ECON 1001AEF / A121F

Tutorial Notes (Topic 2 Ch 3)

The Economic Problem
Outline
• 1. Production Possibilities
• Production Possibility Frontiers (PPF)
• 2. Opportunity Cost
• The Opportunity Cost of a Cell Phone
• Opportunity Cost and the slope of the PPF
• 3. Economic Growth
• Discussion Questions
Production Possibilities
• Production Possibility Frontiers
(PPF)
• The PPF is the boundary between
the combinations of goods and
services that can be produced
and the combinations that
cannot be produced; given the
available factors of production
and the state of technology.
• Example :
• Production combinations “A”, “B”
“C” and “X” can be produced;
whereas production combination
“Y” cannot be produced
Production Possibilities
• Figure 1 shows the
PPF for cell phones
and DVDs.
• Each point on the
graph represents a
column of the table.
• The line through the
points is the PPF.
Production Possibilities
Note the three features of
production possibilities :
•  Attainable and
unattainable combinations
•  Efficient and inefficient
production
•  Tradeoffs and free
lunches
Attainable vs. Unattainable Combinations
• We can produce at any point Figure 2 : Attainable vs. Unattainable Combinations

inside the PPF or on the

frontier.
• We cannot produce at any
point outside the PPF such as
point G.
• The PPF separates attainable
combinations from
unattainable combinations.
Efficient Production vs. Inefficient Production
• Production efficiency is a situation in Figure 3 : Efficient vs. Inefficient Production
which we cannot produce more of one
good or service without producing less of
something else.
• Figure 3 illustrates the distinction
between efficient and inefficient
production.
• 1. When production is on the PPF,
such as at point E or D, production is
efficient.
• 2. If production were inside the PPF,
such as at point H, more could be
produced of both goods without
forgoing either good  production is
inefficient
Trade-off vs. Free-Lunch Figure 4 : Trade-offs vs. Free Lunch

• A tradeoff is an exchange—giving up one

thing to get something else.
• A free lunch is a gift—getting something
without giving up something else.
• Figure 4 illustrates the distinction between a
tradeoff and a free lunch.
• 3. When production is on the PPF, we face a
tradeoff.
• 4. If production were inside the PPF, there
would be a free lunch  ie. moving from
point H to point D does not involve a
tradeoff.
Opportunity Cost Figure 5 : Calculating the Opportunity Cost

• The Opportunity Cost of a Cell Phone

• The opportunity cost of a cell phone is the
decrease in the quantity of DVDs divided by
the increase in the number of cell phones as
we move along the PPF.
• Figure 5 illustrates the calculation of the
opportunity cost of a cell phone.
• Formula :
• The Opportunity Cost of a Cell Phone =
Decrease in Quantity of DVDs Produced
Increase in Quantity of CDs Produced

• Example :
• As we move from production combination
point “A” to production combination point
“B”  we decrease the quantity produced
of DVDs by 1 million units and increase the
quantity produced of cell phones by 1
million units
• Hence, the opportunity cost of a cell phone
as we move from production combination
point “A” to production combination point
“B” = 1 million DVDs = 1 DVD
• 1 million cell phones
 Opportunity Cost and The Shape (Slope) of the PPF

• The PPF is bowed outward – ie. concave.

• As more cell phones are produced, the
slope of the PPF becomes steeper and the
opportunity cost of a cell phone increases.
• Example :
• As we move from production combination
point “B” to production combination point
“C” : the opportunity cost of 1 cell phone
increases from 1 DVD to 2 DVDs
• Opportunity cost of 1 cellphone (“B” to “C”)
• = 14 million – 12 million
• 2 million – 1 million
• = 2 million DVDs
• 1 million cell phones
• = 2 DVDs per cell phone
 Figure 6 : Increasing Opportunity Cost
Opportunity Cost
• Increasing Opportunity Cost
• As shown in Figure 6 : the
opportunity cost of a cell
phone increases as more cell
phones are produced.
• Reason :
• As more and more of a good
is produced, resources
suitable to produce the good
becomes increasingly scarce
 more of the good may only
be produced at higher
opportunity cost
The PPF and Economic Growth
• Economic growth is the sustained Figure 7 : An Outward Shift in the PPF Shows
Economic Growth
expansion of production
possibilities.
DVDs
• An economy grows when it
develops better technology,
improves the quality of labor, or
increases the quantity of capital.
PPF2
• When an economy’s resources
increase, its production possibilities
expand and its PPF shifts outward.
• This is illustrated in Figure 7 PPF1

