Download The production possibility frontier (1)

Chapter 1
Economics and the Economy
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
9th Edition, McGraw-Hill Education, 2008
PowerPoint presentation by Alex Tackie and Damian Ward
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Society and Scarce Resources:
– The management of society’s resources
is important because resources are
scarce.
– Scarcity. . . means that society has
limited resources and therefore cannot
produce all the goods and services
people wish to have.
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Economics is the study of how society
manages its scarce resources.
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What is Economics?
• ECONOMICS ...
• is the study of how society decides:
– What
– For whom
– How
to produce...
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The price of oil
Tripled in 1973-74, and doubled again in 1979-80
… and affected people all over the world.
120
US$ per barrel
100
80
60
40
20
0
1965
1970
1975
1980
1985
1990
1995
2000
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An increase in the price of oil
affects:
• What to produce
– less oil-intensive products
• How to produce
– less oil-intensive techniques
• For whom to produce
– oil producers have more buying power;
importers have less
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The distribution of world population and
GNP, 2007
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
GNP
Population
LIC
MIC
HIC
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Income Distribution and Three
Questions
• Poor Countries which has 40% of the population
has 3% of the total income
• Rich Countries has 15% of the population and get
80% of the total income
• What to produce
– Whatever consumers in developed countries
prefer.
• How to produce
– Cheaper techniques (labor or capital intensive)
• For whom to produce:
– Consumers in developed countries
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Scarcity forces choices to be
made
• Opportunity cost
• a crucial concept in economic analysis
• the quantity of other goods that must be
sacrificed to obtain another unit of a good
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The production possibility frontier
(1)
• For each level of the output of one good, the production
possibility frontier shows the maximum amount of the
other good that can be produced.
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The production possibility frontier
(2)
F/G = opportunity cost
Food output (F)
(=1/2)
Unattainable
points
A

14
F= 4
10
G = 8
6
B
14
Production
possibility
frontier
Film output (G)
Production
possibilities set.
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The production possibility frontier
(3)
• The points on the curve are efficient points
because these represents the maximum
production given the limited resources.
• The points below the curve (in the set) are
inefficient points.
• The points above the curve are unattainable
points
• If the economy grows and have more capital,
labor, land or technology, the PPF shift out and
the previously unattainable points would be a
possibility.
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The production possibility frontier
(5)
• Diminishing Marginal Returns
• The PPF is a curve (not a line !) because the
opportunity cost of producing a product increases
as we produce more of that product.
• As we produce more of a good, we have to use
less productive inputs in production of that good.
This increases the opportunity cost.
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The operation of markets
• Market
• a shorthand expression for the process by
which …
– households’ decisions about consumption of
alternative goods
– firms’ decisions about what and how to
produce
– and workers’ decisions about how much and
for whom to work
• … are all reconciled by adjustment of prices
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Resource allocation (1)
• Resource allocation is crucial for a society and is
handled in different ways in different societies,
e.g.:
– Command economy
– Mixed economy
– Free market
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Resource allocation (2)
• In market economies, the prices are determined
by supply and demand.
• The price is an important factor for resource
allocation.
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Efficiency or Equity ?
• In market economies, efficiency is more of a
concern whereas the planned economies gives
more emphasis on equity.
• Since the prices are not free in the planned
economies a central office decides the prices and
the production. A heavy bureaucracy is required
for this process. Lack of competition decreases
the productivity and quality in planned
economies.
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Market orientation
China
Cuba
Command
economy
Sweden
Hungary
USA
UK
Free
market
economy
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Normative and Positive
Economics
• Positive economics deals with objective
explanation
– e.g. if a tax is imposed on a good its price will
tend to rise
• Normative economics offers prescriptions based
on value judgements
– e.g. a tax should be imposed on tobacco to
discourage smoking
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Micro and Macro (1)
• Microeconomics
– offers a detailed treatment of individual
economic decisions concerning particular
commodities
– Footballers’ wages and the price of oil, for
example, are both microeconomic issues
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Micro and Macro (2)
• Macroeconomics
– emphasises the interactions in the economy as
a whole
– Gross domestic product, the aggregate price
level and unemployment, for example, are all
macroeconomic issues
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Models and data
• If we investigate the relationship between
unemployment and minimum wage, we should
start with a model.
• Model
– a framework based on simplifying
assumptions
– helps to organize our economic thinking
• Data
– the economist’s link with the real world
– time series
– cross section
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Real and nominal
• Many economic variables are measured in
money terms
• Nominal values
– measured in current prices
– not good for time series analysis.
• Real values
– adjusted for price changes compared with a
base year
– measured in constant prices
– Good for time series analysis.
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