Lecture note

Production Possibilities Frontier

Major takeaways

1. A production possibilities curve shows the combinations of two goods an economy

is capable of producing.
2. The downward slope of the production possibilities curve is an implication of
scarcity.
3. The bowed-out shape of the production possibilities curve results from allocating
resources based on comparative advantage. Such an allocation implies that the law
of increasing opportunity cost will hold.
4. An economy that fails to make full and efficient use of its factors of production will
operate inside its production possibilities curve.
5. Specialization means that an economy is producing the goods and services in which
it has a comparative advantage.

Production Possibilities Frontier

The production possibility frontier illustrates the trade-offs facing an economy that produces
only two goods. It shows the maximum quantity of one good that can be produced for any given
quantity produced of the other.

Comparative advantage

A country has a comparative advantage in producing a good or service if its opportunity cost of
producing the good or service is lower than other countries’. Likewise, an individual has a
comparative advantage in producing a good or service if his or her opportunity cost of producing
the good or service is lower than for other people.

Factors of production are resources used to produce goods and services.

Technology is the technical means for producing goods and services.

A country has an absolute advantage in producing a good or service if the country can produce
more output per worker than other countries. Likewise, an individual has an absolute advantage
in producing a good or service if he or she is better at producing it than another people. Having
an absolute advantage is not the same thing as having a comparative advantage.

The circular-flow diagram represents the transactions in an economy by flows around a circle.
A household is a person or a group of people that share their income.
A firm is an organization that produces goods and services for sale.
Firms buy the resources they need to produce goods and services in factor markets.
An economy’s income distribution is the way in which total income isdivided among the
owners of thevarious factors of production.
Exercise
True or false? Explain your answer.
a. An increase in the amount of resources available to Boeing for use in producing Dreamliners
and small jets does not change its production possibility frontier.
2. In Italy, an automobile can be produced by 8 workers in one day and a washing machine by 3
workers in one day. In the United States, 6 workers can produce an automobile in one day and a
washing machine by 2 workers in one day.
a. Which country has a comparative advantage in the production of washing machines? In
automobiles?
c. What pattern of specialization results in the greatest gains from trade between the two
countries?
Which of the following statements is a positive statement? Which is a normative statement?
a. Society should take measures to prevent people from engaging in dangerous personal
behavior.
b. People who engage in dangerous personal behavior impose higher costs on society
Through higher medical costs.