Cell phones
The PPF and Economic Growth
• If there is an increase in the Figure 8 : Improvement in Resources Used to Produce
quality and/or quantity Cell Phones & Outward Shift in PPF
used to produce
cellphones, and no change DVDs
in the resources used to
produce DVDs;
 maximum quantity of
cell phones produced will
increase
• The outward shift in the
PPF is as illustrated in
Figure 8 PPF2
PPF1
Cell phones
The PPF and Economic Growth
• If there is an increase in the Figure 9 : Improvement in Resources Used to Produce
quality and/or quantity DVDs & Outward Shift in PPF
used to produce DVDs, and
no change in the resources DVDs
used to produce cell
phones;
 maximum quantity of
DVDs produced will PPF2
increase
• The outward shift in the
PPF is as illustrated in
Figure 9 PPF1

Cell phones
Discussion Questions : Question 1
• Identify and explain three (3) economic
concepts that may be illustrated in the
production possibility frontier (PPF)?
• Sketch a relevant diagram to illustrate your
answer.
Discussion Points
• Recall :
• The PPF is the boundary between the
combinations of goods and services that
can be produced and the combinations
that cannot be produced; given the
available factors of production and the
state of technology.
• The PPF may illustrate the following
economic concepts :
• 1. Scarcity
• 2. Choice
• 3. Free-lunch, trade-off and opportunity
cost
• 4. Productive efficiency – efficient vs.
inefficient
Discussion Points
• Scarcity
• Points outside the PPF – eg. point “G” is unattainable
• Movement from any point on the PPF to another point on the
PPF
• Example : movement from point “C” to point E” means that 250
units of capital goods (ie. 800 - 550)must be given up to increase
production of consumer goods by 200 units (ie. 1,300 – 1,100) C
• Choice & Opportunity Cost
• Choosing any production combination on or inside the PPF is a
choice
• Example : choosing production combination “E” over production
combination “C” means that more consumer goods is preferred over
capital goods
• And, to produce more consumer goods (ie. increase the production
of consumer goods by 200 units) means a reduction the quantity of
capital goods must be reduced by 250 units
• Opportunity cost for producing 1 more unit of capital good (moving
from “C” to “E”)
• = 250 units of capital goods
• 200 units of capital goods
• = 1.25 capital good per unit of consumer good
Discussion Points
• Productive Efficiency, Trade-offs and Free- Lunch
• Production efficiency: A situation in which the
economy is producing all that it can from its resources
and cannot produce more of one good or service
without producing less of something else.
• Thus, any production combination on the PPF (eg. points A,
C, E and B) are productively efficient
• Producing on any point on the PPF would mean that it is NOT
possible to increase the production of one good without
reducing the production of the other good.
• This means that trade-offs and opportunity cost must be
incurred when we choose one production combination over
another (eg. Production combination “C” over “E”
• Production combinations inside the PPF – eg.
production combination “D” is productive inefficient
• More of either capital goods or consumer goods may be
produced without reducing the production of the other good
– ie. a point like “D” represents “free lunch”
 Discussion Questions : Question 2
Figure 1 : Concave (Bowed Outward) PPF
• Refer to the
following
production
possibility frontiers
(PPFs).
• Which PPF exhibits
increasing
opportunity cost?
Explain.
Figure 2 : Linear (Straight-Line) PPF
• Which PPF exhibits
constant
opportunity cost?
Explain.
Discussion Points
Figure 1 : Concave (Bowed Outward) PPF
• A concave PPF shows increasing
opportunity cost
• As more and more of a good is
produced  an increasing number
of the other good must be given up
• Moving from production combination
A to B : opportunity cost of producing
1 more hamburger
• = 100 hotdogs  200 hamburgers
= ½ hotdog per hamburger
• However, as more of hamburgers are
produced  opportunity cost of
producing 1 more hamburger
increases
• Example :
• As we move from production
combination D to E : opportunity cost
of producing 1 more hamburger
• = 200 hotdogs  100 hamburgers 950
= 2 hotdogs per hamburger 1,050
Discussion Points Figure 2 : Linear (Straight-Line) PPF
• A linear (straight-line) PPF (ie. Figure 2)
shows constant opportunity cost
A
• Regardless of the level of production of a
good, opportunity cost remained constant
when increasing the quantity produced
• In other words, as more of a good is
produced, opportunity cost to produce 1
more unit of the good remained constant.
• Example :
G
• Moving from production combination “A” to 9
“G” : opportunity cost of producing 1 coconut
• = 9 fishes  12 coconuts
= 0.75 fish per coconut
• Moving from production combination “G” to
“M” : opportunity cost of producing 1
coconut = 9 fishes  12 coconuts M
= 0.75 fish per coconut.
• Note that the opportunity cost of 1 coconut 24
12
remained unchanged (ie. at 0.75 fish per
coconut) although the production of coconut
has increased.
Discussion Questions : Question 3
• Refer to the extract and
answer the following
questions :
• a. Is it possible for the US to
produce 4 trillion cubic feet of
shale gas and 100 units of
other goods and services?
Why?
• b. What does the shift from
PPF10 to PPF12 signify?
• c. What causes the shift from
PPF10 to PPF12?
• d. Does the US face scarcity
following its shift from PPF10
to PPF12? Explain.
 a. Is it possible for the US to produce 4
Discussion Point : Question 3(a) trillion cubic feet of shale gas and 100
units of other goods and services?
Why?

