Economics Today, Fifth Canadian Edition, Instructor’s Manual Macro/Micro Chapter 2
Chapter 2
Production Possibilities and Economic Systems
Chapter Overview
This chapter begins with the production possibilities model and applies the model to illustrate the
concepts of scarcity, trade-offs, increasing opportunity cost, efficiency, full employment, and
economic growth. Then the concepts of absolute and comparative advantages are examined and
used to explain how specialization and trade can increase production and consumption. The
latter part of the chapter studies how different societies employ different economic systems in
order to respond to the problem of resource scarcity. This section opens with a discussion of the
three basic economic questions and then focuses on the features of the pure command economy,
pure capitalist economy, and mixed economic systems. Appendix B illustrates how
specialization based on comparative advantage leads to gains from trade.
Chapter Objectives
After studying this chapter students should be able to:
2.1
Define the production possibilities curve and identify its assumptions.
2.2
Use the production possibilities curve to illustrate the concepts of scarcity,
trade-offs, unemployment, productive efficiency, allocative efficiency, increasing
opportunity cost, and economic growth.
2.3
Use the production possibilities curve to explain the trade-off between
consumption goods and capital goods.
2.4
Distinguish between absolute advantage and comparative advantage and use these
concepts to explain how specialization and trade can increase production and
consumption.
2.5
Explain the differences between the pure capitalist, pure command, and mixed
economic systems.
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2.6
Describe the features of pure capitalism and explain how capitalism answers the
three basic economic questions.
Chapter Outline
2.1 The Production Possibilities Curve (PPC)
The PPC represents all possible production combinations of two goods that can be produced
assuming full and efficient employment of resources, a fixed time period, fixed quantity and
quality of resources, and fixed technology.
Production Possibilities Curve: An Example: See Figure 2-1, p. 31.
2.2 Applications of the Production Possibilities Curve
a. The Production Possibilities Curve, Scarcity, and Trade-Offs: Scarcity refers to the condition
that arises because wants always exceed what can be perceived with limited resources. The
PPC is a boundary separating the attainable production combinations - on or inside the curve,
from the unattainable points outside the curve. Due to scarcity, society is forced to make
choices that involve trade-offs – more of one good means less of another. The downward
slope of the PPC illustrates such trade-offs.
b. The Production Possibilities Curve and Unemployment: Any point inside the PPC represents
the condition of unemployment of resources. Land, labour, entrepreneurship, and physical
and human capital resources are not fully employed and so society forgoes some production
of goods and services.
c. The Production Possibilities Curve and Efficiency:
i. Productive efficiency occurs when an economy is producing the maximum output
with given technology and resources. Productive efficiency is represented
graphically by any point on the PPC.
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ii. Allocative efficiency is producing the mix of goods and services most valued by
society. While all of the points on the PPC are productively efficient, only one
production combination will be allocatively efficient.
d. The Production Possibilities Curve and Opportunity Cost: Opportunity cost is the value of
the best alternative that must be given up because a choice was made. When a society takes
more resources and applies them to the production of any specific good, the opportunity cost
increases for each additional unit produced.
i. Law of Increasing Relative Cost makes the PPC bowed outward. The reason for
increasing opportunity cost is that resources are generally not perfectly acceptable for
alternate uses.
e. The Production Possibilities Curve and Economic Growth: Economic growth shifts the PPC
outward over time. Such economic growth occurs because of many things, including
increases in the quantity of resources available, increases in the productivity of existing
resources, and the changes in technology.
2.3 Consumption Goods versus Capital Goods
a. Why We Make Capital Goods: Capital Goods such as machines and factories are society’s
resources. Producing more of them allows a society to produce more of all types of goods
and services in the future.
b. Forgoing Current Consumption: When existing productive resources are used to make
capital goods, additional goods and services could be produced in the future. Meanwhile,
current consumption of goods and services such as clothes and entertainment are sacrificed
by devoting resources to the production of capital goods.
c. The Trade-Off between Consumption Goods and Capital Goods: There is a trade-off between
present consumption and future consumption. If a society currently produces fewer
consumer goods and more capital goods, then it can consume more goods in the future. This
would result in a higher rate of economic growth or a greater outward shift of the PPC.
