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only by devoting more land and labor to growing wheat. But this choice simultaneously
reduces soybean production (the curve must move downward) because less land and labor
remain available for growing soybeans.
Notice that, in addition to having a negative slope, our production possibilities frontier
AE has another characteristic: It is “bowed outward.” What does this curvature mean? In
short, as larger and larger quantities of resources are transferred from the production of
one output to the production of another, the additions to the second product decline.
Suppose farmer Jones initially produces only soybeans, using even land that is compar-
atively most productive in wheat cultivation (point A). Now he decides to switch some
land from soybean production into wheat production. Which part of the land will he
switch? If Jones is sensible, he will use the part that, because of its chemical content, direc-
tion in relation to sunlight, and so on, is relatively most productive in growing wheat. As
he shifts to point B, soybean production falls from 40,000 bushels to 30,000 bushels as
wheat production rises from 0 to 38,000 bushels. A sacrifice of only 10,000 bushels of soy-
beans “buys” 38,000 bushels of wheat.
Imagine now that our farmer wants to produce still more wheat. Figure 1 tells us that
the sacrifice of an additional 10,000 bushels of soybeans (from 30,000 bushels to 20,000
bushels) will yield only 14,000 more bushels of wheat (see point C). Why? The main rea-
son is that inputs tend to be specialized. As we noted at point A, the farmer was using
resources for soybean production that were relatively more productive in growing wheat.

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Part 1
44 Getting Acquainted with Economics

Consequently, their relative productivity in soybean production was low. When these re-
sources are switched to wheat production, the yield is high.
But this trend cannot continue forever, of course. As more wheat is produced, the
farmer must utilize land and machinery with a greater productivity advantage in growing
soybeans and a smaller productivity advantage in growing wheat. This is why the first
10,000 bushels of soybeans forgone “buys” the farmer 38,000 bushels of wheat, whereas
the second 10,000 bushels of soybeans “buys” only 14,000 bushels of wheat. Figure 1 and
Table 1 show that these returns continue to decline as wheat production expands: The next
10,000-bushel reduction in soybean production yields only 8,000 bushels of additional
wheat, and so on.
If the farmer™s objective is to maximize the amount of wheat or soybean product he gets
out of his land and labor then, as we can see, the slope of the production possibilities fron-
tier graphically represents the concept of opportunity cost. Between points C and B, for
example, the opportunity cost of acquiring 10,000 additional bushels of soybeans is shown
on the graph to be 14,000 bushels of forgone wheat; between points B and A, the opportu-
nity cost of 10,000 bushels of soybeans is 38,000 bushels of forgone wheat. In general, as
we move upward to the left along the production possibilities frontier (toward more soy-
beans and less wheat), the opportunity cost of soybeans in terms of wheat increases.
Looking at the same thing the other way, as we move downward to the right, the oppor-
tunity cost of acquiring wheat by giving up soybeans increases”more and more soy-
beans must be forgone per added bushel of wheat and successive addition to wheat
output occur.

The Principle of Increasing Costs
We have just described a very general phenomenon with applications well beyond farm-
ing. The principle of increasing costs states that as the production of one good expands,
The principle of increas-
ing costs states that as the the opportunity cost of producing another unit of this good generally increases. This prin-
production of a good ciple is not a universal fact”exceptions do arise. But it does seem to be a technological reg-
expands, the opportunity
ularity that applies to a wide range of economic activities. As our farming example sug-
cost of producing another
gests, the principle of increasing costs is based on the fact that resources tend to be at least
unit generally increases.
somewhat specialized. So we lose some of their productivity when those resources are
transferred from doing what they are relatively good at to what they are relatively bad at.
In terms of diagrams such as Figure 1, the principle simply asserts that the production pos-
sibilities frontier is bowed outward.
Perhaps the best way to understand this idea is to contrast it with a case in which no
resources are specialized so costs do not increase as output proportion changes. Figure 2
depicts a production possibilities frontier for producing black shoes and brown shoes.
Because the labor and machinery used to produce black shoes are just as good at pro-
ducing brown shoes, the frontier is a
straight line. If the firm cuts back its
production of black shoes by 10,000
Production Possibilities 50
pairs, it can produce 10,000 additional
Frontier with No
pairs of brown shoes, no matter how big
Specialized Resources A
40 the shift between these two outputs. It
Black Shoes

loses no productivity in the switch
because resources are not specialized.

More typically, however, as a firm con-
centrates more of its productive capacity
on one commodity, it is forced to employ
D inputs that are better suited to making
another commodity. The firm is forced to
vary the proportions in which it uses
inputs because of the limited quantities
10 20 30 40 50
of some of those inputs. This fact also
Brown Shoes explains the typical curvature of the
firm™s production possibilities frontier.
NOTE: Quantities are in thousands of pairs per week.

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Chapter 3 45
The Fundamental Economic Problem: Scarcity and Choice

Like an individual firm, the entire economy is also constrained by its limited resources and
technology. If the public wants more aircraft and tanks, it will have to give up some boats
and automobiles. If it wants to build more factories and stores, it will have to build fewer
homes and sports arenas. In general:
The position and shape of the production possibilities frontier that constrains society™s
choices are determined by the economy™s physical resources, its skills and technology,
Production Possibilities
its willingness to work, and how much it has devoted in the past to the construction of
Frontier for the Entire
factories, research, and innovation.
Because so many nations have long debated whether to reduce
or augment military spending, let us exemplify the nature of soci-
ety™s choices by deciding between military might (represented by B
missiles) and civilian consumption (represented by automobiles).

