Economics 2010

1. Economics 2010 Rober Martinez-Espineira Lecture 3 The Economic Problem

2. Any questions on the course outline?

3. The fundamental economic problem is to decide which of our wants to satisfy and to which extent, how and when

4. Production and Cost • Some definitions • Production possibility frontier • Production efficiency • Opportunity cost • Increasing opportunity cost

5. Some definitions • Production is making wealth, valuable things by using productive resources. The greater the value, the greater is production

6. Some definitions • Natural resources are called Land • Human resources are called Labor • Capital resources are called Capital • Human capital: the skill and knowledge of people. It comes from education, on the job training, and work experience • Productive resources are organized by entrepreneurial ability

7. Some definitions • Goods (material wealth) and services (immaterial wealth): things that people value • They fall into two categories: • Consumption goods and services • Capital goods

8. Production Possibility Frontier • The production possibility frontier(PPF)is the boundary between those production levels that can be produced and those that cannot • The PPF depends on the quantities of productive resources and on the state of technology

9. Production Possibility Frontier • Jones Inc. can produce two types of goods: computers and stereos • Using all its resources to produce computers, it can produce 50 a week • Using all its resources to produce stereos, it can also produce 50 a week • Similarly, Mark produces trousers, western cuts and/or baggys

10. Production Possibility Frontier

11. Production Efficiency • Production efficiency is achieved when it is not possible to produce more of one good without producing less of another good

12. Production Efficiency • Production efficiency occurs at all points on the PPF • Possible production points inside the PPF such as point z are inefficient

13. Opportunity Cost • The opportunity cost of an action is the best alternative foregone

14. Increasing Opportunity Cost • Almost every productive resource is better at producing some things than others • For example: most capital is custom designed to do a small range of jobs

15. Increasing Opportunity Cost • At one point on the PPF, every productive resource is being used in its most productive way • And as the economy moves from that point, in either direction, the opportunity cost of producing more of a good increases

16. Increasing Opportunity Cost • The PPF in this figure illustrates increasing opportunity cost

17. Increasing Opportunity Cost • Suppose that Initially, production is at e • If production moves toward a, the opportunity cost of missiles increases

18. Increasing Opportunity Cost • The first 1,000 games cost 200 missiles • The second 1,000 games cost 300 missiles

19. Increasing Opportunity Cost • The more games we produce, the greater is the opportunity cost of a game

20. Increasing Opportunity Cost • Similarly, the more missiles we produce, the greater is the opportunity cost of a missile

21. Increasing Opportunity Cost • Increasing opportunity cost is shown by the outward bow of the PPF • We measure opportunity cost as the decrease in the quantity of what we give up divided by the increase in the quantity of what we get • Opportunity cost is a ratio--the decrease in the quantity of one good divided by the increase in the quantity of another good

22. Increasing Opportunity Cost • Increasing opportunity cost is everywhere in the real world

23. Next • Economic Growth • Gains from Trade • The Evolution of Trading Arrangements