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Chapter 2

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ECO 211

Production and Growth Define production possibility frontier Define production efficiency Explain how economic growth expands production possibilities Define allocative efficiency This chapter presents the basic Ricardian model of how specialization in production creates potential gains from trade. Equity and efficiency are two objectives of public policy The Production Possibility Frontier (PPF) Production is the conversion (or transformation) of land, labor, capital, and entrepreneurial ability into goods and services (inputs into outputs). The production possibilities frontier (PPF) marks the boundary between those combinations of goods and services that can be produced and those that cannot. Factors of Production Labor is the time and effort people devote to production.AKAhuman capital Largest factor is producing goods and services is people. Land includes all resources from nature used in production. “Land” includes all productive resources, including raw materials (i.e. oil). (Physical) Capital is goods produced for use in producing other goods & services. (both an input and an output) The term “capital,” as used by economists, refers to physical rather than financial capital. Human capital is not included in the capital input to production. Entrepreneurial ability organizes land, labor, and capital. Entrepreneur: comes up with idea of a business Production Efficiency Production efficiency is achieved when it is not possible to produce more of one good without producing less of some other good. Points inside the PPF are inefficient. Points outside the PPF are unattainable. Points inside the PPF are inefficient because factors of production are being wasted. Incentives are important in economics to understand the choices people make Opportunity CostsAre Inescapable Atrade-off is a constraint that entails giving up one thing to get something else. We face trade-offs in most decisions we make. Getting anAin this course versus extracurricular activities Attending class today versus going to the beach or sleeping Ordering pizza tonight versus saving your money for a movie this weekend. An Example of a PPF Guns Versus Butter The economy’s PPF for guns and butter shows the limits to production of these two goods, given the total resources available. The PPF assumes all resources are fully utilized in production (by definition) The PPF can be shown in tabular or graphical form. Production Possibilities Frontier - Tabular Form Production Possibilities Frontier - Graphical Form a 15 b c 10 d ( 5 e f 0 1 2 3 4 5 Butter (tons) u G Production Possibilities Frontier (Represents Production Capacity vs what you actually produce) - Graphical Form a 15 b Unattainable c 10 d ( Attainable 5 e f 0 1 2 3 4 5 Butter (tons) Concave from the origin 3 Most important ways to increase productive capacity of an economy: 1 technology, 2. capital New technology may cause a loss of jobs in the short-run; new capital creates new types of jobs in the long run Puoduction Possibilities Frontier - Graphical Form G n The Bowed-Out Frontier or Concave from Origin When most resources are devoted to production of one good, the PPF becomes very steep (high opportunity cost) or flat (low opportunity cost). As production of a good increases, the resources available to produce more of it are less suited to its production. Measuring Opportunity Cost The opportunity cost of producing one more ton of butter is the number of guns that must be given up. The cost of increasing production of butter from 0 to 1 ton is 1 gun (15 - 14). Production Possibilities Frontier - Tabular Version Using Resources Efficiently Marginal cost The opportunity cost of producing one more unit of a good or service. The marginal cost of an additional ton of butter is the quantity of guns that must be given up to get one more ton of butter--the opportunity cost. Opportunity Cost and Marginal Cost Opportunity Cost and Marginal Cost MC 5 …means increasing marginal cost of 4 butter. 3 ( 2 G 1 0 1 2 3 4 5 Butter (tons) Opportunity cost of producing more guns in terms of butter Convex: downward sloping Straight line: horizontal, fixed, constant u Opportunity Cost and Marginal Cost
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