The Foundations of Microeconomics D I A N N A D A S I L V A - G L A S G O W D E P A R T M E N T O F E C O N O M I C S U N I V E R S I T Y O F G U Y A N A 1 4 S E P T E M B E R, 2 0 1 7
Wk 3 Lectures I and II... THE FOUNDATIONS OF MICROECONOMICS (PRODUCTION POSSIBILITIES FRONTIER)
Scarcity Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Just as each member of a household cannot get everything he or she wants, each individual in a society cannot attain the highest standard of living to which he or she might aspire. All Rights Reserved DR. DAVID P ECHEVARRIA 3
Why do we have Scarcity? We have Unlimited Wants and Needs But Limited Resources Create Scarcity So we need to make Choices What to produce, How to Produce, For Whom to produce (tomorrow s lesson)
Trade Offs When you choose between two possible uses for a resource, giving up one alternative for another.
Trade off: Sleep vs. Study Options Benefit Opportunity Cost 1 hour of extra study time 2 nd hour of extra study time 3 rd hour of extra study time Grade of C on test Grade of B on test Grade of B+ on test 1 hour of sleep 2 hours of sleep 3 hours of sleep
Cadillacs... 1944 and 1946 Opportunity cost of tank = 10 passenger autos M5 Tank Cadillac Coupe
Opportunity Costs When you make a trade off, there are costs. The value of time, money, goods, and services given up in an economic choice. The #1 alternative is the Opportunity cost.
Opportunity Costs Opportunity cost of any choice What we forego when we make that choice Most accurate and complete concept of cost Opportunity cost of a choice includes both explicit costs and implicit costs Explicit cost dollars actually paid out for a choice Implicit cost value of something sacrificed when no direct payment is made
Opportunity Cost and Society All production carries an opportunity cost To produce more of one thing Must shift resources away from producing something else
Production Possibilities Frontiers (PPF) The PPF is a valuable tool for illustrating the effects of scarcity and its consequences. PPF is a curve showing all combinations of two goods that can be possibly produced Given the available Factors of production (labor, capital, materials) Production technology (capital intensity) Society s choices are limited to points on or inside the PPF
Production Alternative Type of A B C D E Product Pizzas 0 1 2 3 4 Cars 10 9 7 4 0
Exercise: Plot the PPF A B C D E F G H I J Cupcakes: 0 2 6 10 14 18 22 26 28 30 Robots: 30 28 26 22 18 14 10 6 2 0
PRODUCTION POSSIBILITIES The PPF illustrates three features of production possibilities Attainable and unattainable combinations Full employment and unemployment Tradeoffs
PRODUCTION POSSIBILITIES Attainable and Unattainable Combinations We can produce at any point inside the PPF or on the frontier. Points outside the PPF such as point G are unattainable. Because the PPF shows the limits to production, it separates attainable combinations from unattainable ones.
Beer Points outside the the PPF are not feasible with existing resources..a Pizza
Beer All points on the curve correspond to full use of resources. A B Pizza
PRODUCTION POSSIBILITIES Full Employment and Unemployment Full employment occurs when all the available resources are being used. Unemployment occurs when some resources are available but are not used. When resources are fully employed, production occurs at points on the PPF such as D and E. When resources are unemployed, production occurs at a point inside the PPF such as point H. PRODUCTION POSSIBILITIES AND COMPARATIVE ADVANTAGE 19
PRODUCTION POSSIBILITIES Tradeoffs A tradeoff is a constraint or limit to what is possible that forces an exchange or a substitution of one thing for something else. When production is on the PPF, we face a tradeoff. To get more of one good we must forgo some of the other good as we move along the PPF. PRODUCTION POSSIBILITIES AND COMPARATIVE ADVANTAGE 20
Figure 1: The Production Possibilities Frontier Quantity of All Other Goods per Period 1,000,000 950,000 850,000 A At point A, all resources are used for "other goods." B C Moving from point A to point B requires shifting resources out of other goods and into health care. 700,000 D 500,000 400,000 W E At point F. all resources are used for health care. 100,000 200,000 300,000 400,000 500,000 F Number of Lives Saved per Period
Increasing Opportunity Cost According to the law of increasing opportunity cost The more of something we produce the greater the opportunity cost of producing even more of it. The law of increasing opportunity cost is reflected in the shape of the PPC. The curve is bowed out from the origin of the graph.
Beer A typical PPF has the following shape:. The curve has a negative slope. The curve is concave to the origin. Pizza 23
Beer Concave shape, increasing opportunity costs. Beer given up, the opportunity cost, is increasing Pizza
PRODUCTION POSSIBILITIES The PPF and Opportunity Cost: Illustration
PRODUCTION POSSIBILITIES The PPF and Opportunity Cost: Illustration 26
Consider a straight line PPF Beer Beer given up, the opportunity cost, remains constant Pizza
Efficiency and the Production Possibility Frontier The PPF shows choices which are -- efficient (exactly on the frontier) -- inefficient (within the frontier)
Beer Periods of unemployment or inefficiency in production correspond to points under the PPF..A Pizza
Full production implies two kinds of efficiency, productive efficiency and allocative efficiency. Productive efficiency is the production of any particular mix of goods and services in the least costly way. While, allocative efficiency is the production of that particular mix of goods and services most wanted by society.
The PPF and Growth The PPF assumes; Fixed Resources the available supply of factors of production are fixed in both quantity and quality. Nevertheless, they can be reallocated, within limits, among different uses. Fixed Technology the state of technology does not change. These assumptions imply that we are looking at an economy at a certain point in time or over a very short period of time.
The PPF and Growth Productivity The PPF will shift outward due to Growth in resources Population growth increases the supply of labour Productivity growth due to increased skills of labour force Increase in capital stock Improvements to land Technological advancement Improvement in machinery and equipment G. Mankiw 32
3 Quantity of Computers Produced 4,000 3,000 2,300 2,200 A shift in the production possibilities frontier A G A technological advance in the computer industry enables the economy to produce more computers for any given number of cars. As a result, the production possibilities frontier shifts outward. If the economy moves from point A to point G, then the production of both cars and computers increases. 0 600 650 1,000 Quantity of Cars Produced
PRODUCTION POSSIBILITIES The PPF and Economic Growth A country that chooses point A, representing a relatively high level of current consumption and a relatively low level of investment, sees its future PPF shift out to PPF 2010 with A. A country that chooses point B, representing a relatively lower level of current consumption and a relatively higher level of investment, sees its future PPF shift out to PPF 2010 with B.
The PPF and Growth Productivity The PPF will shift inward due to Decrease in population (due to disease, war etc.) Loss of land Decrease in productivity due to aging population, poor health etc. G. Mankiw 36