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2.4 Specialization and Greater Productivity
Specialization involves working at a relatively well-defined, limited endeavour. Usually
specialization leads to an increase in productivity.
a. Absolute Advantage: Absolute advantage being more productive at doing something than
anyone else. It is the ability to perform a task using the fewest number of labour hours.
Absolute advantage is not the basis for specialization.
b.
Comparative Advantage: Comparative advantage is the ability to perform an activity at the
lowest opportunity cost. This is the basis for specialization.
c. Scarcity, Self-Interest, and Specialization: Individuals who are making decisions that further
their self-interest will make choices that minimize their opportunity costs. The result is that
they specialize based on their comparative advantage and so earn higher incomes because
they are more productive. Thus, with any given set of resources specialization will result in
higher output.
d. Comparative Advantages and Trade among Nations: When countries specialize where they
have a comparative advantage and then engage in international trade, the average standard of
living in the world increases. International trade improves worldwide economic efficiency
by allowing the world to move from inside the global PPC toward the curve.
e. The Division of Labour: Division of labour occurs when individuals specialize in a subset of
tasks related to a specific product. Division of labour permits greater specialization and
therefore increases output.
2.5 Economic Systems
There are three basic questions of resource allocation, i.e., the assignment of resources to specific
uses. The three questions are what and how much will be produced, how it will be produced,
and for whom will it be produced. Answering the question “what and how much will be
produced” requires a mechanism to cause society's scarce resources to be used for some things
and not for others. “How” something will be produced requires a decision on the particular mix
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of inputs, their organization, and how they will be brought together. “For whom” something will
be produced addresses how goods and services are distributed throughout the economy.
a. Pure Command Economy: This is an economic system characterized by public ownership of
all resources. A central authority answers the three basic economic questions.
b. Pure Capitalist Economy: This is an economic system characterized by private ownership of
all property resources. The decision making process is decentralized. Households and firms
interacting through a system of markets answer the three basic economic questions.
c. Mixed Economic Systems: In a mixed economic system, where there is both private and
public ownership of resources, the three basic economic questions are partly answered by
government and partly by individual firms and households in the markets.
2.6 Capitalism in More Depth
a. Features of Capitalism:
i. Private ownership of resources,
ii. Self interest,
iii. Consumer sovereignty,
iv. Market and prices,
v. Competition, and
vi. Limited government.
b. Capitalism and the Three Economic Questions:
A price or market system is an economic system in which relative prices are constantly changing
to reflect changes in the supply of and demand for different commodities. The prices of those
commodities are signals to everyone within the system about what is relatively scarce or
abundant. This system is only one possible way to organize society.
i. What and How Much Should be Produced? In a price system the interaction of
demand and supply for each good determines what and how much to produce. If the
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highest price consumers are willing to pay is less than the lowest cost to produce a
good, output will be zero.
ii. How Will It be Produced? In a price system the least-cost combination will be
chosen because it maximizes profits.
iii. For Whom Will It be Produced? Who gets what is determined by the distribution of
money income. Ability to pay for goods is based on the size of the consumer's money
income. This depends on the quantities, qualities, and types of various human and
nonhuman resources that an individual owns and supplies to the marketplace. In a
price system, the distribution of finished products is based on consumers' ability and
willingness to pay market price for products. Relative prices ration the available
resources, goods, and services.
Points to Emphasize
1. Choice
After the scarcity problem is analysed, the problem of choice should be presented. Because of
scarcity—that is, wants are greater than the means to satisfy those wants (resources)—people are
forced to choose a means of satisfying their wants. The concepts of opportunity cost, trade-offs,
and production possibilities curve should be then introduced. These concepts are often difficult
for students to grasp. The production possibilities curve can be especially troublesome if the
actual numbers are not presented along with the graph. A successful method of presenting this
model is to use a table of combinations of two goods and fully develop the model before
introducing the graph.
