Economics 2010Economics 2010

Lecture 3

The Economic Problem

Rober Martinez-EspineiraRober Martinez-Espineira

Any questions on the course outline?

The fundamental economic problem is to decide which of our wants to satisfy and to which extent, how and when

Production and CostProduction and Cost

Some definitionsProduction possibility frontierProduction efficiencyOpportunity cost Increasing opportunity cost

Some definitionsSome definitions

Production is making wealth, valuable things by using productive resources. The greater the value, the greater is production

Some definitionsSome definitionsNatural resources are called LandHuman resources are called LaborCapital resources are called CapitalHuman capital: the skill and knowledge

of people. It comes from education, on the job training, and work experience

Productive resources are organized by entrepreneurial ability

Some definitionsSome definitions

Goods (material wealth) and services (immaterial wealth): things that people value

They fall into two categories: Consumption goods and services Capital goods

Production Possibility FrontierProduction Possibility Frontier

The production possibility frontier (PPF) is the boundary between those production levels that can be produced and those that cannot

The PPF depends on the quantities of productive resources and on the state of technology

Production Possibility FrontierProduction Possibility Frontier

Jones Inc. can produce two types of goods: computers and stereos

Using all its resources to produce computers, it can produce 50 a week

Using all its resources to produce stereos, it can also produce 50 a week

Similarly, Mark produces trousers, western cuts and/or baggys

Production Possibility FrontierProduction Possibility Frontier

Production EfficiencyProduction Efficiency Production

efficiency is achieved when it is not possible to produce more of one good without producing less of another good

Production EfficiencyProduction Efficiency Production

efficiency occurs at all points on the PPF

Possible production points inside the PPF such as point z are inefficient

Opportunity CostOpportunity Cost The opportunity cost of an action is the

best alternative foregone

Increasing Opportunity CostIncreasing Opportunity CostAlmost every productive resource is

better at producing some things than others

For example: most capital is custom designed to do a small range of jobs

Increasing Opportunity CostIncreasing Opportunity Cost

At one point on the PPF, every productive resource is being used in its most productive way

And as the economy moves from that point, in either direction, the opportunity cost of producing more of a good increases

Increasing Opportunity CostIncreasing Opportunity Cost The PPF in

this figure illustrates increasing opportunity cost

Increasing Opportunity CostIncreasing Opportunity Cost Suppose that

Initially, production is at e

If production moves toward a, the opportunity cost of missiles increases

Increasing Opportunity CostIncreasing Opportunity Cost The first

1,000 games cost 200 missiles

The second 1,000 games cost 300 missiles

Increasing Opportunity CostIncreasing Opportunity Cost The more

games we produce, the greater is the opportunity cost of a game

Increasing Opportunity CostIncreasing Opportunity Cost Similarly,

the more missiles we produce, the greater is the opportunity cost of a missile

Increasing Opportunity CostIncreasing Opportunity Cost Increasing opportunity cost is shown by the

outward bow of the PPFWe measure opportunity cost as the

decrease in the quantity of what we give up divided by the increase in the quantity of what we get

Opportunity cost is a ratio--the decrease in the quantity of one good divided by the increase in the quantity of another good

Increasing Opportunity CostIncreasing Opportunity Cost Increasing opportunity cost is everywhere in

the real world

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Economic GrowthGains from TradeThe Evolution of Trading Arrangements