Thousands of Automobiles per Year
Just like a single firm, the economy as a whole faces a production
possibilities frontier for missiles and autos, determined by its tech- D
nology and the available resources of land, labor, capital, and raw
materials. This production possibilities frontier may look like E
curve BC in Figure 3. If most workers are employed in auto plants,
car production will be large, but the output of missiles will be
small. If the economy transfers resources out of auto manufactur-
ing when consumer demand declines, it can, by congressional F
action, alter the output mix toward more missiles (the move from
D to E). However, something is likely to be lost in the process
because physical resources are specialized. The fabric used to
make car seats will not help much in missile production. The prin- C
ciple of increasing costs strongly suggests that the production pos- 100 200 300 400 500
sibilities frontier curves downward toward the axes. Missiles per Year
We may even reach a point where the only resources left are
not very useful outside of auto manufacturing. In that case, even
a large sacrifice of automobiles will get the economy few additional missiles. That is the
meaning of the steep segment, FC, on the frontier. At point C, there is little additional out-
put of missiles as compared to point F, even though at C automobile production has been
given up entirely.
The downward slope of society™s production possibilities frontier implies that hard
choices must be made. Civilian consumption (automobiles) can be increased only by
decreasing military expenditure, not by rhetoric or wishing. The curvature of the produc-
tion possibilities frontier implies that as defense spending increases, it becomes progres-
sively more expensive to “buy” additional military strength (“missiles”) in terms of the
resulting sacrifice of civilian consumption.

Scarcity and Choice Elsewhere in the Economy
We have emphasized that limited resources force hard choices on business managers and
society as a whole. But the same type of choices arises elsewhere”in households, univer-
sities, and other nonprofit organizations, as well as the government.
The nature of opportunity cost is perhaps most obvious for a household that must decide
how to divide its income among the goods and services that compete for the family™s atten-
tion. If the Simpson family buys an expensive new car, it may be forced to cut back sharply
on some other purchases. This fact does not make it unwise to buy the car. But it does make
it unwise to buy the car until the family considers the full implications for its overall
budget. If the Simpsons are to utilize their limited resources most effectively, they must rec-
ognize the opportunity costs of the car”the things they will forgo as a result”perhaps a
vacation and an expensive new TV set. The decision to buy the car will be rational if the
benefit to the family from the automobile (however measured) is greater than the opportu-
nity cost”their benefit if they buy an equally expensive vacation or TV set instead.

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Licensed to:
Part 1
46 Getting Acquainted with Economics

Hard Choices in the Real World
Two excerpts from recent newspaper stories bring home the reali- afford the increase. They just can™t afford it.” Gene Russianoff of
ties of scarcity and choice: the Straphangers Campaign gave the board 4,000 anti-fare-
increase petition signatures tied up with a red bow. MTA officials
“As Deficit Shrinks, Battle Looms; Bush and Democrats Prepare
were unmoved, saying they need to offset $6 billion in deficits
to Face off On 2008 Budget,” Washington, July 11”. . . . Yes-
over the next four years. “Today™s vote is an important step in
terday, Mr. Bush seized on the latest White House budget esti-
putting the transit system on a sound financial footing ,” MTA
mates, which predict the 2007 deficit will drop to $205 billion
chairman H. Dale Hemmerdinger said. . . . The new increases
from last year™s $248 billion, to press his point that Republican
will take effect in March. The MTA had proposed increasing base
tax cuts and spending policies are working. He charged that
fares but backed off last month after an additional $220 million
Democrat™s proposals to raise taxes and expand health care and
was found in its updated budget forecasts. . . .
other domestic programs pose a long-term threat to the coun-
try™s economic health. . . . Democrats sought to downplay the SOURCE: Karen Matthews, “Some NYC Transit Fares Will Rise,” Associated Press,
December 19, 2007
latest good news, focusing on the continued high cost of the Iraq
War, the tax breaks Mr. Bush has given to the wealthy and the
resulting run-up in federal debt. . . .
SOURCE: John D. McKinnon and Deborah Solomon, Wall Street Journal, Eastern
Edition, July 12, 2007, p. A4.

“Some NYC Transit Fares Will Rise,” New York (AP), December
19, 2007 ”. . . . The Metropolitan Transportation Authority
voted Wednesday to raise fares for monthly and weekly passes

SOURCE: © AP IMAGES/Jacquelyn Martin
and multiple-ride MetroCards, while keeping the single-use bus
and subway fare at $2. Only 14 percent of subway and bus rid-
ers pay the $2 single-use fare, but transportation officials argue
they are among the poorest customers. . . . Riders™ advocates
and elected officials, however, said that it™s tourists who will see
most of the benefit, while the vast majority of New York™s mil-
lions of commuters watch their costs go up by about 10 cents a
ride. . . . New York City Public Advocate Betsy Gotbaum, speak-
ing to the board before the vote, said, “New Yorkers cannot

As already noted, even a rich and powerful nation like the United States must
cope with the limitations implied by scarce resources. The necessity for choice
imposed on governments by the limited amount they feel they can afford to
spend is similar in character to the problems faced by business firms and
households. For the goods and services that it buys from others, a govern-
ment must prepare a budget similar to that of a very large household. For the
items it produces itself”education, police protection, libraries, and so on”it faces a
production possibilities frontier much like a business firm does. Even though the U.S.
government spent over $2.6 trillion in 2006, some of the most acrimonious debates
between President Bush and his critics arose from disagreements about how the gov-
ernment™s limited resources should be allocated among competing uses. Even if
unstated, the concept of opportunity cost is central to these debates.

So far, our discussion of scarcity and choice has assumed that either the firm or the econ-
omy always operates on its production possibilities frontier rather than below it. In other
words, we have tacitly assumed that whatever the firm or economy decides to do, it does
so efficiently.


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