Economic Challenges Facing Countries & Business PPC: Production Possibilities Curve

Economic System:  A set of rules by which a nation decides how to distribute its resources to satisfy its people’s needs and wants.  3 Basic Questions for Goods & Services:  1. Which goods and services will be produced?  2. How will these goods and services be produced?  3. How will these goods and services be distributed?

Factors of Production  Economic Resources:  Resources that could be used to produce or create goods  or services.  When economic resources are actually used to produce goods or services, they become Factors of Production.  4 Factors of Production:  1. Natural Resources:  2. Human Resources  3. Capital Resources  4. Entrepreneurial Resources

Natural Resources  1.) Natural Resources:  Things that come from the air, water, or earth.  2 Types of Natural Resources:  A. Nonrenewable Resources:  Cannot be replaced or renewed – coal, oil, and other minerals.  B. Renewable Resources:  Can be replenished – water and plants

Human Resources  2.) Human Resources:  People who contribute physical and mental energy to the production process.  Human Resources are also called Labor or Employees.  Experts tell us that Human Resources are the most important resource a business can have. If treated badly, they will leave the business and then the business cannot function.  Treating your employees fairly is critical to the success of your business.

Capital Resources  3.) Capital Resources:  All the other items other than natural resources that are used to produce goods and services.  This includes buildings, machines, equipment, and tools.  Capital Resources do not directly satisfy our wants but are still useful and necessary for production to occur.  Money is not technically considered a Capital Resource since it does not directly produce goods and services.

Entrepreneurial Resources  4.)Entrepreneurship:  The initiative to combine natural, human, and capital resources to produce goods or services.  Entrepreneurs are the people who recognize a new want or need and find ways to combine resources to fulfill that want or need

 What does scarcity force countries to do?  Scarcity causes countries to answer the 3 basic economic questions:  1. Which goods & services will be produced?  2. How will goods and services be produced?  3. How will goods and services be distributed?  Since resources are limited, a country cannot make every good in the quantity its people would like as inexpensively as they may desire.

Population and Production:  Population:  The number of people living in an area, usually a country.  The more people a nation has, the tougher the production decisions become.  Effects of Population Growth :  1. As population increases, the number of needs and wants that must be fulfilled also increases.  2. As population increases, the available labor supply increases.

Making Decisions About Production  The resources used for one purpose cannot also be used for something else  Example: Land used to farm cannot also be used to  build a factory.  To produce one thing we must give up another.  What is this called?  This foregone choice is called the Opportunity Cost.

This graph shows the number of candy bars and gumballs a candy company might produce Candy Bars This graph shows the number of candy bars and gumballs a candy company might produce Candy Bars Production Possibility Curve Candy Bars This graph shows the number of candy bars and gumballs a candy company might produce A Production Possibility Curve/Graph is used to measure the trade-off a country or business makes when deciding to produce one product over another. A production possibility curve is a graph which shows the different production combinations that are possible for two goods or services.

Production Possibilities Frontier  Model used to illustrate opportunity costs  It is the line that shows maximum combinations of goods and/or services an economy can produce when all productive resources are fully employed  Any spot on that line represents a point at which all the resources are being used to produce a max combination of two products  Represents an economy working at its most efficient level of production  Any point inside the line indicates an underutilization of resources Guns v. Butter A – 100 Butter, 30 Guns B – 50 Butter, 120 Guns C – Overuse of resources (temporary) D – Resources not fully employed This graph shows the number of guns and butter a country can produce:

Gumballs

Production Possibility Curve gumballs Candy Bars Look at the red dots. What is the maximum number of Gumballs which can be produced? 25 What is the maximum number of candy bars which can be produced?5 Can we produce the maximum number of both goods? NO

Production Possibility Curve gumballs Candy Bars Why can’t we produce the maximum of both goods? If the maximum amount of one good is produced, then none of the other good can be produced. Look at the green dot If 5 candy bars are made, then 0 gumballs can be made. If 25 gumballs are made, then 0 candy bars can be made.

Production Possibility Curve gumballs Candy Bars We can make any combination of goods which lies along the blue sloping line on the graph. We look for common points along the line for both products. Let’s look at some possibilities.

Production Possibility Curve gumballs Candy Bars 2 We go up the y-axis to 15 gumballs and across to the line. The red dot shows that if we make 15 gumballs then we only have the resources left to make 2 candy bars.