• No, it is not possible for the US to

produce 4 trillion cubic feet of shale
gas and 100 units of other goods
and services
⚫X
• Reason :
• Scarcity of resources
• This production combination is
illustrated by point “X” – a point
outside the US’s PPF – ie.
unattainable with currently available
resources
 b. What does the shift from PPF10 to
Discussion Point : Question 3(b) & (c) PPF12 signify?
c. What causes the shift from PPF10 to
PPF12?
• An outward shift in the PPF show
increased production
combinations – ie. economic
growth
• According to the extract : this
outward shift in the PPF is due to
an advancement in technology
for extracting gas
• This advancement in technology
lowered the cost of extracting
gas, increased the opening of gas
wells  hence, greatly increased
the production of shale gas.
 d. Does the US face scarcity following
Discussion Point : Question 3(d) its shift from PPF10 to PPF12?
Explain.

• Yes.
• The US still face scarcity on PPF12.
• Reason :
• Wants are unlimited (infinite) ;
whereas, although capacity to produce
has increased, these resources are still
finite (limited)
• Example :
• To increase production of shale gas
⚫L
from 8 trillion cubic fee to 10 trillion
cubic feet, the US still need to reduce
the production of other goods and
services from 50 units to 24 units
Discussion Questions : Question 4
• According to the World Health Organization
malaria chief, fully eradicating the disease is
possible, but costly.
• He says that using nets, medicines and DDTs, it
is possible to eliminate 90 percent of malaria.
But to eliminate 100 percent of cases would be
extremely costly.

• a. Sketch a graph of the production possibility

frontier with malaria control on the x-axis and
other goods and services on the y-axis.
Discussion Points Increasing Opportunity Cost for Eradicating Malaria

• Based on the information : PPF is

bowed outwards (ie. concave)
• Implies increasing opportunity cost for
eradicating malaria as more resources
are used to control malaria.
• Indeed, the malaria chief indicated that
the opportunity cost of eliminating the
last 10 percent of malaria would be
extremely high.
• This implies that the slope of the PPF
would be very steep between 90
percent elimination and 100 percent
elimination.
• See figure on the right.
Discussion Questions : Question 5
• What will happen to US production
possibilities as a result of the following
events?
• Sketch relevant PPFs to illustrate your
answer.
• a. Some airline workers were re-employed
to build solar power plants.
• b. Many people opt for early retirement.
• c. Floods devasted New Orleans economy.
 a. Some airline workers were re-
Discussion Points – Question 5(a) employed to build solar power
plants.
• Movement along the PPF
• In this case, the production of Airline Services
solar power plants increased as
more workers are allocated to
the production of solar power
plants; and the production of ⚫ B
airline services decreased as less
workers are now employed ⚫ C
• Note : there are NO increase in the
quantity and quality of labor; but a
mere re-allocation PPF1
• This is shown as movement
down the PPF in the figure on Solar Power Plants
the right
 b. Many people opt for
Discussion Points – Question 5(b) early retirement.

