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neoclassical

neoclassical. Main principle: resource scarcity Not absolute scarcity, relative scarcity Scarcity relative to “unlimited human wants” Opportunity cost – “the value of what could have been produced if resources were used in the best alternative way”. Production Possibilities.

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neoclassical

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  1. neoclassical • Main principle: resource scarcity • Not absolute scarcity, relative scarcity • Scarcity relative to “unlimited human wants” • Opportunity cost – “the value of what could have been produced if resources were used in the best alternative way”

  2. Production Possibilities • Two goods: guns and butter • Given (constant) amounts of resources of land (T), labor (L) and capital (K), and given (constant) technology • Time period is given—one year • Neoclassical goal— efficiently allocating given T, L, and K among competing industries to maximize consumer satisfaction per time period.

  3. Graphing y x 0

  4. Production Possibilities Schedule

  5. Production Possibilities Schedule

  6. Production Possibilities Schedule

  7. Production Possibilities Schedule

  8. Production Possibilities Schedule

  9. Production Possibilities Guns 50 (mil.) 0 Butter 80 (mil. Of tubs)

  10. PPC Constant Trade-off Guns 50 (mil.) 0 Butter 80 (mil. Of tubs)

  11. PPC • Straight-line production possibility curve indicates constant returns and constant opportunity costs • Such a relation implies that resources are perfectly suitable for both industries (cows just as good for guns as butter; machine tools just as good for butter as guns). • Not the normal PPC between two industries

  12. Production Possibilities Schedule

  13. Production Possibilities Schedule Guns (Millions) Butter (Mil. of Tubs) 30 50 65 75

  14. PPC • Normal PPC is “bowed out” from origin • Indicates diminishing returns and increasing opportunity costs • Law of increasing opportunity costs states that in order to get more of any good in a given time period, society must sacrifice ever-increasing amounts of other goods, ceteris paribus.

  15. Production Possibilities Schedule Guns (Millions) Butter (Mil. of Tubs) 30 50 65 75

  16. Prod. Poss. Schedule • Let’s add two additional points to our schedule: • Guns Butter 25 75 15 40

  17. Production Possibilities Schedule Guns (Millions) 25,75 . Butter (Mil. of Tubs) 30 50 65 75

  18. Point outside the curve • Measuring in physical terms (#s of guns, tubs of butter), given resources and technology, a point outside is physically impossible, unattainable • If we were measuring in $ (monetary) terms ($ worth of guns, $ worth of butter), then a point outside would be possible: physical output cannot increase, but prices can—inflation

  19. Production Possibilities Schedule Guns (Millions) (15, 40) . Butter (Mil. of Tubs) 30 50 65 75

  20. Point inside the curve • Point inside the curve is possible, but undesirable—society can produce these combinations, but it is producing below full potential—there is unemployment and excess capacity; resources are being left unused and underutilized; this is inefficient and wasteful.

  21. Point on the curve • Operating anywhere on the curve is efficient, the economy is operating at full employment and full productive capacity. • Operating on the curve, resources are scarce (because full employed) and opportunity cost is in effect (cannot increase production of one good without decreasing production of the other)

  22. PPC • What determines where the curve is? • technology, resources • What happens if there is an increase of resources and/or technological advance? • The curve shifts out (more of both goods can be produced) • What is the economic meaning of a shift out? • Economic growth

  23. Shift of Production Possibilities Curve Guns ’ 0 Butter

  24. Economic Growth • What is the source of economic growth? • Increased resources and technological advance • Parallel shift out, additional resources apply to both industries; technological advance is universal (applies to both)

  25. Economic Growth • What if the additional resources only applies to butter (or gun) production, or the technology only applies to one or the other? • Sector-specific technical advance (or sector-specific resource expansion)

  26. Production Possibilities Curve Guns A B’ B 0 ’ Butter

  27. Sector-specific growth (in butter sector) • More butter can be produced, but if all resources were applied to gun production, gun output would remain the same—technology doesn’t apply to guns) • More of both can be produced, because increased productivity in the butter sector allows some resources to be shifted to gun sector.

  28. Shift-in of curve • Shift in means economic decline—could be universal or sector-specific. Results from a decline in resources and/or technological decline. • Don’t get mixed up between a shift out of the curve and a point outside the curve; or a shift in of the curve versus a point inside the curve.

  29. Economic Growth:Increased Resources: Land • New land may be brought into cultivation, discoveries of new deposits of natural resources, increased stock of stock renewable resources (also, for a given country, conquering another country).

  30. Economic Growth:Increased resources: Labor • Population growth • New sectors of the population enter the workforce (e.g., women during WWII, subsistence workers in Third World) • For one country, Immigration.

  31. Economic Growth: Increased Resources: Capital • Machine tools industries • Capital goods production

  32. Growth: Technological advance • Microelectronics Revolution • Technological innovations • Organizational innovations

  33. Economic Decline:Decreased Resources • War • Natural disaster • Population decline • Emigration

  34. Economic Decline: Technological Decline • Outlawing technologies (or their use at certain times or places) for environmental or health reasons

  35. Unemployment &underemployment

  36. Unemployment and excess capacity • When resources are unemployed, they are not scarce • There is no opportunity cost to employing unemployed resources • When resources are unemployed, more of any good can be produced without decreasing production of other goods; more of both goods can be produced.

  37. PPC (Unemployment) Guns (Millions) A F G1 E G2 D B 0 B2 Butter (Millions of Tubs) B1

  38. Different theories describe different economic scenarios • Neoclassical theory applies when the economy is on the curve (at full employment)—then scarcity and opportunity cost are in effect • Keynesian theory applies when the economy is inside the curve (unemployment and excess capacity)—no scarcity (resources are available) and no opportunity cost to employing them.

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