Lesson 5A: Production Possibilities Curve (Part 1)

Production Possibilities Curve/Frontier (PPC/PPF)

An economic model for Society’s economizing problem and of scarcity, choice and opportunity cost; a graphical representation of choices, or the alternative ways an economy can use its resources; a model of a macro economy used to analyze the production decisions in the economy and the problem of scarcity

Scarce resources

Economic resources are limited relative to wants

Economic resources are sometimes called…

Factors of production and include all natural, human and manufactured resources used to produce goods and services

Resource categories

1. Land

2. Labor or human resources

3. Capital or investment goods

4. Entrepreneurial ability

Land

Natural resources (“gifts of nature”)

Labor

human resources; includes physical and mental abilities used in production (also includes entrepreneurship)

Capital (category of FoP)

Investment goods, all manufactured aids to production like tools, equipment, factories, transportation, etc.

Entrepreneurial ability

A special kind of human resource that provides 4 important functions:

1. Organizes resources needed for production

2. Makes basic economic policy decisions

3. Is an innovator for new products, production techniques, and organizational forms

4. Bears the risks of time, effort, and funds

Production Possibilities Schedule

A device to illustrate the economic problem (choices will be necessary because resources and technology are fixed. This illustrates some of the possible choices)

Assumptions of Production Possibilities Schedule

1. Full Employment: all productive resources (factors of production) should be employed

2. Available supply of resources is fixed in quantity and quality at this point in time (“snapshot in time”)

3. Technology (Know-how) is fixed (constant) during analysis

4. Economy produces only two types of products

PPC has nothing to do with..

Consumer satisfaction or demand! (Only about production possibility NOT supply & demand)

Points ON PPC

Represent maximum possible combinations of Good A and Good B given resources and technology; production efficient (achieves production efficiency)

Points inside PPC

Represent underemployment or unemployment (possible but inefficient); attainable and have some unemployed resources (there are available resources and/or technology to produce more of a good (“free lunch”)

Points outside of PPC

Unattainable at present (not possible given resources and technology given at this time); not enough resources and/or technology to produce at that level

Optimal or best product-mix

1. Will be some point on the curve

2. Which point depends on society; this is a normative decision (based on value judgements)

Law of Increasing Opportunity Cost

1. Opportunity Cost

2. Because resources aren’t completely adaptable to alternative uses, the OC increases as society wants increasing amounts if a particular product

3. Explains why PPC is concave ( bowed out) to origin rather than a straight line

4. Slope of PPC becomes steeper demonstrating increasing opportunity costs (makes curve appear concave)

5. Economic rationale

Opportunity Cost

The amount of other products which must be foregone to obtain more of any given product

Economic Rationale

1. Economic resources arent completely adaptable to alternative uses (costs increase)

2. to get increasing amounts of a good, resources that arent particularly well suited for that purpose must be used (ex. Workers accustomed to one skill may not adapt well to another to produce a different good)

Trade-offs (PPC)

Movements between points on the curve