Lecture 2

• Production Possibilities Frontier (PPF)

  • The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology
  • A valuable tool for illustrating the effects of scarcity and its consequences
• The PPF separates attainable combinations from unattainable combinations
• Production efficiency is a situation in which we cannot produce more of one good or service without producing less of something else
• Tradeoff

  An exchange - giving up one thing to get something else
• Free lunch

  A gift - getting something without giving up something else
• As more cell phones are produced

  The opportunity cost of a cell phone increases
• Opportunity cost

  The value of the best alternative forgone
• The magnitude of the slope of the PPF measures opportunity cost
• The PPF is bowed outward and the opportunity cost of a cell phone increases as more cell phones are produced
• Opportunity cost

  The quantity of DVDs forgone divided by the increase in the quantity of cell phones gained

  
• Opportunity cost

  The quantity of cell phones forgone divided by the increase in the quantity of DVDs gained

  
• When the opportunity cost of a cell phone is x DVDs, the opportunity cost of a DVD is 1/x cell phones

  
• Economic growth

  • The sustained expansion of production possibilities
  • An economy grows when it develops better technology, improves the quality of labor, or increases the quantity of capital
  • When an economy's resources increase, its production possibilities expand and its PPF shifts outward
• Economic growth

  1. Produce cell-phone factories

  2. Produce cell phones
• Absolute advantage

  When one person (or nation) is more productive than another - needs fewer inputs or takes less time to produce a good or perform a production task
• Comparative advantage

  The ability of a person to perform an activity or produce a good or service at a lower opportunity cost than someone else
• Liz's Smoothie Bar

  • Liz can produce either 30 smoothies or 30 salads per hour
  • Liz splits her time equally between smoothies and salads and produces 15 smoothies and 15 salads per hour
• Joe's Smoothie Bar

  • Joe can produce either 6 smoothies or 30 salads per hour
  • Joe spends 50 minutes producing 5 smoothies and 10 minutes producing 5 salads per hour
• Liz has a comparative advantage in producing smoothies and Joe has a comparative advantage in producing salads
• Achieving gains from trade

  1. Liz and Joe specialize in producing the good in which they have a comparative advantage

  2. Liz sells Joe 10 smoothies and buys 20 salads

  3. Joe sells Liz 20 salads and buys 10 smoothies
• Both Liz and Joe gain from specialization and trade