12712_choice and oppurtunity cost

8/6/2019 12712_choice and Oppurtunity Cost

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Introduction

An economic system has to solve threecoordination problems: What, and how much, to produce. How to produce it. For whom to produce it.


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Introduction

All economic knowledge can be boileddown to a single phrase:

There aint no such thing as a free lunch.


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Introduction

Every decision has an opportunity cost the cost in foregone opportunities.


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Opportunity Cost

Opportunity cost : the value of thehighest-valued alternative that must beforgone when a choice is made. It is theevaluation of a trade-off .

Marginal benefits and costs : the benefitsand opportunity costs associated with oneadditional unit of the good.


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Introduction

A production possibility curve is used toillustrate opportunity cost.


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The Production PossibilitiesModel

The production possibilities curve showsthe trade-offs among choices we make.


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The Production Possibility Table

A production possibility table lists achoice's opportunity costs by summarizingwhat alternative outputs you can achievewith your inputs.


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The Production Possibility Table

Output an output is simply a result of anactivity.

Input an input is what you what you putinto a production process to achieve anoutput.


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The Production PossibilityCurve for an Individual

A production possibility curve measures the maximum combination of outputs that can be achieved from a givennumber of inputs.

It slopes downward from left to right.


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The production possibility curve not onlyrepresents the opportunity cost concept, italso measures the opportunity cost.


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The production possibility curvedemonstrates that:

There is a limit to what you can achieve, giventhe existing institutions, resources, andtechnology.

Every choice made has an opportunity costyou can get more of something only by givingup something else.


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A Production Possibility Curvefor a Society

The production possibility curve isgenerally bowed outward. Some resources are better suited for the

production of some goods than others.


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Y

109

8

6543210

.2Y

1 X

A

X 1 2 3 4 5 6 7 8 9

If the slope of the production

curve is -2 at A, theopportunity costof 1 X is 2 Y.

7

McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.


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Comparative advantage explains whyopportunity costs increase as theconsumption of a good increases. Some resources are better suited for the

production of some goods than to theproduction of other goods.


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A Production Possibilities Tableand Curve

% of resourcesdevoted toproductionof guns

Number of guns

% of resourcesdevoted toproductionof butter

Poundsof butter Row

020

406080

100

04

791112

10080

604020

0

1514

12950

AB

C DE F



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1211

A Production Possibilities Tableand Curve

A

B u

t t e r

Guns4 7 901 gun

5 poundsof butter

5

9

15

3 guns

2 poundsof butter

BC

D

E

F

1412

4 guns

1 poundof butter



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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.

The PPC bows outward because there areever-increasing marginal opportunity costs tothe production of any good.


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Increasing Marginal OpportunityCost

The principle of increasing marginal opportunity cost states that opportunitycosts increase the more you concentrateon an activity.

In order to get more of something, onemust give up ever-increasing quantities of something else.

This principle is discussed but Not Named in the Boyes Text


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Increasing Marginal OpportunityCost

B u t t e r

Slope is flat at A. Lowopportunity cost of

guns.

Slope is steep at B. Highopportunity cost of guns.

Guns

B

A


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Specialization

Economic agents (individuals, firms, nations)will be better off if they choose to producethose things for which they have the lowestopportunity costs, and trade for those with

higher costs.

Agents do this because such choices involvegiving up the least amount of other things.


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Specialization & Trade

Comparative Advantage : the ability to producea good or service at a lower opportunity costthan someone else.

Law of comparative advantage : proposition that the joint output of trading

partners will be greatest when each good is produced by the low opportunity cost producer.


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Efficiency

In production, wed like to have productive efficiency achieving asmuch output as possible from a givenamount of inputs or resources.


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Efficiency

Efficiency involves achieving a goal ascheaply as possible.

Efficiency has meaning only in relation toa specified goal.


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Efficiency

Any point within the production possibilitycurve represents inefficiency.

Inefficiency getting less output frominputs which, if devoted to some other activity, would produce more output.


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Efficiency

Any point outside the production possibilitycurve represents something unattainable,given present resources and technology.


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Efficiency and Inefficiency

G u n s

10

86

4

20

2 4 6 8 10Butter

C D

A

B

Efficientpoints

Inefficientpoint

Unattainable point,given available technology,resources and labor force


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Production Possibilities Curve

The production possibilities curve showsthe maximum quantity of goods andservices that can be produced when theexisting resources are used fully and efficiently .


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Production Possibilities

Underutilized(Inefficient)

Nondefense Goods

B 1

F 1C 1

D 1Only nondefensegoods produced

E 1

Only defensegoods produced

A 1

EfficientCombinations

Defense Goods

Impossible

200

175

150

125

100

75

0

7525 50

G 1

100 125

Defense Non-defense

A1 200 0B1 175 75

C 1 130 125

D1 70 150

E 1 0 160

F1 130 25

G 1 200 75

150


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Shifts in the ProductionPossibility Curve

Society can produce more output if: Technology is improved. More resources are discovered. Economic institutions get better at fulfilling our

wants.


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Growth

The PPC moves outward (growth occurs) asthe 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


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A Shift of the PPC

Nondefense Goods

B 1

C 1

D 1

E 1

A 1 Defense Goods 200

175

150

125

100

75

0

7525 50

B 2

100 125 150

225 A2

C 2

D 2

E 2

F 2

Defense Non-defense

A 2 225 0

B2 200 75

C 2 175 120

D2 130 150

E 2 70 160

F 2 0 165


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More output is represented by an outwardshift in the production possibility curve.


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Neutral Technological Change

Butter

A

B Guns0


C

D


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Biased Technological Change


0

B

A

Butter

Guns

C


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Distribution and ProductionEfficiency

The production possibilities curve focuseson productive efficiency and ignoresdistribution.


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Distribution and ProductionEfficiency

In our society, more is generally preferredto less and many policies have relativelysmall distributional effects.


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(a) (c) (d)(b)

Examples of Shifts in theProduction Possibility Curve

12712_choice and oppurtunity cost

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