2. Specialization and Comparative Advantage
After the tools for analysing choice are developed, the chapter discusses specialization based on
comparative advantage. The relationship between these two is essential to develop because it is
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the basis for exchange. A convincing case can be made on an intuitive level that if each person,
region, and country specializes in producing those things that they can produce relatively most
efficiently, then it is possible to increase output without increasing the amount of resources used
in production. Then a more formal demonstration can be given. A consequence of
specialization is that trade occurs because each economic unit ends up producing more of
something than they want. In some cases, they produce something that they do not consume at
all.
3. What, How, For Whom?
Because of scarcity every society must have some mechanism for answering the “what,” “how,”
and “for whom” questions. The actual institutional framework for answering these questions is
called an economic system. It is important to emphasize that all societies face a scarcity
constraint just as individuals do. Good class discussions can be developed around this topic. It
is interesting to point out that even if there were more than enough resources to produce all of
everything that anyone could want, the fact that a person does not live forever would still make it
necessary to make choices, since the amount of time available to any one person would be finite,
even if available goods and services were not.
4. The Ex-Soviet Economic System
According to official Soviet doctrine, the USSR at the time of dissolution was in a state of
socialism. The country did not reach full communism. As such, labour was still paid according
to its productivity rather than according to "need." This is because the "new Soviet man," who
was motivated out of altruism rather than from self-interest had not yet appeared. Also, the
belief was that the state would "wither away" only under full communism. The Soviets simply
were not able to eliminate poverty. Even though they defined poverty at a much lower absolute
level of material well-being than Canada does, the Soviets had much higher percentages of their
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population living in poverty. Their living standards were between 10 and 25 percent of those in
Canada.
Despite a self-proclaimed goal of egalitarianism, the Soviets failed to eliminate a highly
unequal distribution of income. When one takes into account the vast system of privileges that
existed in the Soviet Union, the real or effective income distribution was at least as uneven as
ours. While shortages of many goods and services were a well-known and documented way of
life in the Soviet Union, what is less well known is that shortages were deliberately created in
order to grant special privileges to party members and non-party members who reflected well on
the Soviet system. Official prices were set below market-clearing levels, and this made it
possible for the communist party to bestow special favours on its members. Special privilege
took the form of being able to shop in exclusive stores, or go to special sections of universally
accessible stores. In such places the quality and variety were better, and the prices were lower
than the market price, which was itself below market-clearing levels. Severe housing shortages
made special housing privileges for the select few particularly valuable. The chosen few could
move up waiting lists for autos and other consumer durable goods more rapidly. Special dining
rooms often in one's office building were not uncommon for the elite. Of course, special
privilege was necessary in order to travel abroad, or even to read uncensored literature.
In most cases these benefits were especially valuable due to the fact that shortages were
commonplace. In order to obtain desired goods and services, it was not sufficient to have money
or even to wait in line. It is hard to estimate, therefore, the true distribution of effective
purchasing power because the distribution of income in the ex-USSR understated true inequality.
An interesting technical issue comes to mind. In a land where shortages abounded and
surpluses were not uncommon it was difficult to measure the extent to which the price level was
rising (inflation). It is much easier to record price rises than it is to note that average duration
time in lines is increasing, or that quality is deteriorating. In a land of constant shortages and
surpluses it was very tempting to conclude that shortages reflected general disequilibrium rather
than inflation. If so, we may have underestimated the rate of inflation in the ex-USSR.
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For Those Who Wish To Stress Theory
5. Production Possibilities Curve
An in-depth analysis of the production possibilities curve (PPC) can be especially valuable. In
particular:
i) Rigorously define the PPC. The PPC shows the maximum possible combinations of output
of two goods that can be produced by given resources and technology in a given time period.
ii) Consider the PPC when inputs are equally suited to producing both of the goods. The x
and y intercepts define the maximum quantities of each good that can be produced. By
connecting these two points a linear PPC is derived.
iii) Note that when some resources are better suited to either output, there are two important
differences in the PPC.
a. It is no longer linear. Instead, it is now concave to the origin due to increasing
resource cost. As we move from producing all x to all y, we initially produce units of
y by releasing greater percentages of resources more suited to production of y and
smaller percentages of resources more suited to the production of x. Since only 100
percent of resources exist, we must eventually release greater percentages of x-suited
resources and smaller percentages of y-suited resources to produce additional units of
y. Hence, the marginal resource cost of y production rises and the PPC becomes
concave to the origin.
b. The new PPC lies above the linear PPC except at the x and y intercepts. This is
because the new curve takes into account the fact that inputs are more suitable to
producing x or y.
