2-production and cost

8/8/2019 2-Production and Cost

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EconomicsEconomics


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Production and CostProduction and CostPrelude

Some definitionsProduction possibility frontier

Production efficiency

Opportunity cost Interlude

Increasing opportunity cost


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PreludePrelude

Can we banish scarcity?


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Can we banish scarcity?Can we banish scarcity?Year Average Income

($ perperson peryear)

1799 800

1899 5,500

1999 40,0002099 290,000

2199 2,000,000


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Some definitions

Some definitions

Production: creating things that peoplevalue by using productive resources

Production is not just making stuff

Production is making valuable stuff. Thegreaterthe value, the greater is

production


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Some definitions

Some definitions

Natural resources are called land

Human resources are called labor

Capital resources are called capitalA special type of capital is calledhuman capital--the skill and knowledge

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

Productive resources are organized by

entrepreneurial ability


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Some definitions

Some definitions

Goods and services: the things thatpeople value.

They fall into two categories:

Consumption goods and services

Capital goods


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Production Possibility FrontierProduction Possibility FrontierThe production possibility frontier

(PPF) is the boundary between those

production levels that can be attainedand those that cannot

The PPFdepends on the quantities of

productive resources and on the state oftechnology


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Production Possibility FrontierProduction Possibility FrontierMarks Jeans Inc. can produce two

types of jeans: Western cuts and

Baggys.

Using all its resources to produceWestern Cuts, it can produce 5,000

pairs a week.Using all its resources to produce

Baggys, it can also produce 5,000 pairs

a week.


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Production Possibility FrontierProduction Possibility Frontier

The dotsmarked a,b, c, d, e,

and fare 6points onMarksPPF

The blueline is thePPF


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Mark canproduce atany point

on the PPF-- on theblue line --or inside

the PPF--in theorangearea


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Mark cannotproduce atany point

outside thePPF

These pointsareunattainable


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Production EfficiencyProduction Efficiency

Production

efficiency isachieved

when it is notpossible toproduce moreof one good

withoutproducing lessof anothergood


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Production EfficiencyProduction Efficiency

Production

efficiency

occurs at all

points on thePPF

Possibleproduction

points insidethe PPFsuchas point zareinefficient


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Opportunity CostOpportunity Cost

Theopportunity

cost of an actionis the bestalternativeforgone

ForMark, the

opportunity costof a pairofBaggys is a pairof Western Cuts


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InterludeInterlude

If a university increases its tuition fees,does the opportunity cost of attending

that university increase?

Look at the question from the point ofview of the student and of the entire

community


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IncreasingO

pportunity CostIncreasingO

pportunity CostAlmost every productive resource is

betterat producing some things than

othersSteven Spielberg is a bettermovie

makerthan Michael Jordan

Michael Jordan is a betterathlete thanTony Blair

Tony Blair is a betterpolitician thanWoopie Goldberg and so on


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IncreasingO


pportunity CostSimilarly with land and capital

Some land is rich in minerals, some isgood for farming, and some is best forbuilding shopping malls on

Most capital is custom designed to do asmall range of jobs


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IncreasingO


pportunity CostAt one point on the PPF, every

productive resource is being used in itsmost productive way

And as the economy moves from thatpoint, in eitherdirection, the opportunitycost of producing more of a goodincreases


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IncreasingO


pportunity CostSuppose, forall example, that all the

outstanding movie makers are

employed making moviesAnd all the best athletes are employed

producing entertaining ball games

If we now produce more movies, wemust take athletes out of jobs they dowell and put them into jobs they do lesswell


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IncreasingO


pportunity CostThe production of entertaining games

falls a lot and the production of movies

increases only a littleAnd the more we move in this direction,

the smaller the increase in movies fora

given loss of gamesThe opportunity cost of movies

increases


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IncreasingO


pportunity CostSimilarly if we move in the opposite

direction

Using good movie makers to play ballgames decreases the production ofmovies by a lot and increases the

production of entertaining games only alittle


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Increasing Opportunity CostIncreasing Opportunity Cost

The PPFinthis figureillustrates

increasingopportunitycost


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It is thePPFformissiles and

videogames


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Along thisPPF, as theproduction

of missilesincreases,theopportunity

cost of amissileincreases


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Also, alongthis PPF, asthe

productionofvideogamesincreases,

theopportunitycost of avideo game

increases


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Suppose thatInitially,production is at

e If production

moves towarda, the

opportunitycost of missilesincreases


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If productionmovestoward g,

theopportunitycost ofvideo

gamesincreases


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The first1,000games cost

200 missiles The second

1,000games cost

300 missiles


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The third1,000games cost

500 missiles The fourth

1,000games cost

1,000missiles


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And the fifth1,000games cost

2,000missiles


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The moregames weproduce, the

greater istheopportunitycost of a

game


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Similarly fortheopportunity

cost ofmissiles

The first1,000

missilescost 400games


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The second1,000missiles

cost 600games

The third1,000

missilescost 1,000games


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And thefourth 1,000missiles

cost 3,000games


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The moremissiles weproduce, the

greater istheopportunitycost of a

missile


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IncreasingO


pportunity Cost Increasing opportunity cost is shown by the

outward bow of the PPF

We measure opportunity cost as thedecrease in the quantity of what we giveup divided by the increase in the quantityof what we get

Opportunity cost is a ratio--the decrease inthe quantity of one good divided by theincrease in the quantity of anothergood


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NextNext

Economic Growth

Gains from Trade

The Evolution of Trading Arrangements

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