Introduction to Budget Lines and Production Possibilities Curves

Introduction

Budget Lines  Definition: A budget line is an economic model that illustrates all the possible combinations of goods and services that could be purchased given a fixed amount of time

Budget Lines  Each economic model has a set of well-defined assumptions to assist in simplifying the economic behavior expressed by the model. Only 2 goods can be purchased  In this model- pizza and hamburgers The price of the goods is set  In this model the set price is $1.00 each Income is set  In this model income or allowance is set at $5.00 a week All income must be spent on goods Ceteris Paribus

Budget Lines  The line in the model represents the budget line.  It shows a maximum (possible) combinations of hamburgers and pizzas that can be purchased for $5 For example at point C, you can purchase:  3 hamburgers  and 2 pizzas A B C D E F H G HAMBURGERSHAMBURGERS PIZZAS

Budget Line Practice  Given the assumptions of the model, which one of the following statements is true? It is possible to purchase either five hamburgers or five pizzas It is possible to purchase 5 hamburgers and 5 pizzas A B C D E F H G HAMBURGERSHAMBURGERS PIZZAS

Budget Line Practice A B C D E F H G HAMBURGERSHAMBURGERS PIZZAS  Given the assumptions of the model, which one of the following statements is true? At point B, 4 hamburgers and 1 pizza can be purchased At point D, 2 hamburgers and 3 pizza can be purchased All of the above

Budget Line Practice Hint: Opportunity cost- what is given up  Given the assumptions of the model, which one of the following statements is true? The opportunity cost of purchasing at point A is 5 hamburgers The opportunity cost of purchasing at point A is 5 Pizzas There is no opportunity cost for purchasing at point A A B C D E F H G HAMBURGERSHAMBURGERS PIZZAS

Budget Line Practice  Given the assumptions of the model, which one of the following statements is true? The opportunity cost of moving from point B to D is 2 hamburgers The opportunity cost of moving from point B to D is 2 pizzas There is no opportunity cost of moving from B to D A B C D E F H G HAMBURGERSHAMBURGERS PIZZAS

Budget Line Practice  Given the assumptions of the model, which one of the following statements is true? For each pizza purchased, one hamburger is given up The cost of pizzas in terms of hamburgers is constant All of the above are true HAMBURGERSHAMBURGERS A B C D E F H G PIZZAS

Budget Line Practice F A B C D E H G HAMBURGERSHAMBURGERS PIZZAS  Given the assumptions of the model, which one of the following statements is true? Point G is impossible to purchase given the income available More income would be needed to purchase at G because it is outside of the budget line All of the above are true

Budget Line Practice  Given the assumptions of the model, which one of the following statements is true? Point H is impossible to purchase given the income available Point H is possible but would mean that not all given income would be spent All of the above are true F A B C D E H G HAMBURGERSHAMBURGERS

Production Possibilities Curves  Definition: A production possibilities curve is an economic model that illustrates all the possible combinations of output that could be produced by an economy given the resources available

Differences?  What is the difference between PPC and Budget Lines? Budget Lines show what can be purchased PPC show what can be produced

Assumptions of PPC  Only two products can be produced In this example guns and butter  All resources are fixed Resources are land, labor, capital and entrepreneurship  All technology is fixed  All resources are used fully and efficiently  Ceteris paribus

Production Possibilities Curve  The curved line represents all the possible combinations of guns and butter that could be produced under the assumptions of the model A B C D E F GUNSGUNS BUTTER

PPC Practice  All resources are fully and efficiently utilized, Points A, B, C, D  Not possible given the resources Point E  Not full employment/use of resources Point F A B C D E F GUNSGUNS BUTTER

PPC Practice  If all resources are used fully and efficiently utilized, which one of the following combinations could be produced? Points A, B, C, or D Point F only Point E only None of the above A B C D E F GUNSGUNS BUTTER

PPC Practice  If all resources are fully and efficiently utilized, which one of the following is true concerning point E? There would still NOT be enough resources to produce a point such as E which is outside the PPC Point E would be possible if less guns or less butter were produced A B C D E F GUNSGUNS BUTTER

PPC Practice  To produce the combination of guns and butter at point E would require More resources (L,L,C,E) than currently available New technology to more efficiently use resources All or either of the above A B C D E F GUNSGUNS BUTTER

PPC Practice  Producing the combination of guns and butter at point F indicates that…. All resources are being fully and efficiently utilized Resources are not being fully and efficiently utilized. Unemployment of resources is occurring A B C D E F GUNSGUNS BUTTER

PPC Practice  Point F is under the PPC because it represents a combination of guns and butter that is less than what could be possible if all resources were fully and efficiently used. When an economy produces below its PPC, it means that resources are available but not used. This can happen during a recession or slowdown in the economy. High unemployment means that labor is not being used fully and efficiently A B C D E F GUNSGUNS BUTTER

PPC Practice  If production were changed by society from point A to point C, the opportunity cost of the decision would be The two units of butter The two units of guns given up None of the above A B C D E F GUNSGUNS BUTTER gained

PPC Practice  If production were changed by society from point D to point C, which one of the following would be true? One gun would be gained but 1/4 th of a unit butter would be given up 2 3/4 ths units of butter would be gained and 1 gun would be given up None of the above A B C D E F GUNSGUNS BUTTER 2 ¾

PPC Practice A B C D E F GUNSGUNS BUTTER  If production were changed by society from point C to point B, which one of the following would be true? One gun would be gained but 3/4 ths of a unit butter would be given up 2 units of butter would be gained and 1 gun would be given up None of the above 2 ¾

PPC Practice A B C D E F GUNSGUNS BUTTER  If production were changed by society from point B to point A, which one of the following would be true? One gun would be gained but 2 units butter would be given up 3 units of butter would be given up and 1 gun would be gained None of the above

Law of Increasing Costs  Note that each time in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased  The first gun cost ¼ th unit of butter A B C D E F GUNSGUNS BUTTER 2 ¾

Law of Increasing Costs  Note that each time in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased  The second gun cost ¾ ths unit of butter A B C D E F GUNSGUNS BUTTER 2 ¾

Law of Increasing Costs  Note that each time in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased  The third gun cost 2 units of butter A B C D E F GUNSGUNS BUTTER

Law of Increasing Costs  This is due to the LAW OF INCREASING COSTS  The law of increasing costs states: As more of a product is produced, each additional unit has a higher opportunity cost.

Effects of lifting the assumptions of the PPC  If we lift the assumptions of fixed resources and/or technology, what will happen to the curve? The curve will shift to the left (inward) or to the right (outward) ‏ The shape of the curve will change from bowed out to bowed in Society will be forced to produce at a point below its PPC.

Lifting the assumptions of the curve Adding more resources or discovering new technology  A shift to the right indicates that the economy can now produce more of both good X and Y.  A shift to the right increases the productive potential of the economy by adding new resources or technology

Lifting the assumptions of the curve Declining resources or technology  A shift to the left indicates that the economy’s productive potential has been reduced  Its possibilities have been diminished

Lifting the assumptions of the curve Producing below the curve is different from a shift of the curve to the left  A shift to the left indicates that the economy cannot produce as much X or Y as before  The resources are no longer available for use; thus, the economy’s production possibilities decreases  A point under (below) the curve means that resources are available to produce the maximum indicated by the curve; however, these resources are not being used fully or efficiently Unemployment of resources- i.e., unemployment of labor