6. What Will Be Produced?
The text points out that what gets produced in the price system are those things that are profitable
to produce. This is a good place to point out that resources flow into those activities that are
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most profitable, and out of those areas that are not as profitable or where there are losses.
Students often think that resources go where they are "needed," i.e., to produce those things that
are most needed. It is important to make clear that profits determine what gets produced.
Backing up one step allows students to see that what gets produced is determined by what people
will buy at profitable prices. The result is that the most economic value is produced; in other
words, economic efficiency is the result.
7. Is Planning Really Superior?
In the past, it was widely assumed that planning was superior to free markets as a method of
organizing production and promoting economic growth. Yet China, Russia, and other former
communist countries, were not the high growth nations. The real "wonder" areas of economic
growth include such places as Japan, South Korea (South versus North Korea, and East versus
West Germany provide nearly perfect laboratory experiments), Hong Kong, Nationalist China,
Malaysia, and so on. Russia itself grew more rapidly under Czar Nicholas than it did under the
Soviets.
One reason planning is not obviously successful is that a system in which profit is the
overriding concern is inherently more efficient than one in which people follow rules. If the rule
is, simply, maximize profit, then a firm must be concerned, automatically, with minimizing
costs, making the product acceptable to buyers, and introducing new technology. Contrast this
with a system in which a rule such as the following is given: fulfil a production goal of 10,000
nails per annum and you will be paid a bonus of X dollars for every nail over the quota. In order
to maximize the letter, if not the spirit, of that rule, one would produce very small, very thin nails
without any concern about whether such attributes are desired by potential buyers. On the other
hand, a rule that sets a quota in gross weight will generate very fat, huge "spikes." This
happened in the ex-USSR. Multiply such perverse incentives by several thousand, and it is
apparent how difficult it is to organize an economic system based on specific rules.
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Another seemingly inherent disadvantage of planning over free market decentralization deals
with reactions to the unknown. Through time things change; weather is unpredictable, climate
can change drastically, tastes vary, and specific resources become more or less scarce for
unforeseen reasons. Bottlenecks emerge in any society resulting from errors in planning or
simply from acts of nature. Under a command economy there is only one forecast: the plan. To
the extent that the unforeseen is important, the entire plan is knocked askew. In a decentralized
market economy, there are lots of forecasts; different people base their decisions on different
forecasts. A given unforeseen event may well be more troublesome in a command economy
because in a market economy some may well have forecast exactly that unexpected event. This
purely probabilistic advantage of decentralization over planning is likely decidedly understated.
Further Questions for Class Discussion
1. Does the government face a scarcity constraint?
In discussions of the federal government people often speak as if it has virtually unlimited funds
for a project that has some supposed beneficial social impact. At the same time almost everyone
knows about the debt. The government does, indeed, face a scarcity constraint in the form of a
limited budget with which to accomplish its goals. The way this constraint is manifested is in
wrangling about budget priorities. More for one program means less for others.
2. Is specialization and trade along lines of comparative advantage beneficial?
Students will usually agree that it is. Point out Adam Smith's statement in The Wealth of Nations
that no "...prudent master ...[will] ...make at home what it will cost him more to make than to
buy." Ask why this should not apply to international trade as well. The concern about American
or Japanese competition, for example, seems inappropriate. After all, if it is better to buy cheap
and sell dear, then why should we want to restrict trade with them? This will usually generate
considerable controversy.
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3. In the 1930s and 1940s an argument was made that in principle, a central planning agency
could duplicate the results of a competitive market by frequently adjusting prices of all goods,
services, and inputs to eliminate surpluses and shortages, and by requiring firms to produce to
the point where MC = price. In practice this was not done. Why do students think such a system
was not tried in the former communist countries? After all, a switch to market capitalism will
simply get a result similar to this theoretical model, and also eliminate the position of the
communist party.
