ECON 110 Introductory Microeconomics

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ECON 110Introductory Microeconomics

• Lecture 2
• Fall, 2009
• William Chow

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PPF Contd

• Obviously, there are different types of goods and
  services a country can produce
• To simplify analysis, we deal with 2 goods at a
  time
• E.g. By mobilizing its resources, Germany can
  produce beer and/or sausages
• We use the example in the book with Guns and
  Butter

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PPF with Guns and Butter
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PPF with Guns and Butter

• Each point in the diagram represents a
  combination of (Butter, Guns) produced
• The blue curve is the PPF
• All points bounded by X-axis, Y-axis and the PPF
  are attainable

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PPF with Guns and Butter
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PPF with Guns and Butter

• Beyond the PPF, combinations of Butter and Guns
  not achievable
• A point on the PPF indicates production
  efficiency - we cannot ? the production of one
  good without ? that of the other

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PPF with Guns and Butter

• A tradeoff is thus necessary when on the PPF
• Is this true for points inside the PPF (in the
  color region)?
• The Answer is NO. It entails wastage or
  mis-allocation of resources

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Important Notes

• The PPF is downward sloping (the slope is
  negative).
• This signifies a tradeoff situation more
  butter, less guns or vice versa.
• The slope increases from NW direction to the SE.

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Important Notes
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Important Notes

• The key here is opportunity cost. Recall this is
  the value of best alternative forgone
• In this context, it is the slope of the PPF

Amount of Guns Forgone _________________
______________ Amount of Butter Produced
additionally
? Guns ______ ? Butter
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Important Notes

• This is the opportunity cost of producing Butter
• It increases as more and more Butter is produced
  imagine that when ALL resources (including
  mechanical engineers) are used to produce butter,
  some of these resources are not being used
  efficiently the cost of trading off more guns
  for butter becomes very large.
• The inverse of the slope is the opportunity cost
  of producing Guns

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Important Notes

• This is because

? Butter ______ ? Guns
Amount of Butter Forgone _____________
__________________ Amount of Guns Produced
Additionally
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Important Notes

• The PPF is not a line, it bows outward
• This is because resources used to produce Guns
  and Butter are NOT Perfect Substitutes
• We know that to be on the PPF is production
  efficient
• Is there a single point that is especially
  preferred?
• Turns out that the Answer is YES.