Chapter 2

Production Possibilities
and Opportunity Cost
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2000 South-Western College Publishing
1
In this chapter, you will
learn to solve these
economic puzzles:
Why
Why would
are you
so fewspend
rock
Why are investment and an
extra
stars hour
or reading
movie stars
economic growth so this
in
text, rather
your than going
classes?
important? to a
movie or sleeping?
2
 What are the three
Fundamental Economic
Questions?
What to produce?
How to produce?
For whom to produce?
* Return to previous slide while in slide show
3
 What is
Opportunity Cost?
The best alternative
sacrificed for a
chosen alternative

4
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
5
 Can Opportunity Cost
be something other than
money?
Yes! That most desired
activity that you are
presently giving up
is considered an
opportunity cost
6
 What is
Marginal Analysis?
An examination of the
effects of additions to
or subtractions from a
current situation

7
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
8
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
9
What is Technology?
The body of knowledge
and skills applied to how
goods are produced

10
 Production Possibilities Curve
A Efficient
Military Goods

Unattainable

Inefficient

B
Consumer Goods
11
 What three assumptions
underlie the Productions
Possibilities Curve Model?
• Fixed resources
• Fully employed resources
• Technology unchanged

12
What is the conclusion of
the Production
Possibilities Curve?
Scarcity limits an
economy to points on or
below its production
possibilities curve
13
 What is the Law of
Increasing
Opportunity Costs?
The principle that the
opportunity cost
increases as production
of one output expands
14
 What is
Economic Growth?
The ability of an economy to
produce greater levels of
output, represented by an
outward shift of its
production possibilities curve
15
Computers
Technological Advance

Pizzas
16
 What happens when a
country decides not to
invest in new technology?
Everything else being equal,
the country will not grow

17
 What is Investment?
The accumulation of capital,
such as factories,
machines, and inventories,
that is used to produce
goods and services

18
What is the Opportunity
Cost of investment?
The consumer goods that
could have been purchased
with the money spent for
plants and other capital

19
What does an increase in
investments make
possible in the future?
Economic growth and
more goods and services

20
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
21
Key Concepts

22
• What are the three Fundamental Economic Q
• What is Opportunity Cost?
• Can Opportunity Cost be something other tha
• What is Marginal Analysis?
• What is a Production Possibilities Curve?
• What three assumptions underlie the Producti

23
• What is the conclusion of the Production Possi
• What is the Opportunity Cost of investment?
• What does an increase in investments make po
• What conclusion can we make about investmen

24
Summary

25
 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.
26
 Opportunity cost is the best
alternative foregone for a chosen
option. This means no decision
can be made without cost.

27
 Opportunity
Cost

Choice

Scarcity
28
 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.

29
 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:

30
 (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.
31
 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.

32
 Production Possibilities Curve
A Efficient
Military Goods

Unattainable

Inefficient

B
Consumer Goods
33
 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.

34
 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.

35
 Economic growth is represented
by the production possibilities curve
shifting outward as the result of an
increase in resources or an advance in
technology.

36
Computers
Technological Advance

B
A

Pizzas
37
 Economic
growth

Technological
advance
38
Chapter 2 Quiz

©2000 South-Western College Publishing

39
1. Which of the following decisions must be
made by all economies?
a. How much to produce? When to
produce? How much does it cost?
b. What is the price? Who will produce it?
Who will consume it?
c. What to produce? How to produce? For
whom to produce?
d. none of the above.
C. Regardless of the size of wealth of a
nation, it must choose a system to answer
these three basic questions
40
2. A student who has one evening in which to
prepare for two exams on the following day
has the following two alternatives:

Possibility Score in Economics Score in Accounting

A 95 80
B 80 90

41
Possibility Score in Economics Score in Accounting
A 95 80
B 80 90
The opportunity cost of receiving 90, rather
than 80, on the accounting exam is
represented by how many points on the
economic exam?
a. 15 points. A. By spending more time
b. 80 points. studying for accounting and
therefore spending less time
c. 90 points. studying for the economics
d. 10 points. exam, 15 points on the
economics exam are given up.
42
3. Opportunity cost is the
a. purchase price of a good or service.
b. value of leisure time plus out-of-pocket
costs.
c. best option given up as a result of
choosing an alternative.
d. Undesirable sacrifice required to
purchase a good.
C. Opportunity cost is that which is
given up in the best alternative, not
that which is paid in money for the
good bought.
43
 Production Possibilities Curve
A Efficient
Military Goods

Unattainable

Inefficient

B
Consumer Goods
44
4. On a production possibilities curve, the
opportunity cost of good X in terms of good
Y is represented by
a. the distance to the curve from the
vertical axis.
b. the distance to the curve from the
horizontal axis.
c. the movement along the curve.
d. all of the above.
C. To have more units of good X a person will
have to give up units of good Y as
represented on the horizontal axis.

45
5. A farmer is deciding whether or not to add
fertilizer to his or her crops. If the farmer adds
1 pound of fertilizer per acre, the value of the
resulting crops rises from $80 to $100 per acre.
According to marginal analysis, the farmer
should add fertilizer if it costs less than
a. $12.50 per pound.
b. $20 per pound.
c. $80 per pound.
d. $100 per pound.
b. As long as the fertilizer costs less than $20
per acre, the farmer will gain more by
fertilizing then he or she will lose by the
expense of the fertilizer.
46
6. On a production possibilities curve, the
opportunity cost of good X in terms of good Y
is a production possibilities curve; a change
from economic inefficiency to economic
efficiency is obtained by
a. movement along the curve.
b. movement from a point outside the curve
to a point on the curve.
c. movement from a point inside the curve to
a point on the curve.
d. a change in the slope of the curve.
C. All points on the production possibilities
curve represents combinations of both
goods while operating at the most efficient
level possible.
47
7. Any point inside the production
possibilities curve is a (an)
a. efficient point.
b. nonfeasible point.
c. inefficient point.
d. maximum output combination.
C. While operating within the boundaries of
the production possibilities curve, more of
both goods can be attained if efficiency is
improved. However, points beyond the
curve are not possible without an increase
in resources or technological advance.
48
8. Using a production possibilities curve,
unemployment is represented by a point
located
a. near the middle of the curve.
b. at the top corner of the curve.
c. at the bottom corner of the curve.
d. outside the curve.
e. inside the curve.
E. Any point underneath the production
possibilities curve indicates that the
economy’s resources are not being
used efficiently, including labor.
49
9. Along a production possibilities curve, an
increase in the production of one good can
be accomplished only by
a. decreasing the production of another
good.
b. increasing the production of another
good.
c. holding constant the production of
another good.
d. producing at a point on the corner of the
curve.
A. Along the production possibilities curve,
there are no unemployed resources.
Therefore, in order to produce more of
one product, units of the other product
must be given up.
50
 10. Education and training that improve the
skill of the labor force are represented on
the production possibilities curve by a
(an)
a. movement along the curve.
b. inward shift of the curve.
c. outward shift of the curve.
d. movement toward the curve from an
exterior point.
C. Investment in human capital enhances
people’s ability being able to more
effectively use the economy’s capital and
push the production possibilities curve
outward where more units of both
products can be attained.
51
11. A nation can accelerate its economic
growth by
a. reducing the number of immigrants
allowed into the country.
b. adding to its capital stock.
c. printing more money.
d. imposing tariffs and quotas on
imported goods.
B. By increasing its stock of capital a nation
can increase its productivity.

52
 Internet Exercises
Click on the picture of the book,
choose updates by chapter for
the latest internet exercises

53
END

54