PARKIN

MICROECONOMICS
Thirteenth Edition, Global Edition
THE ECONOMIC PROBLEM
After studying this chapter, you will be able to:

 Define the production possibilities frontier and use it to

calculate opportunity cost
 Distinguish between production possibilities and
preferences and describe an efficient allocation of
resources
 Explain how current production choices expand future
production possibilities
 Explain how specialization and trade expand production
possibilities
 Describe the economic institutions that coordinate
decisions
 Production Possibilities and
Opportunity Cost

The production possibilities frontier (PPF) is the

boundary between those combinations of goods and
services that can be produced and those that cannot.
To illustrate the PPF, we focus on two goods at a time and
hold the quantities of all other goods and services
constant.
That is, we look at a model economy in which everything
remains the same (ceteris paribus) except the two goods
we’re considering.

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 Production Possibilities and
Opportunity Cost

Production Possibilities Frontier

Figure 2.1 shows the PPF for two goods: cola and pizzas.

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© 2014 Pearson Education
 Production Possibilities and
Opportunity Cost

Any point on the frontier such as E and any point inside the
PPF such as Z are attainable.
Points outside the PPF are unattainable.

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 Production Possibilities and
Opportunity Cost

Production Efficiency
We achieve production
efficiency if we cannot
produce more of one
good without producing
less of some other good.
Points on the frontier are
efficient.

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© 2014 Pearson Education
 Production Possibilities and
Opportunity Cost

Any point inside the

frontier, such as Z, is
inefficient.
At such a point, it is
possible to produce more
of one good without
producing less of the
other good.
At Z, resources are either
unemployed or
misallocated.

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 Production Possibilities and
Opportunity Cost

Tradeoff Along the PPF

Every choice along the
PPF involves a tradeoff.
On this PPF, we must give
up some cola to get more
pizzas or give up some
pizzas to get more cola.

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 Production Possibilities and
Opportunity Cost

Opportunity Cost
As we move down along
the PPF,
we produce more pizzas,
but the quantity of cola we
can produce decreases.
The opportunity cost of a
pizza is the cola forgone.

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 Production Possibilities and
Opportunity Cost
In moving from E to F:
The quantity of pizzas
increases by 1 million.
The quantity of cola
decreases by 5 million
cans.
The opportunity cost of the
fifth 1 million pizzas is
5 million cans of cola.
One of these pizzas costs
5 cans of cola.
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 Production Possibilities and
Opportunity Cost
In moving from F to E:
The quantity of cola
increases by 5 million
cans.
The quantity of pizzas
decreases by 1 million.
The opportunity cost of
the first 5 million cans of
cola is 1 million pizzas.
One of these cans of cola
costs 1/5 of a pizza.
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 Production Possibilities and
Opportunity Cost
Opportunity Cost Is a
Ratio
Note that the opportunity
cost of a can of cola is the
inverse of the opportunity
cost of a pizza.
One pizza costs 5 cans of
cola.
One can of cola costs 1/5
of a pizza.

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 Production Possibilities and
Opportunity Cost
Question:
What is the OC of increase production of Pizza from A
to B by one unit?
What is the OC from B to C?
What about C to D?
D to E?
E to F?

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 Production Possibilities and
Opportunity Cost
Question:
What is the OC of increase production of Pizza from A
to B by one unit? 1
What is the OC from B to C? 2
What about C to D? 3
D to E? 4
E to F? 5

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 Production Possibilities and
Opportunity Cost
Increasing Opportunity
Cost
Because resources are
not equally productive in
all activities, the PPF
bows outward.
The outward bow of the
PPF means that as the
quantity produced of each
good increases, so does
its opportunity cost.

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 Using Resources Efficiently

All the points along the PPF are efficient.

To determine which of the alternative efficient quantities
to produce, we compare costs and benefits.
The PPF and Marginal Cost
The PPF determines opportunity cost.
The marginal cost of a good or service is the opportunity
cost of producing one more unit of it.

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 Using Resources Efficiently

Figure 2.2 illustrates the

marginal cost of a pizza.
As we move along the
PPF, the opportunity cost
of a pizza increases.
The opportunity cost of
producing one more
pizza is the marginal cost
of a pizza.

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© 2014 Pearson Education
 Using Resources Efficiently

In part (b) of Fig. 2.2, the

bars illustrate the
increasing opportunity
cost of a pizza.
The black dots and the
line MC show the
marginal cost of producing
a pizza.

The MC curve passes

through the center of each
bar.

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© 2014 Pearson Education
 Using Resources Efficiently

Preferences and Marginal Benefit

Preferences are a description of a person’s likes and
dislikes.
To describe preferences, economists use the concepts of
marginal benefit and the marginal benefit curve.
The marginal benefit of a good or service is the benefit
received from consuming one more unit of it.
We measure marginal benefit by the amount that a
person is willing to pay for an additional unit of a good or
service.

