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Production Possibilities | how economies make decisions

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TOPIC 1.2 \| OPPORTUNITY COST AND THE PPC
ENDURING UNDERSTANDING: The production possibilities curve (PPC) model is used to demonstrate the full employment level of output and to illustrate changes in full employment.
Learning Objective	Essential Knowledge
Define (using graphs as appropriate) the PPC and related terms.	The PPC is a model used to show the tradeoffs associated with allocating resources. The PPC can be used to illustrate the concepts of scarcity, opportunity cost, efficiency, underutilized resources, and economic growth or contraction. The shape of the PPC depends on whether opportunity costs are constant, increasing, or decreasing. The PPC can shift because of changes in factors of production as well as changes in productivity/technology. Economic growth results in an outward shift of the PPC.
Explain (using graphs as appropriate) how the PPC illustrates opportunity costs, tradeoffs, inefficiency, efficiency, and economic growth for contraction under various conditions.
Calculate (using data from PPCs or tables as appropriate) opportunity cost.

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The Economic Way of Thinking

Everything has a cost
People choose for good reasons.
People gain from voluntary trade.
Economic thinking is marginal (cost/benefit) thinking.
Economic actions create secondary effects.
The test of a theory is its ability to predict correctly.

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When faced with SCARCITY of resources, decisions have to be made about how to use those resources

Companies calculate Opportunity Costs and understand Trade-offs

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Economists use models to make decisions…

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Trade-Offs

This is the decision making process that is occurring in your mind right now…

Am I going to pay attention to what Mr. Bosley/Roth is saying, or am I going to daydream?

…or am I going to nap?
…or am I going to go to the bathroom?
…or am I going to go on my phone?

Am I going to stay in school or go find a full time job? or travel?

Each and every decision you make has a cost!

Not necessarily a cost in dollar terms, but that you must give up something when a decision is made

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Opportunity Cost

The “price you pay” for each decision you make is called the OPPORTUNITY COST.

Monetary → it is calculable
Non-Monetary

Opportunity cost is vital to the understanding of economics.

“The amount of a product or service that must be forgone (given up) in order to obtain the best alternative product or service”

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Production Possibilities Frontier

Visual representation of the Opportunity Cost

Calculable
Shows…

Productive Capacity of economies
Opportunity Costs of decisions
Efficiency of economies

How much can be made with resources

Economic Growth/Decline

Is a vital Link to “Aggregate Supply” (short/long run)

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Production Possibilities Frontier�Increasing Opportunity Costs

Wheat

Rice

0

Wheat

Rice

NOTE: The GAIN in Rice is

CONSTANT while the LOSS

In Wheat is INCREASING each Time…What is going on???

80

78

70

55

38

0

20

40

60

80

100

80

70

60

50

40

20

10

10 20 30 40 50 60 70 80 90 100

.

-2

-8

-15

-17

-38

+20

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Why are there Increasing Opportunity Costs

type of land suitable for growing Wheat is DIFFERENT than the land for growing Rice.
So, if a society wants MORE Rice, then you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy)

What’s the result? it is MORE costly to do that, in terms of Wheat production

We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat

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Why does this matter?

Economies produce way more than just Wheat and Rice.

We can broadly categorize goods into TWO categories

Capital Goods - goods used in the production of other goods
Consumer Goods - goods bought by consumers

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The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production Possibilities Curve

The PPC shows the relationship between two goods:

Capital Goods (Investment Goods)

Goods that satisfy our wants INDIRECTLY and promote future growth or “happiness” — Delayed gratification.

Consumer Goods

Goods that satisfy our wants DIRECTLY —

Instant Gratification

Lesson 1 Act 1

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Production Possibilities Frontier

Capital

Goods

Consumer Goods

0

Capital Goods

“Stuff you use to make other Stuff”

Tools, equipment, factories, other infrastructure

Consumer Goods

“Stuff” for immediate

Consumption, Food, consumer, Electronics, etc.

Allocative Efficiency

Where a society decides to

Produce on its PPF. A value

Decision based on values/politics

Productive Efficiency

Full-employment of resources

And producing at the lowest cost

.

A

.

B

.

C

.

D

.

