The PPCThe PPC

.. Because resources are scarce, Because resources are scarce, economies cannot have an unlimited economies cannot have an unlimited output of goods and services. So, societies output of goods and services. So, societies must choose which goods and services must choose which goods and services to produce. These choices can be to produce. These choices can be illustrated using a illustrated using a production production possibilities modelpossibilities model; which ; which illustrates the illustrates the maximum amounts of two goods that can bemaximum amounts of two goods that can beproduced assuming the full and efficientproduced assuming the full and efficientuse of available resources.use of available resources.

..

1. Resources are fixed. There is no way to increase the

availability of land, labor, capital or entrepreneurship. However, reallocation of these resources is possible.2. All resources are fully employed. No unused land, labor, capital, or entrepreneurship exists. The economy is running at full production and producing goods and services at the least cost (productive efficiency].

3. Technology is fixed. No new technological breakthroughs. The PPC represents one specific time period.

4. Only two things can be produced (2-good model).

Four Assumptions for our PPC ModelFour Assumptions for our PPC Model

VS

Constant Opportunity CostConstant Opportunity Cost1 Corn = 1 Tomato1 Corn = 1 Tomato

The STRAIGHT LINESTRAIGHT LINE shows the two products are

““equally substitutableequally substitutable””,, that is, they areare notnotspecialized inspecialized in particular usesparticular uses, so the

opportunity costs will remain constantopportunity costs will remain constant.

But in the real world resources are not completely adaptable to alternative uses. Thus the PPC graph has a curve that indicates a changing trade-off between resources. Obtaining more of one good requires giving up larger amounts of the alternative good.

Notes...

As the production of a good increases, the opportunity cost of producing an additional unit rises.

LAW OF INCREASINGLAW OF INCREASINGOPPORTUNITY COSTSOPPORTUNITY COSTS

The PPC is concaved outward due to the law of increasing opportunity cost.

Cap

ital

(th

ou

san

ds)

Consumer (hundred thousands)

121211111010 99 88 77 66 55 44 33 22 11

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

This is the first of sixteen economic models you will be expected to know, so let’s draw it now. You Y axis will be labeled capital goods, and your X axis will be labeled consumer goods. Don’t worry about the numbers right now. Draw you curve making sure that it is bowed to the right.

EE

AABB

CC

DD

Consumer GoodsConsumer Goods

Cap

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Go

od

sC

apit

al G

oo

ds

This graph show the health of the economy as it is frozen in time. The economy may change in the future; but remember we will assume that things are fixed right now. The relationship between a point on the graph and the curve illustrates the health of the economy.

Cap

ital

(th

ou

san

ds)

Consumer (hundred thousands)

121211111010 99 88 77 66 55 44 33 22 11

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

The curve represents the limit, or frontier, of economic production (how much our economy can produce effectively). Also called full employment, it represents about 96% employment and 80% production capacity.

PPF or Full employment

Cap

ital

(th

ou

san

ds)

Consumer (hundred thousands)

121211111010 99 88 77 66 55 44 33 22 11

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

Our economy could be forced to achieve 100% production output. And 100% of our labor force could be forced to work. But this would over-extend the economy. Over-extended economic production is illustrated by placing a point right outside the curve (point A). The economy could give a little

bit more output but the cost is too high, because the economy will not be operating at its best level.

PPF or Full employment

AA

BB

CC

DD

EEUnattainableUnattainable

*Shows opportunity cost *Shows opportunity cost

InefficientInefficient

BreadBread

Ro

bo

tsR

ob

ots

Points inside the curve represents economic inefficiency (point B). Resources are not being fully utilized.

A point on the curve represents economic efficiency (point C & D). Resources are being fully utilized.

Point movement along the curve represents your opportunity cost (moving from point C to point D). The single optimal or best combination of output for any society depends upon the preferences of society.

Points far outside the curve represents economically unattainable (point E). The economy can’t produce there unless it grows.

And How Is Economic Growth Demonstrated And How Is Economic Growth Demonstrated on aon a Graph? Like This Graph? Like This

Economic GrowthEconomic Growth

A

B

C

D

C

E

Cap

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Go

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s

Consumer Goods0

[Ability to produce a largertotal output over time]

Q

Q

Ro

bo

tsR

ob

ots

(th

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BreadBread (hundred thousands)

1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

More of either orboth is possible

Factors that Cause Economic GrowthFactors that Cause Economic Growth;;

Notes...Economic GrowthEconomic Growth

1. Increase in resources Increase in resources --

2. 2. Better resource quality Better resource quality --

3. 3. Technological advances Technological advances --

More of either orboth is possible

Factors that Cause Economic Growth;Factors that Cause Economic Growth;

Notes...Economic GrowthEconomic Growth

1. Increase in resources -Increase in resources -

2. Better resource quality -2. Better resource quality -

3. Technological advances -3. Technological advances -

These factors require an investment in capital goods (they are developments for future economic utility.)

FAVORINGFAVORINGPRESENT GOODSPRESENT GOODS

FAVORINGFAVORINGFUTURE GOODSFUTURE GOODS

Goods for the PresentGoods for the Present

Go

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s fo

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utu

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for

the

Fu

ture CURRENTCURRENT

CURVECURVE

FUTUREFUTURECURVECURVE

CONSUMPTION

Goods for the PresentGoods for the Present

Go

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utu

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for

the

Fu

ture

FUTUREFUTURECURVECURVE

CONSUMPTIONCONSUMPTION

CURRENTCURRENTCURVECURVE

So economies that produce a majority of capital goods (goods for the future) will experience more economic growth than the economy that produces a majority of consumer goods (goods for the present.)

FAVORINGFAVORINGCONSUMER GOODSCONSUMER GOODS

Goods for the PresentGoods for the Present

Go

od

s fo

r th

e F

utu

reG

oo

ds

for

the

Fu

ture

FUTUREFUTURECURVECURVE

CONSUMPTIONCONSUMPTION

CURRENTCURRENTCURVECURVE

Technological advance that is useful in producing consumer goods but not capital goods is shown below.

The EndThe End