BECO1000 Principles of Microeconomics (008, 009), 2024/2025-1

THE ECONOMIC PROBLEM

(Textbook: 63-69, 75-77, 80-81)

The production possibilities frontier (PPF) is the boundary between those combinations of
goods and services that can be produced and those that cannot, given the total resources and
technology available to produce them.

Assumptions:
(1) Given amount of resources
(2) Given state of technology
(3) 2-good case (e.g., pizzas & cola)

The table lists six production possibilities for pizzas and cola. For example, row A tells us that
if we produce no pizzas, the maximum quantity of cola we can produce is 15 million cans.

SCARCITY
The PPF separates the attainable from the unattainable.
(a) Points outside the PPF: unattainable (production impossibilities) - these points describe
wants that cannot be satisfied

(b) Points on the PPF: attainable (production possibilities)

Production efficiency
(full employment of resources [no under-usage/wastage]; no misallocation of resources
[best assignment with skill match])

(c) Points inside the PPF: attainable (production possibilities)

Production inefficiency
(either unemployment of resources [under-usage/wastage]; or misallocation of resources
[assignment with skill mismatch]; or both)

1
CHOICE
A choice along the PPF involves a tradeoff.

OPPORTUNITY COST
A tradeoff involves an opportunity cost. Along the PPF, there are only two goods, so there is
only one alternative foregone: some quantity of the other good. To produce more pizza, we
must produce less cola. The opportunity cost of producing an additional pizza is the cola we
must forgo. Similarly, the opportunity cost of producing an additional can of cola is the quantity
of pizza we must forego.

The negative slope of the PPF indicates the trade-off that a society faces between two goods.

Opportunity cost is the decrease in the quantity produced of one good divided by the increase
in the quantity produced of another good as we move along the PPF.

Opportunity cost of 1 pizza

(in terms of cans of cola)
Get 1 million of pizzas. Forgo 1 million cans of cola (A to B) 1
Get 1 million of pizzas. Forgo 2 million cans of cola (B to C) 2
Get 1 million of pizzas. Forgo 3 million cans of cola (C to D) 3
Get 1 million of pizzas. Forgo 4 million cans of cola (D to E) 4
Get 1 million of pizzas. Forgo 5 million cans of cola (E to F) 5

Moving down along the PPF, the opportunity cost of a piece of pizza increases as the quantity
of pizza produced increases. The outward-bowed shape of the PPF reflects increasing
opportunity cost.

The PPF is bowed outward because resources are not all equally productive in all activities.
People with many years of experience producing cola may not be very good at making pizza.
So, if we move some of these people from producing cola to making pizza, we get a small
increase in the quantity of pizza but a large decrease in the quantity of cola. The more of a good
we try to produce, the less productive are the additional resources we use to produce that good
and the larger is the opportunity cost of a unit of that good.

2
The marginal cost (MC) of a good is the opportunity cost of producing one more unit of it.

Allocative efficiency means producing the quantities of goods and services that provide the
greatest possible benefit.

The marginal benefit (MB) from a good or service is the benefit received from consuming
one more unit of it. This benefit is subjective, which depends on people’s preferences –
people’s likes and dislikes and the intensity of those feelings.

The device that we use to illustrate preferences is the marginal benefit curve, which is a curve
that shows the relationship between the marginal benefit from a good and the quantity
consumed of that good. The marginal benefit from a good or service is measured by the most
that people are willing to pay for an additional unit of it. The more we have of any good or
service, the smaller is its marginal benefit and the less we are willing to pay for an additional
unit of it, because we like variety. The more we consume of any one good or service, the more
we tire of it and would prefer to switch to something else. This is the principle of decreasing
marginal benefit.

3
At any given point on the PPF, we cannot produce more of one good without giving up some
other good. At the best point on the PPF, we cannot produce more of one good without giving
up some other good that provides greater benefit. We are producing at the point of allocative
efficiency - the point on the PPF that we prefer above all other points.

4
ECONOMIC GROWTH
Economic growth influences the pattern of production.

The expansion of production possibilities (shifting out of the PPF) is called economic growth.

Economic growth comes from

(1) capital accumulation (growth of capital resources)
(2) technological change (development of new goods and better ways of producing goods and
services)

Consumer goods and services: goods and services produced for present consumption

Capital goods and services: goods and services produced for further production

To use resources in research and development and to produce new capital, we must decrease
our production of consumption goods and services.

For example, if we devote no resources to producing pizza ovens and produce 5 million pizzas
at point A on PPF0, our production possibilities will remain the same at PPF0. But if we
decrease pizza production to 3 million and produce 6 ovens, at point B on PPF0, our production
possibilities expand. After one period, the PPF rotates outward to PPF1 and we can produce at
point B’, a point outside the original PPF0. We can rotate the PPF outward, but we cannot avoid
opportunity cost. The opportunity cost of producing more pizzas in the future is fewer pizzas
today.

Ethiopia, a low-income country, has production possibilities per person on PPF0. More than
one third of its production, 36 percent, is from agriculture; and 17 percent from industry.
Investment in capital and more productive technology expands production possibilities to the
middle-income level in China on PPF1. Industry increases to 41 percent of production and
agriculture shrinks to 9 percent.

5
At China’s level of production on PPF2, production is divided equally between services and a
combination of agriculture and industry. When investment in capital and more productive
technology expands production possibilities to the high-income level in the United States on
PPF3, most of the increased production is of services, which increases to 80 percent.