Module The Production Possibilities Curve Model

1. 3 ModuleThe ProductionPossibilitiesCurve Model • KRUGMAN'S • MACROECONOMICS for AP* Margaret Ray and David Anderson

2. What you will learninModule 3: The purpose of Module 3 is to extend the concepts of scarcity and opportunity costs by introducing the model of production possibilities. This simple model identifies the notion of efficiency and furthers the discussion of economic growth by asking the three (3) basic economic questions

3. What you will learnin Module 3: • The importance of trade-offs in economic analysis • What the production possibilities curve model tells us about efficiency opportunity cost, and economic growth • The two sources of economic growth - increases in the availability of resources and improvements in technology

4. The Production Possibilities Curve • Better known as the PPC • a/k/a the Production Possibility Frontier • PPF • The PPC is a basic workhorse in economics • Important for understanding some basic issues in economics • Efficiency • Opportunity Cost • Economic Growth

5. The Production Possibilities Curve • To be efficient, an economy must produce as much of each good as it can, given the production of other goods, and it must also produce the mix of goods that people want to consume • PPCshows the amount that can possibly be produced if all resources are fully employed

6. The Production Possibilities Curve

7. The Production Possibilities Curve All models have simplifying assumptions: • Available supply of resources is fixed in quantity and quality at this point in time. • Technology is constant during analysis. • Economy produces only two types of products. A PPC is a graphical representation of different production choices that use all of the available resources. All points along the curve are efficient in production, showing that resources are not created equal.

8. OPPORTUNITY COST • The opportunity cost of an activity is the value of the resources used in that activity when they are measured by what they would have produced when used in their next best alternative. • The slope of the PPC measures the marginal opportunity cost of producing one good in terms of the amount of the other good foregone.

9. A A PPC with a straight line has a constant slope, and therefore, constant opportunity cost. Opportunity Cost - Constant

10. L A PPC that has a bowed-out shape reflects increasing opportunity cost Opportunity Cost - Increasing

11. Economic Growth means • Expansion of the economy’s production possibilities—the economy can produce more of everything • Availability of resources (land, labor, capital, entrepreneurship)--CELL • Technology—technological advances • A bigger or a more educated/skilled work force

12. A Typical PPC Picture The marginal opportunity cost of consumer goods in terms of capital goods is increasing as we move down the PPC! The PPC is typically bowed-out or linear. It is not bowed-in Capital Goods unattainable just attainable inefficient just attainable Consumer Goods

13. What questions need to be asked THE THREE KEY ECONOMIC QUESTIONS • WHAT to produce • HOW to produce • FOR WHOM to produce THESE THREE ECONOMIC KEY QUESTIONS APPLY TO EVERYTHING—ASK YOURSELF

14. Economic Growth

15. PRODUCTION POSSIBILITIES CURVE A B F C Capital Goods G D E Consumer Goods

16. PRODUCTION POSSIBILITIES CURVE A B F C Capital Goods G D E Consumer Goods

17. The Production Possibility Curve—What is it? • The curve itself is determined by what would be possible if there were full employment in the economy • An economy can not produce more of one good without producing less of the other.

18. EASY ON THE MEMORY GIVE UP • OPPORTUNITY COST = ---------------- GET

19. PPC Gymnastics • The PPF is also useful for many other types of questions. • Questions about efficiency. • Questions about equity. • Questions about tax and transfer policy. • Questions about composition of output. • Questions about growth and productivity. Capital Goods PPF new PPF old Consumer Goods