LS 3 - CHAPTER 2 The Economic Problem Production...

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The Economic Problem CHAPTER 2 Production Possibilities and Opportunity Cost The production possibilities frontier ( PPF ) is the boundary between those combinations of goods and services that can be produced and those that cannot. To illustrate the PPF , we focus on two goods at a time and hold the quantities of all other goods and services constant. That is, we look at a model economy in which everything remains the same ( ceteris paribus ) except the two goods we’re considering. Production Possibilities and Opportunity Cost Possibility Pizzas (millions) CDs (millions) A 0 and 15 B 1 and 14 C 2 and 12 D 3 and 9 E 4 and 5 F 5 and 0 Suppose you have a factory that can produce either CDs or pizzas:
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Production Possibilities and Opportunity Cost Production Possibilities Frontier Figure 2.1 shows the PPF for two goods: CDs and pizza. Any point on the frontier such as E and any point inside the PPF such as Z are attainable. Points outside the PPF are unattainable. Production Possibilities and Opportunity Cost Production Efficiency We achieve production efficiency if we cannot produce more of one good without producing less of some other good. Points on the frontier are efficient . Production Possibilities and Opportunity Cost Any point inside the frontier, such as Z , is inefficient . At such a point, it is possible to produce more of one good without producing less of the other good. At Z , resources are either unemployed or misallocated.
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Production Possibilities and Opportunity Cost Tradeoff Along the PPF Every choice along the PPF involves a tradeoff . On this PPF, we must give up some CDs to get more pizzas or give up some pizzas to get more CDs. Production Possibilities and Opportunity Cost Opportunity Cost The PPF makes the concept of opportunity cost precise. As we move down along the PPF, we produce more pizzas but the quantity of CDs we can produce decreases. The opportunity cost of a pizza is the CDs forgone. Production Possibilities and Opportunity Cost In moving from E to F, the quantity of pizzas produced increases by 1 million. The quantity of CDs produced decreases by 5 million. The opportunity cost of producing the fifth 1 million pizzas is 5 million CDs. One of these pizzas costs 5 CDs.
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Production Possibilities and Opportunity Cost In moving from F to E , the quantity of CDs produced increases by 5 million. The quantity of pizzas produced decreases by 1 million. The opportunity cost of the first 5 million CDs is 1 million pizzas. One of these CDs costs 1/5 of a pizza. Production Possibilities and Opportunity Cost Note that the opportunity cost of a CD is the inverse of the opportunity cost of a pizza. One pizza costs 5 CDs. One CD costs 1/5 of a pizza. Production Possibilities and Opportunity Cost Because resources are not all equally productive in all activities, the PPF bows outward—is concave.
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LS 3 - CHAPTER 2 The Economic Problem Production...

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