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CChapter hapter 22Production Production
Possibilities and Possibilities and Opportunity CostsOpportunity Costs
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Economic PrinciplesEconomic Principles
Factors of production
Production possibilities
Opportunity cost
The law of increasing costs
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Economic PrinciplesEconomic Principles
Technological change and economic growth
Division of labor and specialization
Absolute and comparative advantage
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Factors of ProductionFactors of Production
Factors of production
• Any resource used in a production process.
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Factors of ProductionFactors of Production
These resources include:
• Labor• Land• Capital• Entrepreneurship
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Factors of ProductionFactors of Production
Labor
• Labor is the physical and intellectual effort of people engaged in producing goods and services.
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Factors of ProductionFactors of Production
Land
• Land is a natural-state resource such as real estate, grasses and forests, and metals and minerals.
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Factors of ProductionFactors of Production
Capital
• Capital includes the manufactured goods used to make and market other goods and services.
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Factors of ProductionFactors of Production
Human capital
• Human capital is the knowledge and skills acquired by labor, principally through education and training.
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Factors of ProductionFactors of Production
Entrepreneurship
• Entrepreneurship describes the people who alone assume the risks and uncertainties of a business.
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Production Production PossibilitiesPossibilities
Production possibilities
• The various combinations of goods that can be produced in an economy when it uses its available resources and technology efficiently.
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EXHIBIT 1 PRODUCTION POSSIBILITIES FRONTIER
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Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier
1. What do points A, B, C, and D represent in Exhibit 1?• They represent four consumption and capital goods possibilities when resources are used efficiently.
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Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier
2. What does the curve that passes through points A, B, C, and D represent?• The curve represents all of the possible combinations of consumption goods and capital goods.
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Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier
3. Why does the curve have a balloon-like shape?• The law of increasing costs accounts for the balloon-like shape of the production possibilities curve.
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Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier
4. If a production possibilities frontier was a downward-sloping straight line, would the law of increasing costs still hold?
• No.
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Exhibit 1: Production Exhibit 1: Production Possibilities FrontierPossibilities Frontier
5. What would cause a production possibilities frontier to be a downward-sloping straight line?
• Resources are not specialized.
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Production Production PossibilitiesPossibilities
1. Is an economy operating on its production possibilities frontier if there is a high rate of unemployment?
• No. In this case the economy is operating inside its production possibilities frontier.
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2. How can an economy produce a combination of goods outside its production possibilities frontier?• If more resources become available, or if existing resources become more productive.
Production Production PossibilitiesPossibilities
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Evaluating Evaluating Production Production PossibilitiesPossibilities
1. Two things to keep in mind when evaluating production possibilities:• Opportunity cost
• The law of increasing costs
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Evaluating Evaluating Production Production PossibilitiesPossibilities
Opportunity cost
• The quantity of other goods that must be given up to obtain a good.
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Evaluating Evaluating Production Production PossibilitiesPossibilities
Opportunity cost is typically subjective. One must rely on calculating expected gains and expected opportunity costs of choices made.
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Evaluating Evaluating Production Production PossibilitiesPossibilities
Law of increasing costs
• The opportunity of producing a good increases as more of the good is produced.
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Evaluating Evaluating Production Production PossibilitiesPossibilities
The law of increasing costs is based on two facts:• Not all resources are suited to the production of all goods.
• The order of use of a resource in producing a good goes from the most productive resource unit to the least.
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Evaluating Evaluating Production Production PossibilitiesPossibilities
Relationship between opportunity cost and law of increasing costs:A) The opportunity cost of producing a good increases as more of a good is produced.
B) The negative slope of the production possibilities curve illustrates the fact that any increase in capital goods production must come at the cost of consumption goods production.
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EXHIBIT 2 SHIFTS IN THE PRODUCTION POSSIBILITIES FRONTIER
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Exhibit 2: Shifts in the Exhibit 2: Shifts in the Production Possibilities Production Possibilities
FrontierFrontier1. What will cause the production possibilities frontier to shift to the right?• Investing in capital today expands the resource base of later periods, therefore allowing more capital and consumption goods in the future.
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Exhibit 3: Exhibit 3: Comparative Comparative
Economic GrowthEconomic Growth1. If an economy chooses to produce at point C, why does the production possibilities curve shift to the right?
