Chapter 2The Concept of Opportunity CostOpportunity Cost for IndividualsSlide 4Slide 5Example 1Example 2Example 3Opportunity Cost and SocietyProduction Possibilities Frontiers (PPF)Production Possibilities FrontiersSlide 12Increasing Opportunity CostThe Search for a Free LunchProductive inefficiencyEconomic GrowthSlide 17Slide 18Slide 19Slide 20Consumption versus GrowthSlide 22Economic SystemsSpecialization and ExchangeSlide 25Further Gains to SpecializationSlide 27Slide 28Resource AllocationMethods of Resources AllocationThe Nature of MarketsThe Importance of PricesResource Allocation in the USResource OwnershipTypes of Economic SystemsSlide 36Understanding the MarketAre We Saving Lives Efficiently?Slide 39Chapter 2Scarcity, Choice, and Economic SystemsECONOMICS: Principles and Applications, 4e HALL & LIEBERMAN, © 2008 Thomson South-WesternThe Concept of Opportunity Cost•Opportunity cost of any choices–What we must forego when we make that choice –Accurate and complete concept of cost–Used when making or analyzing decisions –Everything you actually sacrifice in making the choice–The next best choice is used to determine the opportunity cost of the choice2Opportunity Cost for Individuals•When the alternatives to a choice are mutually exclusive, only the next best choice, the one that would actually be chosen, is used to determine the opportunity cost of the choice.•Economists like to attach a monetary value to opportunity cost.34Opportunity Cost for Individuals•The opportunity cost of a choice includes–Explicit cost•The dollars sacrificed - and actually paid out for a choice–Implicit cost; e.g. foregone income•The value of something sacrificed when no direct payment is madeOpportunity Cost for Individuals•Arises from the scarcity of time or money•Time is money: –The sacrifice of time often means sacrifice of money–The money that could have been earned during that time5Example 1•Jessica, a writer, decides to see a movie•Ticket: $10; time: 3 hours.•Assume:–Wage rate: $20/hr; •Opportunity cost: $10+3*$20=$706Example 27FIGURE XHours StudyingPhysics ScoreGeology Score0 40 301 50 602 60 803 85 904 90 100•4 hours to study for two exams;•If spending two hours studying each, what would be his opportunity cost of an additional hour studying physics?•ANSWER: 20 points on his geology examExample 38•A weapons plant can manufacture 1,000 more guns or 50 more tanks /yr. What is the plant’s opportunity cost of an extra gun? 1/20 of a tank9Opportunity Cost and Society•Arises from the scarcity of society’s resources•Our desire for goods is limitless–Limited resources to produce them•To produce more of one thing–Society must shift resources away from producing something elseProduction Possibilities Frontiers (PPF)10•Figure 2 The Production Possibilities FrontierNumber of Tanks per YearBushels of Wheat per Year1,000 2,000 3,000 4,000 5,0001,000,000950,000850,000700,000400,000BACDEF11Production Possibilities Frontiers•Production Possibilities Frontier (PPF) –A curve showing all combinations of two goods that can be produced with the resources and technology available•Points outside the PPF–Unattainable•Points on or inside the PPF–Attainable12Production Possibilities Frontiers•Figure 2 The Production Possibilities FrontierNumber of Tanks per YearBushels of Wheat per Year1,000 2,000 3,000 4,000 5,0001,000,000950,000850,000700,000400,000BACDEFWall resources areused for wheatMoving from point A to point Brequires shifting resources outof wheat and into tanksall resources areused for tanks13Increasing Opportunity Cost•The law of increasing opportunity cost –The more of something we produce, the greater the opportunity cost of producing even more of it–Explains •The concave (upside-down bowl) shape of the PPF•Why the PPF becomes steeper as we move rightward and downward14The Search for a Free Lunch•There is no such thing as a free lunch–Even if a meal is provided for free of charge to someone, society still uses up resources to provide it–From society’s point of view, there is no such thing as free internet service, free broadcast television.Productive inefficiency•A firm, an industry, or an entire economy is productively inefficient if it could produce more of at least one good without sacrificing the production of any other good•When inefficient, we are operating inside the PPF (all resources are being used, but not in the most productive way)1516Economic Growth•Produce more of everything–Increase the economy’s productive capacity•Factors contributing to economic growth–Increase in the quantities of available resources•Physical capital•Human capital–Technological change17Economic Growth•Figure 4 Economic Growth and the PPF (a)Wheat (bushels per year)Tanksper YearAA’DHJF3,000 5,000700,0001,000,0001,200,000Additional resources or technological advance affect only the wheat production18Economic Growth•Figure 4 Economic Growth and the PPF (b)Wheat (bushels per year)Tanksper YearAD5,0001,000,0001,200,0006,000Additional resources or technological advance affect only the tank production19Economic Growth•Figure 4 Economic Growth and the PPF (c)Wheat (bushels per year)Tanksper YearD5,0001,000,0001,200,000Additional resources or technological advance affect the production of both goods6,000Economic Growth•A technological change or an increase in the capital stock, even when the direct impact is to increase production of just one type of good, allows us to choose greater production of all types of goods.2021Consumption versus Growth•Capital:–a resource: produce goods and services–a good: needs resources to be produced •Technological change–Needs resources – used in (R&D)•The tradeoff: Resources •Used to produce capital (R&D) this year •not being used to produce consumer goods22Economic Growth•Figure 5 How Current Production Affects Economic GrowthConsumer Goods(units per year)Capital Goods(units per year)A(a) High Consumption, Low GrowthConsumer Goods(units per year)Capital Goods(units per year)A’(b) Low Consumption, High GrowthThis year’s PPFNext year’s PPFThis year’s PPFNext year’sPPF23Economic Systems•Economic system–The way our economy is organized•Specialization –Each person specializes in a limited number of activities•Exchange–Trading with others to obtain what we want24Specialization and ExchangeEnable us to enjoy–Greater
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