Transcript Production Possibilities

Lecture 3 & 4
Dominika Milczarek-Andrzejewska
The Economizing Problem
Economic Systems
Outline of Lecture 3 and 4
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Unlimited Wants
Scarce Resources
Resource Categories
Employment and Efficiency
Production Possibilities Curve
Economic Systems (Market and Command
System)
• Circular Flow Model
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Economizing problem:
Society’s material wants are unlimited
while resources are limited or scarce.
• Suppose you have $50 and are deciding how to
spend it.
• Should you buy a new pair of jeans or three
compact discs?
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Unlimited Wants
(The First Fundamental Fact)
1. Economic wants - desires of people to use
goods and services that provide utility
2. Luxuries or necessities
–
Food and race cars
3. Services satisfy wants as well as goods
4. Businesses and governments also have wants
–
Business – equipment; government - schools
5. Over time, wants change and multiply
–
DVD, digital cameras
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Scarce Resources
(The Second Fundamental Fact)
• Economic resources - limited relative to
wants
• Economic resources - sometimes called
factors of production
• Four categories:
– Land or natural resources,
– Capital or investment goods (tools,
equipment, factories, etc.)
– Labor or human resources
– Entrepreneurial ability
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Entrepreneurial ability
1. Takes initiative - Combines resources
needed for production
2. Makes strategic business decisions
3. Innovator for new products, production
techniques, organizational forms
4. Bears the risk of time, effort, and funds
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Resource payments
Property resources:
LAND
RENTAL INCOME
CAPITAL
INTEREST INCOME
Human resources:
LABOR
WAGES
ENTREPRENEUR
PROFITS
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Employment and Efficiency
• Economics is a science of efficiency in
the use of scarce resources.
• Efficiency requires:
– full employment of available resources and
– full production
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Allocative and Productive Efficiency
Full production: employed resources are providing
maximum satisfaction of our economic wants.
Full production implies two kinds of efficiency:
1. Allocative efficiency - resources are used for
producing the combination of goods and services
most wanted by society
– for example, producing computers with word
processors rather than manual typewriters
2. Productive efficiency - least costly production
techniques are used
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Allocative and Productive Efficiency
• Full production means producing the “right”
goods (allocative efficiency) in the “right” way
(productive efficiency)
• Allocative efficiency requires productive
efficiency
• Productive efficiency can occur without
allocative efficiency
– Goods can be produced in the least costly method
without being the most wanted by society
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Production Possibilities
Assumptions:
1. Economy is operating efficiently
2. Available supply of resources is fixed in
quantity and quality at this point in time
3. Technology is constant during analysis
4. Economy produces only two types of products
• Choices will be necessary because resources
and technology are fixed
• A production possibilities curve is a graphical
representation of choices
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Production Possibilities
What if we could only produce ...
10,000 Robots
or
400,000 Pizzas
Using all of our resources, to
get some pizza, we must give
up some robots!
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Production Possibilities
in table form
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
1
2
3
9
7
4
(in thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
(in thousands)
graphical
form
Pizzas (hundred thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
(in thousands)form
graphical
Pizzas (hundred thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
(in thousands)form
graphical
Pizzas (hundred thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
(in thousands)form
graphical
Pizzas (hundred thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
graphical
(in thousands)form
Pizzas (hundred thousands)
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Production Possibilities
1
2
3
9
7
4
(thousands)
Robots
PIZZA
0
4
ROBOTS
(in hundred thousands)10
0
graphical
(in thousands)form
Pizzas (hundred thousands)
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Production Possibilities
Robots
(thousands)
Q
13
12
11 A
B
10
9
C
8
7
D
6
5
Attainable
4
but
3
Inefficient
2
1
1
2
3
Pizzas
Unattainable
W
Attainable
& Efficient
E
4
5
6
7
(hundred thousands)
8
Q
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Production Possibilities
• Points on the curve represent maximum possible
combinations of goods given resources and
technology
• Points inside the curve represent
underemployment or unemployment
• Points outside the curve are unattainable
• Optimal or best product-mix:
– a point on the curve;
– the exact point depends on society (a normative
decision)
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Law of Increasing Opportunity Costs
Opportunity cost - the amount of other products
that must be foregone to obtain more of any
given product
• The more of a product produced the greater is
its opportunity cost
• The slope of the production possibilities curve
becomes steeper, demonstrating increasing
opportunity cost.
