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Production Possibilities, Opportunity Cost and

Economic Growth

©2005 South-Western College Publishing

• Key Concepts• Summary

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What will I learn in this chapter?

Having learned that scarcity forces choices, here you will study the choices people make in more detail.

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What are the three fundamental

economic questions?

What to produce?How to produce?

For whom to produce?

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What are two key concepts in this

chapter?• Opportunity costs• Marginal analysis

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What isopportunity cost?The best alternative sacrificed for a chosen alternative

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What opportunity cost am I experiencing now?

The most money that you could be making if you were somewhere else instead of studying these slides

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Can opportunity cost be something other

than money? That most desired activity that you are presently giving up is considered an opportunity cost

Yes!

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Scarcity

Choice

OpportunityCost

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What ismarginal analysis?An examination of the effects of additions to or subtractions from a current situation

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What is an example of marginal analysis?

When your benefit of studying these slides exceeds the opportunity cost, you will spend time studying these slides

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What is a production possibilities curve?

A curve that shows the maximum combinations of two outputs that an economy can produce, given its available resources and technology

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What is technology?The body of knowledge and skills applied to how goods are produced

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A

B

Milit

ary

G

ood

s

Consumer Goods

Unattainable

Inefficient

Production Possibilities CurveEfficient

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What assumptions underlie the productions

possibilities model?• Fixed resources• Fully employed resources• Technology unchanged

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What is the conclusion of the production

possibilities curve?Scarcity limits an economy to points on or below its production possibilities curve

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What is the law of increasing

opportunity costs?The principle that the opportunity cost increases as production of one output expands

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What iseconomic growth?

The ability of an economy to produce greater levels of output, an outward shift of its production possibilities curve

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What makes possible economic growth?

Research and development of new technologies

Increase production in excess of worn out capital

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Technologicaladvance

Economicgrowth

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ACom

pu

ters

Pizzas

Technological Advance

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What happens when a country does not invest

in new technology?Everything else being equal,

the country will not grow

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What is investment?The accumulation of capital, such as factories, machines, and inventories, that is used to produce goods and services

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What is the opportunity cost of

investment?The consumer goods that could have been purchased with the money spent for plants and other capital

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What does an increase in investments make

possible in the future?Economic growth and more goods and services

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What conclusion can we make about investments?

A nation can accelerate growth by increasing production of capital goods in excess of the capital being worn out

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Key Concepts

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• What are the three fundamental economic questions?

• What is opportunity cost?• Can opportunity cost be something other than

money?• What is marginal analysis?• What is a production possibilities curve?• What three assumptions underlie the producti

ons possibilities curve model?

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• What is the conclusion of the production possibilities curve?

• What is the opportunity cost of investment?• What does an increase in investments make po

ssible in the future?• What conclusion can we make about investmen

ts?

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Summary

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Thee fundamental economic questions facing any economy are What, How, and For Whom to produce goods. The What question asks exactly which goods are to be produced and in what quantities. The How question requires society to decide the resource mix used to produce goods. The For Whom problem concerns the division of output among society’s citizens.

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Opportunity cost is the best alternative foregone for a chosen option. This means no decision can be made without cost.

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Scarcity

Choice

OpportunityCost

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Marginal analysis examines the impact of changes from a current situation and is a technique used extensively in economics. The basic approach is to compare the additional benefits of a change with the additional cost of the change.

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A production possibilities curve illustrates an economy’s capacity to produce goods, subject to the constraint of scarcity. The production possibilities curve is a graph of the maximum possible combinations of two outputs that can be produced in a given period of time, subject to three conditions:

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(1) All resources are fully employed

(2) The resource base is not allowed to vary during the time period.

(3) Technology, which is the body of knowledge applied to the production of goods, remains constant.

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Inefficient production occurs at any point inside the production possibilities curve. All points along the curve are efficient points because each point represents a maximum output possibility.

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A

B

Milit

ary

G

ood

s

Consumer Goods

Unattainable

Inefficient

Production Possibilities CurveEfficient

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The law of increasing opportunity costs states that the opportunity cost increases as the production of an output expands. The explanation for the law of increasing opportunity costs is that the suitability of resources declines sharply as greater amounts are transferred from producing one output to producing another output.

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Investment means that an economy is producing and accumulating capital. Investment consists of factories, machines, and inventories (capital) produced in the present that are used to shift the production possibilities curve outward in the future.

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Economic growth is represented by the production possibilities curve shifting outward as the result of an increase in resources or an advance in technology.

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ACom

pu

ters

Pizzas

Technological Advance

B

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Technologicaladvance

Economicgrowth

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END