The problem is one of information costs. In capitalist economy information costs exist but are
localized at the level of the firm. The "planning apparatus" in a capitalist firm deals with a
relatively small number of prices compared to a planning agency for an entire economy. Thus
prices can be changed relatively quickly in response to changes in cost or demand conditions. In
a centrally planned economy the number of prices that would have to be changed simultaneously
and continuously would be enormous. While it is theoretically possible to do this by solving
systems of simultaneous equations, it is not practical.
4. Should production be guided by profits?
Students will often argue that production should be to meet people's needs. There are two related
problems here. What is a need, and what mechanism should be used to make sure that people's
needs are met? Rarely can a need be identified as opposed to a want. Clearly, an accident victim
who is about to die unless given medical care can be said to need medical treatment. However,
there are very few such circumstances in practice. While people need food to live, they do not
need steaks. There are vegetarians who demonstrate that fact. So what particular kind of food is
"needed"? Producing those things that people will buy at profitable prices solves the problem
efficiently. Private producers will try to produce at minimum cost and compete with each other
so that prices are kept low. If something is very profitable, resources flow into the production of
that good. In the long run, output expands to satisfy demand. An alternative would be to have
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government ask people what they need, or simply to decide via central planning what is needed
and then order it done. Since there would be no incentive to control costs or minimize the use of
resources, the cost to society would be high. Less would be produced under these circumstances.
“For Critical Analysis” Questions: Answers appear on pages 462-478 of the Macro text
and pages 428-445 of the Micro text.
“Business Application” Problems: Answers appear on pages 446-448 of the Micro text
and pages 479-482 of the Macro text.
Answers to End-Of-Chapter Problems
1.
a. The maximum amount of factories will be 2000 as shown by the production possibilities
curve.
b. The maximum number of factories would be 5000, as shown by combination A.
c. A fixed amount of resources and technology prevents Epica from being able to produce
combination J in 2008.
d. If Epica is at point I, this could conflict with the goals of productive efficiency and full
employment.
e. i. The opportunity cost of an additional factory when moving from point E to D would be 2
yachts.
ii. The opportunity cost of an additional factory when moving from point C to B would be 4
yachts.
f. i. The opportunity cost of an additional yacht when moving from point A to B would be 1/5 of
a factory.
ii. The opportunity cost of an additional yacht when moving from point E to F would be 1
factory.
g. The Law of Increasing Relative Cost
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h. This situation conflicts with allocative efficiency.
i. Economic growth will shift the production possibilities curve outward.
2.
a. 15,000 TVs as shown by combination C.
b. A fixed amount of resources and technology.
c. 20,000 TVs as shown by combination A
d. If Fantasia is at combination G, this would conflict with the goals of productive efficiency and
full employment.
e. i. The opportunity cost of an additional machine when moving from point A to B would be 2
TVs
ii. The opportunity cost of additional machine when moving from point D to E would be 5 TVs.
f. The Law of Increasing Relative Cost
g. This situation conflicts with allocative efficiency.
h. This situation conflicts with allocative efficiency.
i. E would lead to a greater rate of economic growth. At E resources are used to make more
capital goods (machines) and fewer consumer goods (TVs). The trade-off between consumption
goods and capital goods is illustrated here.
j. Economic growth will shift the production possibilities.
3.
The PPC exhibits constant opportunity costs. That is, the cost of earning an additional mark in
economics is always the same, in terms of additional biology marks sacrificed. In this case, the
PPC is a straight line with the opportunity cost of earning an additional mark in economics
always being 1 mark in biology.
See graph, Micro, page 442; Macro, page 473.
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4.
The law of increasing relative cost does seem to hold because of the principle that some
resources may be more suited to one productive use than to another. In moving from cheese to
apples, the economy will first transfer those resources most easily sacrificed by the cheese sector,
holding on to the very specialized (to cheese) factors until the last. Thus different factor
intensities will lead to increasing relative costs. The graph representing 10 percent growth will be
similar to Figure 2-3 on page 37 of the Micro text.