• The PPF shifts inward

• Reason :
• Fewer labor is now
available – ie. a decrease
in the quantity of labor
available  this will
lower a country’s
production capability &
the PPF will shift inward.
• See figure on the right
 c. Floods devasted New
Discussion Points – Question 5(c) Orleans economy.
• The PPFs shifts inwards.
• Reason :
• The floods destroys both
land (ie. natural resources
such as arable land) and
capital (ie. buildings and
infrastructure)  this will
lower production capability
& the PPF will shift inwards.
• See figure on the right
Multiple Choice Questions
• Question 1

• The production possibilities frontier illustrates the

• A.maximum combinations of goods and services that can be
produced.
• B.resources the economy possess, but not its level of technology.
• C.goods and services that people want.
• D.limits to people's wants.
Multiple Choice Questions
• Question 2
• Consider a production possibility frontier with jeans on the
vertical axis and shoes on the horizontal axis. As the country
moves along the frontier closer to the horizontal axis,
• A. more jeans are produced.
• B. the country eventually chooses an unattainable point.
• C. more tradeoffs occur.
• D. more shoes are produced.
Multiple Choice Questions
• Question 3
• Production efficiency occurs
• A. anywhere inside or on the production possibilities
frontier.
• B. at all points on the production possibilities frontier.
• C. at only one point on the production possibilities frontier.
• D. at all points inside the production possibilities frontier.
Multiple Choice Questions
• Question 4
• A movement from a point inside the production possibilities frontier
to a point on the production possibilities frontier represents
• A. a tradeoff.
• B. a free lunch.
• C. full employment of labor but not capital.
• D. unemployment of labor but not capital.
Multiple Choice Questions
• Question 5

• A reason the production possibilities frontiers exist is :

• A. unlimited resources and technology.

• B. scarcity of resources.
• C. unemployment.
• D. that people’s wants are unlimited.
Multiple Choice Questions
Table 1
• Refer to Table 1 to answer the Questions 6 - 8
• Question 6 Fish Berries
• Table 1 shows the PPF of an island community. Choose the Possibility (pounds) (pounds)
best statement.
A 0 and 40
• A. This community has enough resources to produce 2
pounds of fish and 36 pounds of berries. B 1 and 34
• B. This community cannot produce 2 pounds of fish and C 2 and 27
36 pounds of berries because this combination is D 3 and 19
inefficient.
E 4 and 10
• C. This community will waste resources if it produces 2
pounds of fish and 27 pounds of berries. F 5 and 0
• D. This community can produce 2 pounds of fish and
25 pounds of berries but this combination is
inefficient.
Multiple Choice Questions
Table 1
• Refer to Table 1 to answer the Questions 6 - 8
• Question 7 Fish Berries
• Table 1 shows the PPF of an island community. Choose the best Possibility (pounds) (pounds)
statement.
A 0 and 40
• A. Suppose that this community produces 3 pounds of fish
and 15 pounds of berries. If it decides to gather more B 1 and 34
berries, it faces a tradeoff.
C 2 and 27
• B. When this community produces 4 pounds of fish and 10
pounds of berries it faces a tradeoff, but it is inefficient. D 3 and 19
E 4 and 10
• C. Suppose that this community produces 5 pounds of fish
and 0 pounds of berries. If it decides to gather some berries, F 5 and 0
it will get a free lunch.

• D. If this community produces 3 pounds of fish and 19

pounds of berries, production is efficient but to produce
more fish it faces a tradeoff.
Multiple Choice Questions
Table 1
• Question 8
• The table above shows the PPF of an island Fish Berries
community. This community’s opportunity Possibility (pounds) (pounds)
cost of producing 1 pound of fish .
• A. is the increase in the quantity of A 0 and 40
berries gathered as the quantity of fish B 1 and 34
increases by 1 pound
C 2 and 27
• B. increases as the quantity of berries
gathered increases D 3 and 19
• C. is 10 pounds of berries if the quantity E 4 and 10
of fish increases from 2 to 3 pounds F 5 and 0
• D. increases as the quantity of fish
caught increases
Multiple Choice Questions
• Question 9 Figure 1
• Refer to Figure 1.
• Which of the following would most
likely have caused the production
possibilities frontier to shift outward
from A to B?
• A. an increase in the availability of
capital-producing resources
• B. a technological advance in the
consumer-goods industries
• C. a general technological advance
• D. a decrease in unemployment
Multiple Choice Questions
• Question 10
Table 2
• Refer to Table 2.
• Toyland is a toy company that produces two items Dolls Fire Trucks
- dolls and fire trucks.
• What is the opportunity cost of 1 doll to Toyland
400 0
as it increases its production of dolls from 200 to
300? 300 200
• A. 2 fire trucks 200 350
• B. 1.50 fire trucks
• C. 1 fire truck
100 450
• D. It is impossible to tell what the opportunity cost 0 500
is since in this example costs are not constant.