A) The economy produced a mixture of consumption and capital goods.
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Exhibit 3: Exhibit 3: Comparative Comparative
Economic GrowthEconomic Growth1. If an economy chooses to produce at point C, why does the production possibilities curve shift to the right?
B) Therefore, capital goods have been added to the resource base for future production.
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Exhibit 3: Exhibit 3: Comparative Comparative
Economic GrowthEconomic Growth2. If an economy chooses to produce at point A on the Production Possibilities Curve, how will its economy compare to the first economy?
• Over time, the production gap between the two economies will widen.
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Productive Power of Productive Power of Advanced TechnologyAdvanced Technology
Innovation
• Innovation is an idea that eventually takes the form of new, applied technology.
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EXHIBIT 4 PRODUCTION POSSIBILITIES GENERATED BY SPEAR AND NET TECHNOLOGIES
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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A) The “new” technology of the fishing net uses a different combination of land and labor.
Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?
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Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies1. In Exhibit 4, why does the net technology yield greater production possibilities than the spear technology?B) The new combination makes it easier to move down along the production possibilities curve—producing even more capital goods—and shifting the curve further to the right.
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2. Relationship between technology and economic growth:
A) Innovation makes the creation of even more advanced technology possible.
B) Innovation expands the growth potential of our economy.
Exhibit 4: Production Exhibit 4: Production Possibilities Generated by Possibilities Generated by
Spear and Net TechnologiesSpear and Net Technologies
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EXHIBIT 5 INWARD AND OUTWARD SHIFTS OF THE PRODUCTION POSSIBILITIES CURVE
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Exhibit 5: Inward and Exhibit 5: Inward and Outward Shifts of the Outward Shifts of the
Production Possibilities Production Possibilities CurveCurve
1. What could cause the production possibilities curve to shift inward in Exhibit 5?• The destruction of capital goods and the disruption of people’s lives can cause the production possibilities curve to shift inward.
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Exhibit 5: Inward and Exhibit 5: Inward and Outward Shifts of the Outward Shifts of the
Production Possibilities Production Possibilities CurveCurve
2. After shifting inward, what can explain the curve’s shift back to its original position and beyond?• While capital goods can be destroyed, ideas are far more durable.
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Exhibit 5: Inward and Exhibit 5: Inward and Outward Shifts of the Outward Shifts of the
Production Possibilities Production Possibilities CurveCurve
• Resources can be rebuilt and advanced technologies can be applied to recoup or even surpass the economy’s levels of production previously attained.
2. After shifting inward, what can explain the curve’s shift back to its original position and beyond?
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Possibilities, Possibilities, Impossibilities, and Impossibilities, and
Less than PossibilitiesLess than PossibilitiesTwo possible states of an economy
A) Underemployed resources
B) Economic efficiency
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Possibilities, Possibilities, Impossibilities, and Impossibilities, and
Less than PossibilitiesLess than PossibilitiesUnderemployed resources
• The less than full utilization of a resource’s production capabilities.
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Possibilities, Possibilities, Impossibilities, and Impossibilities, and
Less than PossibilitiesLess than PossibilitiesEconomic efficiency
• The maximum possible production of goods and services generated by the fullest employment of the economy’s resources.
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EXHIBIT 6 POSSIBLE, IMPOSSIBLE, AND LESS THAN POSSIBLE
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Exhibit 6: Possible, Exhibit 6: Possible, Impossible, and Less Impossible, and Less
than Possiblethan Possible1. What point in Exhibit 6 reflects underemployed resources?
• Point U reflects underemployed resources. This point, as well as all others inside the curve, describe an economy with inefficient production.
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Exhibit 6: Possible, Exhibit 6: Possible, Impossible, and Less Impossible, and Less
than Possiblethan Possible2. What point reflects a currently unattainable production possibility?
• Point E and all other points located outside of the production possibilities curve represent impossible production combinations. These points are unattainable with the resources and technology currently available.
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Production Possibilities Production Possibilities and Economic and Economic StabilizationStabilization
Labor specialization
• The division of labor into specialized activities that allow individuals to be more productive.