Production Possibility Curve gumballs Candy Bars Now, how many gumballs can we make?5 We go across the x-axis to 4 candy bars and up to the line. The red dot shows that we can make only 5 gumballs

Production Possibility Curve gumballs Candy Bars How many gumballs do we lose if we make 4 candy bars instead of 2? 10 Look at the red dots AT, 2 candy bars, we make 15 gumballs AT, 4 candy bars, we make 5 gumballs WE lose 10 gumballs: law of increasing costs (opportunity cost increases)

Production Possibility Curve gumballs Candy Bars How do we decide which is better, 2 or 4 candy bars?

The answer is…… We can’t, not just yet. We would need more information. It’s the same way for companies and countries. They will look at many factors such as: the cost of the ingredients for each product, how many of each item they can sell, how much they can charge for each product, how many workers or machines are needed for each. Business can be very complex.

Using the Production Possibilities Frontier The production possibilities frontier (PPF) is a useful tool for understanding economic choices made by societies. It is also a useful model for understanding economic growth. The PPF is a graph that shows how a country might allocate scarce resources in its production of goods and services. For simplicity, the model shows the production of two types of goods and services— defense goods (military goods and services produced for national defense; for example, tanks, satellites, and warplanes) and civilian goods (goods and services produced for consumption for nonmilitary purposes; for example, cars, education, and medical care)—we might draw a graph that looks like Figure 1.

Frontier: Represents the max quantity of defense goods and civilian goods the economy can produce with its currently available resources. Economic resources: Land (natural resources) Labor (workers) Capital (goods used to produce other goods and services)

For Example: This society might choose to allocate resources in a combination reflected by point “B” Which shows a large quantity of defense goods produced (11 units) And a much smaller quantity of civilian goods produced (5units) This society would enjoy a greater sense of security but have fewer goods and services available for consumption by its civilian population

Or,  The society might choose to produce the combination reflected by point “D”  Which shows a larger quantity of civilian goods (11units)  And a much smaller quantity of defense goods (5 units)  Now, the society has chosen to forgo some national security in exchange for a higher consumption of civilian goods.

In both cases, when society is producing on the “frontier”! It indicates that the society is using all its available resources and producing at an efficient level

Alternatively, the society might choose point “A” This indicates a much smaller production of both defense goods and civilian goods (5 units each) The choice of a point inside the PPF shows the resources in the economy are underutilized Society is using fewer resources than optimal This might occur during an economic recession when some factories sit idle And/or some workers are unemployed

PPF is useful to visualize the economic concepts of - Scarcity and Opportunity cost Imagine a society that chooses point “D” as its current allocation of resources between defense goods and civilian goods If this society decides more security is needed (greater spending on defense goods by moving to point B) Then, this choice would require giving up 6 units of civilian goods. Why? Because of Scarcity The resources used to produce defense goods are not available for the production of civilian goods The civilian goods given up as a result of this choice constitute an opportunity cost – The value of the next best alternative when a decision is made; it’s what is given up

Economic Growth means more of both goods: In the model that we’ve been looking at, we learned that the frontier represents maximum production with current resources. In this case, when we are looking at an economy’s production of goods and services – production point “E” is not possible with current resources

The frontier itself can shift outward (to the right and up) This shift represents economic growth that creates Rising opportunities, Living standards And incomes for people

The shift can be a result from increases in inputs and outputs  The increase in inputs is simply an increase in the # of available resources  More land (natural resources)  Labor  Or, capital  Outputs - Sustainable long-run growth is the result of better use of existing land, labor and capital through technological progress and innovation

The outward shift of the frontier made possible by economic growth makes production at point “E” possible

During recessions, the economy may operate with an above-average number of unemployed people. That is, when the economy is operating below its productive capacity; this is indicated by a point inside the PPF, such as point “A”

 Monetary policies leading to lower interest rates or fiscal policies—such as tax cuts or increases in government spending—designed to push the economy back toward the PPF might be used in recessions to move the economy back toward its potential, such as point “B.”  This move toward the economy’s potential is often referred to as economic expansion.

The Difference between Economic Expansion and Long-run Economic Growth:  Economic expansion moves production capacity toward the previously established PPF  Economic growth shifts the PPF outward  This makes the production at point “C” possible

 Lower interest rates, tax cuts, and increases in government spending can be used to support economic expansion

 But, Economic Growth that shifts the PPF is a result of increases in resources and productivity and is supported by economic institutions that promote growth