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 Using Resources Efficiently

It is a general principle that:

The more we have of any good, the smaller is its marginal
benefit and …
the less we are willing to pay for an additional unit of it.
We call this general principle the principle of decreasing
marginal benefit.
The marginal benefit curve shows the relationship
between the marginal benefit of a good and the quantity of
that good consumed.

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 Using Resources Efficiently
At point A, with 0.5 million pizzas available, people are
willing to pay 5 cans of cola for a pizza.

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© 2014 Pearson Education
 Using Resources Efficiently
At point B, with 1.5 million pizzas available, people are
willing to pay 4 cans of cola for a pizza

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 Using Resources Efficiently
At point E, with 4.5 million pizzas available, people are
willing to pay 1 can of cola for a pizza.

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 Using Resources Efficiently
The line through the points shows the marginal benefit
from a pizza.

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 Using Resources Efficiently

Allocative Efficiency
When we cannot produce more of any one good without giving up some other
good, we have achieved production efficiency.
We are producing at a point on the PPF.
Notes: there might be many production efficiency points
When we cannot produce more of any one good without giving up some other
good that we value more highly, we have achieved allocative efficiency.
We are producing at the point on the PPF that we prefer above all other
points.
Notes: the allocative efficiency point refers to the highest valued point.

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 Using Resources Efficiently

Figure 2.4 illustrates

allocative efficiency.
The point of allocative
efficiency is the point on
the PPF at which marginal
benefit equals marginal
cost.
This point is determined by
the quantity at which the
marginal benefit curve
intersects the marginal
cost curve.

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 Using Resources Efficiently
If we produce fewer than
2.5 million pizzas, marginal
benefit exceeds marginal
cost.
We get more value from our
resources by producing
more pizzas.
On the PPF at point A, we
are producing 1.5 million
pizzas, which is too few.
We are better off moving
along the PPF to produce
more pizzas.
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 Using Resources Efficiently
If we produce more than
2.5 million pizzas, marginal
cost exceeds marginal
benefit.
We get more value from
our resources by
producing fewer pizzas.
On the PPF at point C, we
are producing 3.5 million
pizzas, which is too many.

We are better off moving

along the PPF to produce
fewer pizzas.
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 Using Resources Efficiently
On the PPF at point B, we
are producing the efficient
quantities of pizzas and
cola.
If we produce exactly 2.5
million pizzas, marginal
cost equals marginal
benefit.
We cannot get more
value from our resources.

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© 2014 Pearson Education
 Economic Growth

The expansion of production possibilities—an increase in

the standard of living—is called economic growth.
Two key factors influence economic growth:
 Technological change
 Capital accumulation
Technological change is the development of new goods
and of better ways of producing goods and services.
Capital accumulation is the growth of capital resources,
which includes human capital.

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 Economic Growth

The Cost of Economic Growth

To use resources in research and development and to
produce new capital, we must decrease our production
of consumption goods and services.
So economic growth is not free.
The opportunity cost of economic growth is less current
consumption.

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 Economic Growth

Figure 2.8 illustrates the

tradeoff we face.
We can produce pizzas or
pizza ovens along PPF0.
By using some resources to
produce pizza ovens today,
the PPF shifts outward in the
future.

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© 2019 Pearson Education Ltd.
 Economic Growth

Changes in What We Produce

Investment in capital and technology creates economic
growth and increases income.
The model of specialization and trade explains the
different patterns of production across countries.
Figure 2.9 illustrates how economic growth influences the
pattern of production.

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 Economic Growth

Figure 2.9(a) compares low-income Ethiopia and China.

Figure 2.9(b) compares China and the rich United States.

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© 2019 Pearson Education Ltd.
 Economic Coordination

To reap the gains from trade, the choices of individuals

must be coordinated.
To make coordination work, four complimentary social
institutions have evolved over the centuries:
 Firms
 Markets
 Property rights
 Money

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 Economic Coordination

A firm is an economic unit that hires factors of production

and organizes those factors to produce and sell goods
and services.
A market is any arrangement that enables buyers and
sellers to get information and do business with each other.
Property rights are the social arrangements that govern
ownership, use, and disposal of resources, goods, or
services.
Money is any commodity or token that is generally
acceptable as a means of payment.

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 Economic Coordination

Circular Flows
Through Markets
Figure 2.8 illustrates how
households and firms
interact in the market
economy.
Factors of production,
and …
goods and services flow
in one direction.
Money flows in the
opposite direction.
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© 2019 Pearson Education Ltd.
 Economic Coordination

Coordinating Decisions
Markets coordinate
individual decisions
through price
adjustments.

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