. Gottheil — Principles of Economics, 7e

  43. Exhibit A: National Security, Conventional War and Terrorism 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? • AGG’s national security remains Unchanged. DEF’s response results in both having less of other goods and no increase in national security. Gottheil — Principles of Economics, 7e

  44. Exhibit A: National Security, Conventional War and Terrorism 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? • 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. Gottheil — Principles of Economics, 7e

  45. Exhibit A: National Security, Conventional War and Terrorism 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? • 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. Gottheil — Principles of Economics, 7e

  46. Possibilities, Impossibilities, and Less than Possibilities Two possible states of an economy A) Underemployed resources B) Economic efficiency Gottheil — Principles of Economics, 7e

  47. Possibilities, Impossibilities, and Less than Possibilities Underemployed resources • The less than full utilization of a resource’s production capabilities. Gottheil — Principles of Economics, 7e

  48. Possibilities, Impossibilities, and Less than Possibilities Economic efficiency • The maximum possible production of goods and services generated by the fullest employment of the economy’s resources. Gottheil — Principles of Economics, 7e

  49. EXHIBIT 6 POSSIBLE, IMPOSSIBLE, AND LESS THAN POSSIBLE Gottheil — Principles of Economics, 7e

  50. Exhibit 6: Possible, Impossible, and 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. Gottheil — Principles of Economics, 7e

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