Production Possibilities Curve

Production Possibilities Curve PPC

PPC • A Graphical representation showing the maximum quantity of goods and services that can be produced using limited resources to the fullest extent possible.

What can you make out of the resource of Rubber? • Examples • If a company can make shoes or tires • If all resources of rubber are used for shoes the company can make 100 million pairs of shoes and 0 tires and vice versa.

Production Possibilities for Production of Economy Cars and Luxury Cars for an Economy • Point Economy Cars Luxury Cars • A 0 5 • B 2.8 4.2 • C 4.5 3 • D 6 1.5 • E 7 0 • F 5.1 4.9 • G 3 2

The curve represents the maximum that can be produced.

Points on the Curve • If production lies along a point along the PPC curve for those resources it is said to be efficient. • Efficiency- The case in which a given level of inputs is used to produce the maximum output is produced at minimum cost.

Points Inside the Curve • Points that lie within the PPC but are not on the curve represent either an unemployment of resources or production inefficiency • Underutilization- If a point lies within the curve it indicates that the resources are being underutilized. This means that production is not being carried out to its fullest capacities

Points Outside the Curve • This represents the use of more resources than are available. This is an impossible combination if everything else remains constant.

Shifts in the PPC Curve • This is the real life situation. • The PPC shifts all the time because all things do not remain constant. • Resources get overused and new resources are found all the time. • In this case a shift in the PPC will occur. • If more resources are made available or discovered, the curve will shift to the right indicating a situation in which there is more production possible. • The curve can also shift to the left indicating a loss of the availability of resources inciting less production.

Assumptions Underlying the PPC Curve • Resources are fully employed • We are looking at production over a specific time period—for example one year • The resource inputs, in both quantity and quality, are fixed over this time period. • Technology does not change over this time period.

Economic Model • Simplification of a more complicated idea, concept • Not reality • Representation to help us understand certain economic concepts • Opportunity Cost • Law of Increasing Opportunity Cost

An economy producing at point G can produce more luxury cars by moving to point C • This is possible because resources are not fully employed at point G or are not being used efficiently

Negative Slope and Opportunity Cost • As we have seen points that lie on the PPC represent points of full resource employment and production efficiency. • Society can choose only one point on the curve, because a society’s choices are constrained by available resources and existing technology, when these resources are fully and efficiently employed, it can produce more luxury cars only by reducing production of economy cars. • The opportunity cost of the additional luxury cars is the forgone production of economy cars

Negative Slope • The fact that scarcity exists is illustrated by the negative slope of the PPC • Slope= ∆y/ ∆x (∆=change) • ∆y=y2-y1 • ∆x=x2-x1

Negative Slope Point Economy Cars Luxury Cars • A 0 5 • B 2.8 4.2 • C 4.5 3 • D 6 1.5 • E 7 0 • F 5.1 4.9 • G 3 2 • In moving from point E point B luxury production increases from 0 to 4.2 million a change of 4.2 million which is a positive change, but the increase in luxury cars can only be made by decreasing production of economy cars. • Thus when we move from E to B Economy production decreases from 7 to 2.8 million which is a negative change • The slope of the curve, the ratio of the change in luxury to a change in economy is negative • ∆y/ ∆x • 2.8-7/4.2-0=-1

Law of Increasing Opportunity Costs • The negative slope of the PPC indicates the tradeoff that a society faces between two goals • We can learn something further by the shape of the curve and the terms of this tradeoff

PPC for Corn and Wheat • Point Total Corn Production Total Wheat Production • A 700 100 • B 650 200 • C 510 380 • D 400 500 • E 300 550

PPC for Corn and Wheat A B Total Corn Production (millions of bushels annually) C D E Total Wheat Production (millions of bushels annually)

Law of Increasing Opportunity Costs • Suppose that society’s demand for corn dramatically increases. • If this happens, farmers would probably shift some of their land away from wheat. • Such a shift would be represented by a move from C up to and left along the PPC towards A and B • As this happens it becomes more and more difficult to produce more corn • The best land for corn production was presumably already in corn and the best for wheat in wheat. • As we try to produce more and more corn, the land is less and less well suited for that crop. • As we try to produce more corn, more and more land is being taken away from wheat. • We will be taking increasingly better wheat land. • The opportunity cost of more corn, measured in terms of wheat, increases.

Law of Increasing Opportunity Costs • Moving from E to D shows that we can get 100 million bushels of corn (400-300) by sacrificing only 50 million bushels of wheat (550-500), we get 2 for 1. • However, when we are already stretching the ability of the land to produce corn, it becomes more difficult to produce more and the opportunity cost increases. • Moving from points B to A, we can only get 50 million bushels of corn (700-650) by sacrificing 100 million bushels of wheat (200-100) • If the demand for wheat would increase and we were to move down and to the right along the PPC, it would become increasingly difficult to produce wheat and the opportunity cost of wheat in terms of corn would increase. • This is an example of the law of increasing opportunity cost.

Economic Growth • Is characterized by an increase in the total output of an economy. • It occurs when a society acquires new resources or when society learns to produce more with existing resources. • Improved productivity also comes from technological change and innovation, the discovery and application of new efficient production techniques.

Straight Line PPC • Indicates a constant opportunity cost

Production Possibilities Curve