CHAPTER OUTLINE

1. Explainand illustrate the concepts of scarcity, production efficiency, and tradeoffusing the production possibilities frontier.

A. ProductionPossibilities Frontier

1.  Attainableand Unattainable Combinations

2.  Efficientand Inefficient Production

3.  Tradeoffs and Free Lunches

2.Calculate opportunity cost.

A. The OpportunityCost of a Cell Phone

B.  Opportunity Cost and the Slope of the PPF

C. OpportunityCost Is a Ratio

D. Increasing OpportunityCosts Are Everywhere

E.  YourIncreasing Opportunity Cost

 

n What’s New in this Edition?

Chapter 3 in this edition updates Chapter3 in the fifth edition. A new Eye on the U.S. Economy section has been added toillustrate the specialization of labor and trade. The “Guns Versus Butter” Eyeon the U.S. Economy has been rewritten to feature only the more recent yearsafter 1980. Section 3.4 has an expanded introduction to specialization andtrade. The definition of absolute advantage is changed slightly, to “When oneperson (or nation) is more productive than another—needs fewer inputs or takesless time to produce a good or perform a production task.”

n Where We Are

In Chapter 3, we use the production possibilities frontier toillustrate the economic problem and calculate opportunity cost. We illustratethe effect of unemployed resources using the production possibilities frontiermodel. We study how technological change and capital accumulation increase productionpossibilities and lead to economic growth. Then we explain how specializationand trade expand production possibilities.

n Where We’ve Been

In Chapter 2, we described what, how, and for whom goods andservices are produced in theUnited  States, thereby motivating the productionpossibilities frontier model developed in this chapter. In Chapter 2 we usedthe circular flow model to provide a picture of how households and firms interact.We described the economic activities of governments in theUnited Statesand includedgovernments in the circular flow.

n Where We’re Going

The next chapter introduces the supply anddemand model. We will distinguish between quantity demanded and demand, andexplain what determines demand. Likewise we will distinguish between quantitysupplied and supply, and explain what determines supply. We will explore how demandand supply determine price and quantity in a market, and explain the effects ofchanges in demand and supply.

IN THECLASSROOM

nClass Time Needed

The material in this chapter can be coveredin up to two class sessions.

           Anestimate of the time per checklist topic is:

·            3.1 Production Possibilities—25to 40 minutes

·            3.2 Opportunity Cost—15 to 20minutes

·            3.3 Economic Growth—5 to 10minutes

·            3.4 Specialization and Trade—25to 40 minutes

Classroom Activity: You might like toget the students to realize how useful even a simple economic model, such asthe PPF model, is for helping us understand and interpret importantpolitical events in history. For instance, the PPF model can be used toanalyze real-world events such as an “Arms Race” between nations. Draw a PPFfor military goods and civilian goods production. Then draw another PPFfor a country that is about twice the size of the first, but with the samedegree of concavity as the PPF for the first country. Now assume thateach country considers the other as a mortal “enemy,” and that they engage in acostly arms race. Each country picks a point on the PPF that produces anequal level of military output in absolute terms.

        What would happen if the larger country decided to increasemilitary production? Emphasize that while the distance on the military outputaxis at the point of production is equal for both countries, the resulting distanceon the civilian output axis is (by definition) a smaller quantity for the smallercountry. The large country can create significant economic and politicalpressures on the government of the small country by forcing the small countryto match the increase in military production. The PPF reveals how muchmore additional civilian output is forgone by the citizens of the small economyrelative to the citizens of the larger economy. Emphasize also that theopportunity cost of civilian goods is higher for the smaller country.

        What were the economicrepercussions of the Cold War? History and political science majors quicklyperceive that these two PPF models reflect the Cold War relationshipbetween theUnited Statesand the U.S.S.R. during the early 1980s. The Reagan administration increasedU.S.military expenditures during the early 1980s to a post-Vietnam War peak of 6.6percent of GDP (as compared to about 3.5 percent of GDP in the late 1990s).Many experts agree that this strategy contributed to the many political andeconomic pressures that ultimately lead to the dissolution of the U.S.S.R.

        “What are theimplications for the next fifty years?”Chinais currently the world’ssecond largest economy. It is predicted to surpass theU.S.to become the biggest economyin the not-too-distant future. Ask your students how does this developmentinfluence the strategic balance and the position of theUnited States?

Classroom Activity: The PPF model can be used to analyze global environmentalagreements between nations. This application of the PPF is a lesshawkish and perhaps a more green perspective on a timely international policyissue. Compare a rich economy’s PPF to a poor economy’s PPF, eachwith the same degree of concavity. The production levels are now measured asoutput per person and the goods are “cleaner air” and “other goods and services.”

