Learning Objectives:

The Economic Problem

LO4: Understand why trade results in economies being more productive

LO5: Explain the three fundamental questions and the four ways economies can be organized

LO6: Use the production possibilities model to explain choice, opportunity cost, efficiency, and unemployment

CHAPTER 1

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Production Possibilities Model

Production Possibilities Curve: – A graphical representation of the various

combinations of maximum output that can be produced from the available resources and technology

– Assumptions: • Full employment

• Use of the best technology available

• Productive efficiency

1-2© 2012 McGraw-Hill Ryerson Limited

LO6

Production Possibilities Model

1-3© 2012 McGraw-Hill Ryerson Limited

LO6

Figure 1.1

Unattainable

x

ab

c

d

e

Wheat

Cars

Attainable

2019

8

17

13

f

10 2418 3028

LO6

© 2012 McGraw-Hill Ryerson Limited 1-4

- points on the curve represent maximum output possible with available resources

Production Possibilities Model

Scarcity – Represented by points outside the curve

Choice – Represented by points on the curve (efficient) and

points within the curve (inefficient)

Opportunity Cost – Represented by the downward slope of the curve

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LO6

Law of Increasing Opportunity Costs

– Factors of production are not equally suitable

– As output increases, the per unit costs of additional units increases

– Gives the production possibilities curve its bowed out shape

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LO6

Figure 1.2

aWheat

Cars

2019

8

17

13

f

10 2418 3028

+8-2b

c

d

e

+6-4

+4

-5

Law of Increasing Opportunity Costs

LO6

© 2012 McGraw-Hill Ryerson Limited 1-7

- as more cars are produced, an increasing amount of wheat must be given up

Self-Test 5• If society produces 1000 units of butter, how many guns

can it produce?• If society is at “b” on the PPC, what is the cost of 1000

more units of butter?

Qu

anti

ty o

f g

un

s p

er

per

iod

Quantity of butter per period

400

300

150

1000 2000 3000

b

c

d

• Is opportunity cost greater for move from “c” to “d” compared to a move from “b” to “c”?

© 2012 McGraw-Hill Ryerson Limited 1-8

LO6

PPC and Economic Growth

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LO6

Growth means the economy is able to produce more of everything

PPC and Technological Change

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LO6

- Improvement in technology shifts curve to PP2- can produce more of either good, or more of both

Self-Test 6

a. Draw a PPC1 with tools on the horizontal axis

Now, assume new technology that can be used only in the tool industry is developed, which increases tool output by 50%.

b. Draw a new PPC2 that reflects this new technology

c. If Finhorn produced 12 units of tools per year, how many units of grain could be produced after the introduction of the new technology

© 2012 McGraw-Hill Ryerson Limited 1-11

LO6