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 (a) 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 (b) Figure 1.1, page 8 Copyright © 2005 by McGraw- Hill Ryerson Limited. All rights reserved. Production Possibilities Schedule Hamburgers Computers point on graph Production Possibilities Curve b c 10000a 9001b 6002c 03d03d Computers Hamburgers 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 Figure 1.2, page 10 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 a b c d Computers Hamburgers As the quantity of computers rises, so does their opportunity 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

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 Examples to explain: ◦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 require 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

Further Understanding of the Opportunity Cost Calculation

Opportunity Cost = Give up Gain Opportunity cost of one computer = 4-7 televisions = - 3 = -1.5 tv/cmpt 6-4 computers 2

Shifts in Production Possibilities Figure 1.2, page 10 Copyright © 2005 by McGraw- Hill Ryerson Limited. All rights reserved. Production Possibilities Curve Computers Hamburgers With more computers, the curve shifts out in the next period.

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

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.

To Maximize Utility with Scarce (limited) resources - Production Possibilities Curve Determined by economic organization or the type of economic system a society chooses to adopt The economic system adopted will determine the three most basic economic questions

The Basic Economic Questions There are three basic questions any society must answer: ◦what to produce ◦how to produce ◦for whom to produce Copyright © 2005 by McGraw- Hill Ryerson Limited. All rights reserved.