### Chapter 1 Introduction: What is Economics?

```The Model of Production
Possibilities
This is a basic model designed to
highlight the impact of scarcity on
an economic system
1
The model of production
possibilities
One way to illustrate the notion of opportunity cost is
to study the model of production possibilities. In this
model of production possibilities we assume:
1) Only two goods are produced at a given time – pizza
and chapter notes.
2) There are only so many resources available for
production and they are all fully employed;
3) There is a given state of technology;
4) Resources are used to the fullest - technical or
productive efficiency is achieved – for now take this to
mean that resources are used in such a way that the
most output is obtained from them.
2
the ppc model
Let’s say we have 4 people in the economy and with the
resources available each person can produce the given amount
below of pizza OR typed chapter notes in a one hour time
frame. The data is
Blanky 1 pizza or 1 chapter
Gleeper  1 pizza or 2 chapters
Koch  1 pizza or 3 chapters
Theman  1 pizza or 4 chapters.
Note: if all 4 make pizza, then only 4 pizza can be made. If all
4 make chapter notes, then 10 chapter notes can be made.
3
the ppc model
Consider the situation where all are making chapter notes.
We then have 10 chapters made and no pizza. Another
possibility is that we want 1 pizza made and then all the
chapter notes we can get. Who should make the first pizza?
Well, if we want the most from our resources (follow the
assumptions of the model), then Blanky should make the first
pizza because he only gives up one set of chapter notes.
So, another production possibility is 1 pizza and 9 chapter
notes. Using similar logic you will see on the next screen the
production possibilities for the economy.
4
the ppc model
pizza
0
1
2
3
4
chapter notes
10
9
7
4
0
Do you know who made the 2nd, 3rd and 4th pizzas? Let’s put
this data in a graph on the next screen.
(By the way, this table should be read as we can have 0 pizza
and 10 chapter notes, or 1 pizza and 9 chapter notes, and so
on.)
5
the ppc model in a graph
chapter notes
(0, 10)
Each point is an
ordered pair with
pizza first and then
chapter notes.
(1, 9)
(2, 7)
(3, 4)
(4, 0)
pizza
6
Model of PP
When the resources available in the economy are employed and
used to the fullest, the level of production in the economy can be
anywhere along the production possibility curve - PPC.
Things to note about the PPC:
1) The curve shows the maximum output the economy can produce;
2) At any point on the curve, the only way more of one good can be
obtained is if less of the other good is produced - this is the idea of a
3) The curve is bowed out. The reason for the bowed out shape is
that all resources are NOT perfectly adaptable to the production of
both items. Some resources are better suited to making one item
over the other. This is the law of increasing relative cost. (This is
also part of the table we saw before.)
7
Model of PP
To see this last point more clearly, think about being in the upper
left of the graph. Then as one pizza is produced in the economy, the
resources that leave chapter notes are relatively not very good in
chapter note production and so not many chapters are sacrificed.
But, as even more pizzas are made, good chapter note resources
leave and thus chapter production drops by larger and larger
amounts.
You could say a corollary to the principle of opportunity cost is the
notion of increasing relative (opportunity) cost that we see in this
example. In making pizza, the cost of chapter notes forgone
increases the more pizza that is made.
8
Model of PP
How much did the first pizza cost in terms of chapter notes
forgone? Just 1 (Chapter notes went from 10 to 9).
How much did the second pizza cost in terms of chapter notes
forgone? 2 (Chapter notes went from 9 to 7).
Does each pizza cost the same to make? We just showed the
answer to this question to be NO! The cost of making pizza
increases because with each additional pizza not only do we
give up chapter notes, but an increasing amount of chapter
notes is given up.
What do the third and fourth pizzas cost?………………..
9
Economic growth
Economic growth is a situation where more can be produced
in an economy. In our model of production possibilities we
assumed that resources and the state of technology were
fixed.
But if these things actually change in that we get more of
them, then the curve shifts out. This would be an indication
of economic growth.
On the next slide lets focus on two special kinds of output consumption goods and capital goods.
10
Special PPC
Capital
N
M
L
Consumption
11
Special PPC
When we recognize that capital is a resource that is man made
we recognize we have a trade-off between present and future
consumption. As we compare points N, M and L on the
previous screen we see point N has the most capital, but the
least consumption.
The more we move to point N,
the less current consumption we have,
the more future consumption we can have because with
more of the resource capital, the more the curve would shift
out.
Note: we could debate all day, probably, where we should be
on the curve, but that is not the point at this time!
12
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