5.
See graphs, Micro, page 442; Macro, page 473.
6.
Under the assumptions of the problem:
a) To get 1 additional unit of capital Workland must give up 4 units of consumption goods.
b) To get 1 additional unit of capital Playland must give up 1 unit of consumption goods.
c) Workland’s PPC would be expected to shift out further than Playland’s because of its
greater current production of capital goods.
7.
If we assume that a two-year college diploma consists of four 15-week semesters, this amounts
to committing 60 weeks to college studies. The opportunity cost is: 60 wks x 35 h x $7 = $14
700. The incentive of incurring this cost is that, upon graduating, you will be earning an amount
significantly in excess of $7 per hour. You are sacrificing current consumption to obtain a greater
amount of future consumption.
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8.
The concept of opportunity cost is key to understanding why this service is likely to be of
greatest interest to business people. If you compare the ordinary traveller to a business traveller,
the business traveller likely has a higher opportunity cost for his time, and may be able to have
his company pay for this expense. If the business traveller travels regularly to one particular
destination, (such as between offices with a company) they would avoid wasting time packing
and collecting baggage at the airport, which means more time spent on business.
9.
Yes, you and your roommate should specialize. Since your opportunity cost of completing a
basket of laundry (two meals) is lower than your roommate’s (three meals) you should specialize
in the laundry completion, while your roommate should specialize in the meal preparation. As an
example, if you complete an extra basket of laundry, you give up only two meals. However, you
free up an additional three hours of your roommate’s time, which allows your roommate to
produce an additional three meals. Overall, one extra meal is gained.
10.
a. Noah has absolute advantage in pasta salads.
b. Nora has the lower opportunity cost for sandwiches and so has the comparative advantage.
Nora sacrifices only 2 pasta salads as compared to 3 pasta salads sacrificed by Noah.
c. Noah has the comparative advantage in pasta salads and Nora in sandwiches. For each hour of
specializing in the area of comparative advantage, there is a net gain of 10 pasta salads (Noah:
+30 pasta salads and -10 sandwiches; Nora: -20 pasta salads and +10 sandwiches).
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11.
a. Toby has absolute advantage in pizzas.
b. Tony has the lower opportunity cost in producing one lasagne supreme (gives up 1 pizza
versus 2 pizzas for Toby).
c. Toby has the comparative advantage in pizza and Tony in lasagne. For each hour of
specializing in the area of comparative advantage, there is a net gain of 5 pizzas (Toby: +10
pizzas and -5 lasagne; Tony: +5 lasagne and -5 pizzas).
12.
Policy A: Conservative party
Policy B: New Democratic party
13.
The invisible hand of self-interest and competition helps to ensure that firms serve the consumer,
without the heavy hand of government.
14.
In pure capitalism, the economic question, What and How Much Will Be Produced, is based on
consumer demand and resource availability. The question of How Will It Be Produced is
answered by firms who will choose the most efficient or least cost method of production. For
Whom Will It Be Produced is decided based on the quantities, qualities, and types of human and
property resources owned by the different households in the capitalist system.
15.
a. In the market system, the techniques that yield the highest (positive) profits will be used.
b. Profit equals total revenue minus total cost. Because revenue from 100 units is fixed (at $100),
if the firm wishes to maximize profit, this is equivalent to minimizing costs. To find total costs,
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simply multiply the price of each input by the amount of the input that must be used for each
technique.
Costs of A = ($10)(6) + ($8)(5) = $100
Costs of B = ($10)(5) + ($8)(6) = $98
Costs of C = ($10)(4) + ($8)(7) = $96
Because technique C has the lowest costs, it also yields the highest profits ($100 – $96 = $4)
c. Following the same methods yields these costs:
A = $98, B = $100, and C = $102.Technique A will be used because it is the most profitable.
d. The profits from using technique A to produce 100 units of X are $100 – $98 = $2.
