Production Possibilities Curve

Production Possibilities Curve

A graph that illustrates the possible output combinations for an economy

It illustrates the tradeoffs that society faces in using its scarce resources◦ A choice is necessary because producing more of one item means making do with less of the other

The Production Possibilities Model

The production possibilities model is based on three assumptions:◦ an economy makes only two products

◦ resources and technology are fixed

◦ all resources are employed to their fullest capacity

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

The Production Possibilities Curve

The production possibilities curve shows a range of possible output combinations for an economy.◦ It highlights the scarcity of resources.

◦ It has a concave shape, which reflects the law of increasing opportunity costs.

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

The Production Possibilities Curve

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Production Possibilities Schedule

Hamburgers Computers point

on graph

Production Possibilities Curve

0 1 2 3

1000

600

b

c

1000 0 a

900 1 b

600 2 c

0 3 dComputers

Ha

mb

urg

ers

e

f

inefficient

unattainable

d

900

a

Production Efficiency

Achieved when it is not possible to produce more of one good without producing less of the other good

Occurs only at points on the production possibility curve

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

The Law of Increasing Opportunity Cost

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Production Possibilities Schedule

Hamburgers Opportunity Computers point

Cost of on graph

Computers

Production Possibilities Curve

0 1 2 3

1000

6001000 0 a

100

900 1 b

300

600 2 c

600

0 3 d

ComputersH

am

bu

rge

rs

As the quantityof computers

rises, so does theiropportunity cost.

a

b

900

c

d

Law of Increasing Opportunity Cost

The concept that as more of one item is produced by an economy, the opportunity cost of additional units of that product rises

Formula to calculate opportunity cost

Opportunity Cost = Give up

Gain

Further Understanding of the Opportunity Cost Calculation

Further Understanding of the Opportunity Cost Calculation

Opportunity Cost = Give upGain

Opportunity cost of one computer= 4-7 televisions = - 3 = -1.5 tv/cmpt

6-4 computers 2

Shifts in Production Possibilities

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Production Possibilities Curve

0 3

1000

Computers

Ha

mb

urg

ers

With morecomputers, the curve shifts out

in the nextperiod.

To expand production possibilities curve – You need economic growth –but how?

Economic Resources

Basic items that are used in all types of production to meet the needs of wants of individuals and society as a whole◦ Natural Resource

◦ Capital Resource

◦ Human Resources

◦ Entrepreneurship

Specific strategies to increase economic resources

Increase resources by discovery of new oil and gas deposits (Natural resources)

Increase human resources through immigration and improving the skills of the existing workforce

Increase an economy’s capital stock –devote more resources into producing more efficient machines and technology.

Why?

Consider the opposite- what might this graph suggest? Would it make sense?

Hamburgers

Computers

Reason

Resources are not perfectly adaptable to all products

(The assumption also is that the two products are quite distinct)

Law of Increasing Opportunity Cost

Reason:

Specialized resources will not be as productive after transfer

Each machine/person is specialized in one area(Resources are specialized)

Thus, resources used are not perfectly substitutable between both goods produced

Law of Increasing Opportunity Cost

Result:

The result is smaller increase in computers as we transfer resources over

Each computer costs more than the previous one in terms of hamburgers

Law of Increasing Opportunity Cost

A more detailed explanation:◦ Human resources: At first, switching a few staff from one department to another isn’t difficult. However, as you switch more staff, they are taken away from what they are good at and receiving new training for the new job = more money = higher opportunity cost

◦ Capital resources: As production shifts more from one good to the next, even more equipment need to be replaced. Even more money is needed in this replacement process, adding to the opportunity cost