E

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Production Possibilities Curve (Frontier)

The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.
From Point “C” to Point “B” the economy gains up 10 capital goods but gives up 100 consumer goods.
From Point “B” to Point “A” the economy gains up 10 capital goods but gives up 200 consumer goods.

Consumer Goods

Capital Goods

0

100

1000

10 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.
At Point “B” the economy gives up 10 Capital goods in order to get 200 more Consumer goods.

200 Consumer goods = 10 Capital goods
1 Consumer good = 10 Capital goods/200
1 Consumer good = .05 Capital good

Consumer Goods

Capital Goods

0

100

1000

10 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

The bowed nature of the PPC is due to INCREASING OPPORTUNITY COSTS

Not all resources are adaptable to alternative uses.

Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa)

Marshland suitable for growing rice might not be easily converted to build an airport.

Consumer Goods

Capital Goods

0

100

1000

10 20 30 40 50 60 7 0 80 90

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

Lets take a closer look at the PPC.

What do the different points on the PPC represent?

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

Each point represents Productive Efficiency

This means that this economy is allocating ALL of it productive resources in the least costly way

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency

This represents the combination of Capital and Consumer Goods most desired by the society

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

The WHOLE PPC represents
“FULL PRODUCTION”

Productive Efficiency
Full-Employment of Resources

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?

No! Often they operate inside their production possibilities

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

.E

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?

Point “E” represents a point inside the PPC.

Notice that this point “E” represents a lower bundle of Capital and Consumer Goods

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

.E

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?

Point “E” represents a point inside the PPC.

The area between point “E” and the PPC represents underutilization of resources or underemployment of resources, or unemployment.
The economy is being inefficient.

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

.E

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?

Point “E” represents a point inside the PPC.

This economy could be doing better…

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

.E

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?

How about point “F”?

Point F is outside our PPC

It represents a combination of Capital and Consumer Goods that is currently not possible with this economies resources

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

E

.F

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Production Possibilities Curve (Frontier)

Do economy’s always produce on the PPC?
How about point “E”?
Point E is inside our PPC
How about point “F”?
Point F is outside our PPC

F is desirable (more “stuff”), but currently not attainable.

not enough: resources, quality of resources, or tech

Consumer Goods

0

100

1000

100 200 300 400 500 600 700 800 900

.A

.B

.C

.D

E

.F

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Production Possibilities Frontier

Capital

Goods

Consumer Goods

0

Capital Goods

“Stuff you use to make other

Stuff”

Tools, equipment, factories, other

infrastructure

Consumer Goods

“Stuff” for immediate

Consumption. Food, consumer

Electronics, etc.

Allocative Efficiency

Where a society decides to

Produce on its PPF. A value

Decision based on values/politics

Productive Efficiency

Full-employment of resources

And producing at the lowest

cost

.

A

.

B

.

C

.

D

.

E

.

F

.

G

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Production Possibilities Curve�The PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully employed (used) with the best technology currently available

Processing Chips

(Capital Good)

iPhones (Consumer Good)

B

C

E

F

A

G

How do we get to point G??

1. Technological advancement which increases Productivity

2. Discover more/better/new resources

3. Take resources (War)

4. Trade for Resources

D

“OUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT”

CAN YOU THINK OF AN EXAMPLE IN HISTORY WHEN WE WERE INSIDE THE PPC?

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Production Possibilities Curve�The PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully employed (used) with the best technology currently available

B

C

E

F

A

G

How do we get to point G??

1. Technological advancement which increases Productivity

2. Discover new resources

3. Take resources (War)

4. Trade for Resources

D

“OUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT”

CAN YOU THINK OF AN EXAMPLE IN HISTORY WHEN WE WERE SHIFTED THE PPC?

Processing Chips

(Capital Good)

iPhones (Consumer Good)

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Going to War (U.S.) When the U.S. entered WWII, we had severe unemployment.

We were able to step up production of consumer goods and war materials simply by

getting to full production. We went from 14.6% unemployment in 1940 to 1.2% in 1944.

Over 7 million people went to work that were not working in 1940.

Going to War (Russia). Russia, on the other hand, entered WWII at full capacity.

So their preparedness entailed a shifting of resources from civilian goods and a drop in

their standard of living.

Civilian Goods

F

C

United States

[Beginning of WWII]

War Goods

Civilian Goods

War Goods

D

C

Russia

[Beginning of WWII]