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Choice,
Opportunity Costs
and Specialization
Introduction
An economic system has to solve three
coordination problems:
What, and how much, to produce.
How to produce it.
For whom to produce it.
Introduction
All economic knowledge can be boiled
down to a single phrase:
10
9 If the slope of the production
8 curve is -2 at A, the
A
7 2Y opportunity cost
.
6 of 1X is 2Y.
5 1X
4
3
2
1
0
1 2 3 4 5 6 7 8 9 X
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
A Production Possibility Curve
for a Society
Comparative advantage explains why
opportunity costs increase as the
consumption of a good increases.
Some resources are better suited for the
production of some goods than to the
production of other goods.
A Production Possibilities Table
and Curve
% of resources % of resources
devoted to devoted to
production Number production Pounds
of guns of guns of butter of butter Row
0 0 100 15 A
20 4 80 14 B
40 7 60 12 C
60 9 40 9 D
80 11 20 5 E
100 12 0 0 F
5 E
5 pounds
of butter
F
0 4 7 9 11 12 Guns
4 guns 3 guns 1 gun
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Marginal Opportunity Cost
The Production Possibilities Curve (PPC)
illustrates the concept of opportunity cost.
Each point on the PPC means that every other
point is a forgone opportunity.
Guns
Specialization
Economic agents (individuals, firms, nations)
will be better off if they choose to produce
those things for which they have the lowest
opportunity costs, and trade for those with
higher costs.
Unattainable point,
10 given available technology,
resources and labor force
8
Efficient C D
Guns
6
points
B
4
A
Inefficient
2 point
0
2 4 6 8 10
Butter
Production Possibilities Curve
The production possibilities curve shows
the maximum quantity of goods and
services that can be produced when the
existing resources are used fully and
efficiently.
Production Possibilities
Defense Non-defense
A1 200 0
B1 175 75
Only defense
goods produced C1 130 125
Defense Goods D1 70 150
200 A1 E1 0 160
G1
Impossible F1 130 25
175 B1 G1 200 75
150 Efficient
C1 Combinations
125 F1
Underutilized 100
(Inefficient)
Only nondefense
75 goods produced
D1
0 E1
25 50 75 100 125 150 Nondefense Goods
Shifts in the Production
Possibility Curve
Society can produce more output if:
Technology is improved.
More resources are discovered.
Economic institutions get better at fulfilling our
wants.
Growth
The PPC moves outward (growth occurs)
as the result of:
Increased resources
Larger labor force
Change in labor force participation
Chance in labor-leisure decision
Improved technology (innovation)
Expansion of capital stock
An improvement in the rules (laws, institutions,
and policies) of the economy
A Shift of the PPC
Defense Non-defense
225 A A2 225 0
2 B2 200 75
Defense Goods C2 175 120
200 A1 B2
D2 130 150
175 E2 70 160
B1 C2
F2 0 165
150
125 C1 D2
100
75 D1 E2
0 E1 F2
25 50 75 100 125 150 Nondefense Goods
Shifts in the Production
Possibility Curve
More output is represented by an outward
shift in the production possibility curve.
Shifts in the Production
Possibility Curve
Neutral Technological Change
Butter
C
A
0 B D Guns
Shifts in the Production
Possibility Curve
Biased Technological Change
Butter
C
B
0
A Guns
Distribution and Production
Efficiency
The production possibilities curve focuses
on productive efficiency and ignores
distribution.
Distribution and Production
Efficiency
In our society, more is generally preferred
to less and many policies have relatively
small distributional effects.
Examples of Shifts in the
Production Possibility Curve
Specialization