The production possibilities curve is the first graph that we study in microeconomics. It shows us all of the possible production combinations of goods, given a fixed amount of resources. We assume three things when we are working with these graphs:
The production possibilities curve can illustrate several economic concepts including
The production possibilities curve can illustrate several economic concepts including:
Allocative Efficiency—This means we are producing at the point that society desires. This is represented by a point on the PPC that meets the needs of a particular society. If a particular society needs about an equal amount of sugar and wheat, the allocatively efficient point would be C on the graph below.
Productive Efficiency—This means we are producing at a combination that minimizes costs. This is represented by any point on the production possibilities curve.In the below graph, productive efficiency is achieved at points A, B, C, D, and E.
Point F in the graph below represents an inefficient use of resources. This point can also represent higher than normal unemployment.
Point G represents a production level that is unattainable. At this point, you do not have the needed amount of resources to produce that combination of goods.
The PPC accurately demonstrates how we produce goods and services under the condition of scarcity, which is when there are limited resource, but unlimited wants. The above graph shows how, given a fixed set of resources, we can produce either combination A, B, C, D, or E.
This is the value of the next best alternative. We represent this as what we are losing when we change our production combination. For example, moving from A to B on the graph above has an opportunity cost of 10 units of sugar. Per unit opportunity cost is determined by dividing what you are giving up by what you are gaining. So for the graph above, the per unit opportunity cost when moving from point A to point B is 1/4 unit of sugar (10 sugar/40 wheat).
Opportunity cost can also be determined using a production possibilities table:
The opportunity cost of moving from point C to D is 40 tons of oranges. The per unit opportunity cost of moving from point C to point D is 1/2 ton of oranges (40 tons of oranges/80 tons of pears).
Economic growth is shown by a shift to the right of the production possibilities curve.
If a country produces more capital goods than consumer goods, the country will have greater economic growth in the future. Capital goods refers to machinery and tools, while consumer goods include things like phones and clothing. If the country illustrated below produces at point B, they will see more economic growth than if they produce at point D. Since capital goods can be used to produce consumer goods, producing more capital goods will lead to more production of consumer goods in the future, causing economic growth.
Economic contraction is shown by a leftward shift of the production possibilities curve.
The production possibilities curve can illustrate two types of opportunity costs:
Increasing opportunity cost occurs when producing more of one good causes you to give up more and more of another good. This happens when resources are less adaptable when moving from the production of one good to the production of another good. The graph on the left shows increasing opportunity cost because pizza and robots use very different resources.
Constant opportunity cost occurs when the opportunity cost stays the same as you increase your production of one good. This indicates that the resources are easily adaptable from the production of one good to the production of another good. The graph on the right shows constant opportunity cost because pizza and calzones use almost the same exact resources
There are several factors that can cause the production possibilities curve to shift. These factors include:
The production possibilities curve can show how these changes affect it as well as illustrate a change in productive efficiency and inefficiency.
Here are some scenarios that illustrate these shifters:
The graph on the left shows how an improvement in the quality of resources (human capital!) causes economic growth. The graph on the right shows what happens when a country is producing at an inefficient point due to high unemployment.
The graph on the left shows a technology change that just impacts one good that a country produces, and the graph on the right shows what happens when the quantity of resources changes (i.e. number of workers decrease).
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1.3Production Possibilities Curve (PPC)