– the curve is bowed out,
– concave from the origin
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Law of Increasing Opportunity Costs
Economic Rationale:
• Economic resources are not completely
adaptable to alternative uses
For example:
– To get increasing amounts of pizza, resources that are
not particularly well suited for that purpose must be
used
– Workers that are accustomed to producing robots on
an assembly line may not do well as kitchen help
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Allocative Efficiency Revisited
How does society decide its optimal point on
the production possibilities curve?
– It is advantageous to have the additional
product if
MB > MC
– It is not “worth” it to society to produce the
extra unit if
MB < MC
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Allocative Efficiency: MB=MC
Marginal Benefit & Cost
P
MC
$15
MB=MC
10
5
MB
1
2
3
Quantity of Pizzas
Q
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Unemployment and Growth
• Unemployment and productive inefficiency
– the economy is producing less than full
production or
– inside the curve
• In a growing economy, the production
possibilities curve shifts outward
– when resource supplies expand in quantity or
quality
– when technological advances are occurring
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Production Possibilities
Robots
(thousands)
Q
Unemployment &
Underemployment
Shown by Point U
13
12
11
10
9
8
7
6
5
4
3
2
1
More of either or
both is possible
U
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
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Production Possibilities
Robots
(thousands)
Q 14
A’
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Economic
Growth
C’
D’
E’
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
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Production Possibilities
Shifts of production Possibilities Curve:
• Increases in the quality and quantity of
female participation in the labor force
• Technological advances
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International Trade
• A nation can avoid the output limits of its
domestic Production Possibilities through
international specialization and trade
• Specialization and trade have the same
effect as having more and better
resources of improved technology
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Economic Systems
• Differences:
– Who owns the factors of production
and
– The method used to coordinate
economic activity
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Economic Systems
• The market system:
– There is private ownership of resources;
– Markets and prices coordinate and direct
economic activity;
– Each participant acts in his or her own selfinterest;
– In pure capitalism the government plays a
very limited role;
– In the European version of capitalism, the
government plays a substantial role.
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Economic Systems
• Command economy, socialism or
communism:
– There is public (state) ownership of
resources.
– Economic activity is coordinated by central
planning.
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The Circular Flow Model
• Two groups of decision makers in the private
economy: households and businesses
• The market system coordinates these
decisions.
• In the resource markets:
– Households sell resources
– Businesses buy resources in order to produce goods
and services
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The Circular Flow Model
• Interactions determine the price of
each resource
• Flow of payments from businesses for
the resources constitutes business
costs and resource owners’ incomes.
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The Circular Flow Model
• In the product markets:
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Households purchase goods and services
Businesses offer products for sale
Interactions determine the price of each product
Flow of consumer expenditures constitutes sales
receipts for businesses
Circular flow model illustrates this complex web of
decision-making and economic activity that give
rise to the real and money flows.
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The Circular Flow Model
RESOURCE
MARKET
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
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The Circular Flow Model
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
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The Circular Flow Model
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
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The Circular Flow Model
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
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The Circular Flow Model
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
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The Circular Flow Model
Limitations of the model:
• No transactions between households and
businesses
• Lack of government and the “rest of the
world”
• Lack of explanation how prices of
products and resources are determined
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Key Terms
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ECONOMIC RESOURCES
FACTORS OF PRODUCTION
FULL EMPLOYMENT
FULL PRODUCTION
PRODUCTIVE EFFICIENCY
ALLOCATIVE EFFICIENCY
PRODUCTION
POSSIBILITIES TABLE
• PRODUCTION
POSSIBILITIES CURVE
• OPPORTUNITY COST
• LAW OF INCREASING
OPPORTUNITY COST
• ECONOMIC GROWTH
• ECONOMIC SYSTEM
• MARKET SYSTEM
• CAPITALIZM
• COMMAND SYSTEM
• RESOURCE MARKET
• PRODUCT MARKET
• CIRCULAR FLOW MODEL
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