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Production Possibilities Production Possibilities and Economic and Economic StabilizationStabilization
Benefits of Specialization:
A) Allows every entity—from individuals to nations—to do what they do best
B) Leads to greater productivity
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Production Production Possibilities and Possibilities and
Economic Economic StabilizationStabilizationRequirements of Specialization:
A) It requires an exchange system that allows each entity to exchange the goods it produces under specialization
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Production Production Possibilities and Possibilities and
Economic Economic StabilizationStabilizationSpecialization is attractive because:
A) Those who specialize in what they do best will achieve greater material prosperity.
B) Everyone participating in the system produces more, exchanges more, and consumes more.
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Specialization Specialization DecisionsDecisions
Two types of production advantages:A) Absolute Advantage
B) Comparative Advantage
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Absolute AdvantageAbsolute Advantage
Absolute advantage
• A country’s ability to produce a good using fewer resources than the country with which it trades.
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EXHIBIT 7 PRODUCTION OF FISH AND SHIRTS PER EIGHT-HOUR DAY—ABSOLUTE ADVANTAGE
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Exhibit 7: Production of Exhibit 7: Production of FishFish
and Shirts—Absolute and Shirts—Absolute AdvantageAdvantage
1. In Exhibit 7, which country has an absolute advantage in producing fish?• The Yakamaya Island
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1. In Exhibit 7, which country has an absolute advantage in producing shirts?• The Crusoe Island
Exhibit 7: Production of Exhibit 7: Production of FishFish
and Shirts—Absolute and Shirts—Absolute AdvantageAdvantage
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2. What is the advantage of specialization for the islands?
A) Without specialization, total production on the islands is 10 shirts and 10 fish.
B) If they specialize, total production is 16 shirts and 16 fish.
Exhibit 7: Production of Exhibit 7: Production of FishFish
and Shirts—Absolute and Shirts—Absolute AdvantageAdvantage
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Comparative Comparative AdvantageAdvantage
Comparative advantage
• A country’s ability to produce a good at a lower opportunity cost than the country with which it trades.
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EXHIBIT 8 PRODUCTION OF FISH AND SHIRTS PER EIGHT-HOUR DAY—COMPARATIVE ADVANTAGE
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Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage1. In Exhibit 8, which country should produce shirts and which country should produce fish?A) To determine what each country should produce, opportunity costs must be compared.
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B) When Crusoe Island produces 8 shirts, they give up the opportunity to produce 8 fish.
1. In Exhibit 8, which country should produce shirts and which country should produce fish?
Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage
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C) The opportunity cost of producing a shirt is 1 fish.
1. In Exhibit 8, which country should produce shirts and which country should produce fish?
Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage
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D) When Yakamaya Island produces 2 shirts, they give up the opportunity of producing 8 fish.
1. In Exhibit 8, which country should produce shirts and which country should produce fish?
Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage
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E) The opportunity cost of producing a shirt is 4 fish.
1. In Exhibit 8, which country should produce shirts and which country should produce fish?
Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage
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F) Crusoe Island holds a comparative advantage in shirts, so Yakamaya Island should produce fish.
1. In Exhibit 8, which country should produce shirts and which country should produce fish?
Exhibit 8: Production of FishExhibit 8: Production of Fishand Shirts—Comparative and Shirts—Comparative
AdvantageAdvantage
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Comparative Comparative Advantage Practice Advantage Practice
ProblemProblemIf Jack can type 4 pages or file 4 legal briefs in a day, while Sara can type 6 pages or file 12 legal briefs in a day, what should Jack and Sara specialize in producing?
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Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down
1. What are Jack and Sara’s opportunity costs of typing one page?A) Jack’s opportunity cost of one page of typing is one legal brief.
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Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down
1. What are Jack and Sara’s opportunity costs of typing one page?B) Sara’s opportunity cost of one page of typing is two legal briefs.
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Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down
C) Jack has the smaller opportunity cost of one page of typing.
1. What are Jack and Sara’s opportunity costs of typing one page?
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2. What are Jack and Sara’s opportunity costs of filing a legal brief?A) Jack’s opportunity cost of filing a legal brief is one page of typing.
Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down
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B) Sara’s opportunity cost of filing a legal brief is one-half page of typing.
2. What are Jack and Sara’s opportunity costs of filing a legal brief?
Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down
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3. So what should Jack and Sara specialize in producing?
A) The Law of Comparative Advantage tells us that Jack should type and Sara should file legal briefs.
Comparative Advantage Comparative Advantage Practice Problem: Practice Problem: Breaking it DownBreaking it Down