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Chapter 2
Production Possibilities
and Opportunity Costs
1999 South-Western College Publishing
Principles of Economics
2nd edition
by Fred M Gottheil
PowerPoint Slides prepared by
Ken Long

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What is a Production
Possibilities Frontier (PPF)?
A graph that shows the
maximum combinations of
goods that can be produced
when resources and
technology are used efficiently
1999 South-Western College Publishing
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For simplicity, lets take
a world with only 2
products
Lets use beer and
pizza (a typical
college campus?)
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A typical PPF has the following shape:.
Pizza




















B
e
e
r

The curve has a
negative slope.
The curve is
concave to the
origin.


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All points on the curve correspond to
full use of resources.
Pizza




















B
e
e
r

A
B
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Points outside the the PPF are not
feasible with existing resources.
Pizza




















B
e
e
r

.A
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Periods of unemployment or inefficiency in
production correspond to points under the
PPF.
Pizza




















B
e
e
r

.A
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Shape of the PPF? Why
Concave?
If PPF a straight line, we have
constant opportunity costs
If PPF concave, we have
increasing opportunity costs
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Consider a straight line PPF
Beer
Pizza
Beer given up, the
opportunity cost,
remains constant
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Concave shape, increasing opportunity
costs.
Pizza




















B
e
e
r

Beer given up, the
opportunity cost, is
increasing
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What is the Law of
Increasing Costs?
The opportunity cost of
producing a good
increases as more of the
good is produced
1999 South-Western College Publishing
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Why does the Law of
Increasing Opportunity
costs hold?
Because resources are not
perfectly adaptable to all
products
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How do we have
more of everything?
By increasing our resources
1999 South-Western College Publishing
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Economic growth indicates an increase in
the total output of an economy.
Pizza




















B
e
e
r

.A
The PPF shifts
to the right !
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Causes of rightward
shifts in PPFs?
Increase in resources
Increased productivity
Improved technology
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Can a PPF shift inward
(to the left)?
YES!! For just the
opposite reasons as an
outward shift such as a
loss of resources
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Economic growth and the Capital
Consumer goods tradeoff:
Consumer goods
C
a
p
i
t
a
l

g
o
o
d
s

A
B
From which point would
an economy grow faster,
A or B?? Answer is A,
with more capital goods
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What should a country
specialize in producing?
In those goods and
services that it has a
comparative advantage
1999 South-Western College Publishing
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What is
Comparative Advantage?
A countrys ability to
produce a good at a lower
opportunity cost than the
country which it trades
1999 South-Western College Publishing
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What is
Absolute Advantage?
A countrys ability to
produce a good using fewer
resources than the country
with which it trades
1999 South-Western College Publishing
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Example, 2 people, 2 jobs, time
required
Job A Job B
Judy
Sam
60 min. 75 min
90 min 150 min
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In the table, Judy is
absolutely advantaged at
both tasks, but what is
her comparative
advantage? What is
Sams comparative
advantage?
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Judys comparative advantage is
at job B, and Sams
comparative advantage is at job
A
To see why, look at the ratios in
the table- Judy can do job A in
2/3 the time of Sam, but she
can do job B in the time, so
she is relatively more efficient
at job B.
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Theory of comparative
advantage
Argues that output is
greater when resources
tend to specialize in their
greatest comparative
advantages
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Problem
With the same quantity of resources,
Euphoria can produce 100 barrels of
beer to Extasias 50 barrels, and
Euphoria can produce 150 pizzas to
Extasias 100. According to
comparative advantage, what product
should Extasia tend to specialize in?
What about Euphoria?
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ANSWER:

Extasia should specialize
in pizzas, Euphoria in
beer production
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What are Factors of Production?
What is Production Possibilities?
Why does division of labor increase
productivity?
What is an Opportunity Cost?
What is Comparative Advantage?
What is Absolute Advantage?