Answers to Appendix B Problems:
B-1
a. The Richard family has the absolute advantage in each product, assuming that both families
use the same amount of labour input, each day.
b. For the Martin family the opportunity cost of one litre of beer is one litre of wine. For the
Richard family the opportunity cost of one litre of beer is three litres of wine.
c. The Martin family has the comparative advantage (lower opportunity cost) in beer and the
Richard family has the comparative advantage in wine.
d. Total combined beer production increases from three litres to four litres per day, a gain of one
litre. Total combined wine production increases from 17 litres to 18 litres per day, a gain of one
litre.
e. For both families to share the gains, one litre of beer should trade for somewhere between one
and three litres of wine (between each family’s opportunity cost for beer).
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B-2
a. Attica has the absolute advantage in each product, assuming that both countries use the same
amount of labour input, each week.
b. For Mazland the opportunity cost of one camera is 2 phones. For Attica the opportunity cost
of one camera is 4 phones.
c. Mazland has the comparative advantage (lower opportunity cost) in cameras and Attica has the
comparative advantage in phones.
d. Total combined phone production increases from 38 to 40 units a gain of 2 phone units. Total
combined camera production increases from 4 to 5 units, a gain of 1 camera unit.
e. For both nations to share the gains, one camera should trade for somewhere between 2 and 4
phones (between each nation’s opportunity cost for cameras).
Step-By-Step Analysis of Selected End-Of-Chapter Problems
3.
Step 1: Using the table, plot the PPC curve.
Step 2: Observe that the slope of the PPC curve is constant and equals -1 everywhere along the
curve.
4
Step 1: The law of increasing costs is shown by the shape of the PPC. As more cheese is given
up fewer additional units of apples can be produced. When the initial unit of cheese is forgone in
favour of apple production, the economy gets 1.6 units of apples. However, when the final unit
of cheese is given up, the economy gets only 0.2 (3.0 - 2.8) units of apples.
Step 2: Plot curve.
Step 3: Show 10 percent growth. The intersection point on the vertical axis (apples) moves up
from 3 to 3.3, or a 10 percent increase over 3. The intersection with the horizontal axis (cheese)
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Economics Today, Fifth Canadian Edition, Instructor’s Manual Macro/Micro Chapter 2
moves out from 4 to 4.4 or a 10 percent increase over 4. The new curve showing growth is
parallel to the original curve.
6.
a.
Step 1: Workland is at Point E where it produces 4 capital goods and 10 consumption goods.
Step 2: Opportunity cost of capital goods in terms of consumption goods is the amount of
consumption goods sacrificed to go from 3 to 4 capital goods.
Step 3: As Workland moves from 3 to 4 capital goods, it changes from 14 to 10 consumption
goods. Opportunity cost = 14 - 10 = 4.
b.
Step 1: Playland is at point B with 1 capital good and 19 consumption goods.
Step 2: As Playland moves from 0 to 1 capital goods, it goes from 20 consumption goods to 19.
Opportunity cost of capital goods = 20 - 19 = 1.
Selected References
Balinky, Alexander, Marx's Economics: Origins and Development, Lexington, Mass.: D.C.
Heath, 1970.
Fellner, William, The Emergence and Content of Modern Economics, New York: McGraw-Hill,
1970.
Friedman, Milton, Free to Choose, New York: Harcourt, Brace, Jovanovich, 1980.
Friedman, Milton, Capitalism and Freedom, Chicago: University of Chicago Press, 1962.
Goldman, Marshall I., The Soviet Economy: Myth and Reality, Englewood Cliffs, N.J.: Prentice
Hall, 1968.
Heilbroner, Robert L., Marxism: For and Against, New York: Norton, 1980.
Schnitzer, M.C., Comparative Economic Systems, 4th ed., Cincinnati: 1989.
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Economics Today, Fifth Canadian Edition, Instructor’s Manual Macro/Micro Chapter 2
Schotter, Andrew, Free Market Economics: A Critical Appraisal, New York: St. Martin's Press,
1985.
Zimbalist, Andrew and Howard J. Sherman, Comparing Economic Systems, Orlando, Florida.:
Academic Press, Inc., 1984.
________, U.S.S.R. in Crisis: The Failure of an Economic System, New York: Norton, 1983.
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