        What if the citizens ofeach country were required to make equal reductions in per-person greenhousegas emissions? Show an equal quantity increase in per person output on theclean air axis for both countries’ PPF curve. Show how the opportunity costof requiring additional pollution reductions (cleaner air) of equal amounts perperson is much greater for the citizens of a poorer country than for thecitizens of the richer country. This fact has been used to try to persuadedeveloped countries (like theUnited States)to accept larger pollution reduction targets than developing countries (likeChina,India, and the African nations).

 

CHAPTER LECTURE

n 3.1       Production Possibilities

Production Possibilities Frontier

• The production     possibilities frontier     (PPF) is the     boundary between those combinations of goods and services that can be produced     and those that cannot.

• Consider     the production choices for two goods: books and movies. The table with the     data for the PPF is below and a figure showing the PPF is to     the right.

                             

	Books	Movies
A	0	600
B	200	500
C	400	300
D	600	0

• Production points beyond the PPF are not attainable; production points     on and within the PPF are attainable.

To make this model useful, it was necessaryto simplify. By considering the case where production of all goods other than theillustrated two remain fixed, we can use a relatively simple picture to see howconcepts apply to the real world. With three goods, wewould have a 3-D frontier surface. With more than 3 goods, it would beimpossible to represent the frontier using a graph. Meanwhile, all relevantresults of model can be easily illustrated in the simple 2-D case.

Production Efficiency

• Production     is efficient only on the frontier of the PPF. These points are production efficient, a situation     in more of one good or service cannot be produced without producing less     of something else. Points within the PPF,     such as point Z, are inefficient.

TradeoffAlong the PPF

• Moving     along the PPF illustrates how scarcity creates the need to make     choices. Producing more books (moving from point A to point B)     means producing fewer movies, and producing more movies (moving from point     C to point B) means producing fewer books.

·        These movements reflect a tradeoff, which is an exchange of giving up one thing to get something else.

·        A free lunch is agift, getting something without giving up something else. A movement from pointZ to point C is free lunch because more of bothbooks and movies are obtained. When production is efficient – at a point on thePPF – then there will be no opportunity for a free lunch, as attempts toproduce more of  good requires atradeoff.

n 3.2       OpportunityCost

• The opportunity     cost     of an action is the best thing given up.

• If the economy     is at a production efficient point on the frontier, then the opportunity     cost of producing more books or movies is the tradeoff along the frontier.

• The magnitude     of the slope of the PPF measures     the opportunity cost of one more unit of the good measured along the     horizontal axis. The opportunity cost equals the change in the quantity of     the good forgone divided by the change in the quantity of the good that is     gained.

Lecture Launcher:  Students really do think that while somethings are priceless, for everything else there’s MasterCard. Make sure thatthey understand that even if one doesn’t give up money, one must give upsomething because many of them almost instinctively relate costs to monetarycosts. To help them grasp the idea of opportunity cost while moving along the PPF, it is important to get students torealize very early on that thinking only of monetary costs is a narrow view andthat it ignores the most important cost of all—opportunity cost.

        Demonstrate the fact that thatopportunity cost does not necessarily involve money by launching your lecturewith an example that hits close to home. Ask your students to take a minute towrite down a list of things that qualify as the opportunity cost to them ofattending your economics class. Expect a fairly wide range of answers from thedownright silly to the very thoughtful. Stress that the true opportunity costof any endeavor is only the one next best thing forgone. The reason is becauseyou can only perform one other activity in place of whatever it is you aredoing at present. In other words, you will need to convince your students thateven though they have come up with a fairly long list of items, the opportunitycost of attending your economics class can only be one of them. This one is theone that will rank above the others as the next best available alternative.Here might be some possible answers: by taking economics your students cannottake biology, physics or chemistry; they might have to give up overtime at work(if they are taking a night class); or the cost could be the forgone extrasleep they could have enjoyed if they are taking an 8:00 a.m. class!

OpportunityCost Is a Ratio

• The     opportunity cost of producing more of a product is the quantity of the product     forgone divided by the quantity of the product     gained. Hence the opportunity cost of a good or service is a ratio. Being     a ratio, the opportunity costs for two goods will be the inverse of each     other – the opportunity cost of producing good X in terms of good Y     is the inverse of the opportunity cost of good Y in terms of good X.

Increasing Opportunity Cost

• As more of a     product is produced, its opportunity cost increases. In the figure, moving     from point A to point B to point C and so on, the opportunity cost of each additional book     increases.

·        Increasingopportunity cost is reflected in the bowed-out shape of the PPF.

·        Opportunity costs increasebecause resources are not equally productive in all activities. As resourcesare initially shifted into producing a good, the most productive resources forthat good (and least productive for an alternative good) are chosen first –hence the low initial opportunity cost. As more of that good is produced, lessproductive resources for producing that good (and more productive resources forthe alternative good) are shifted towards producing that good – hence theopportunity cost increases.