Production Possibilities Curve

Economic Model An economic model attempts to abstract from complex human behavior in a way that sheds some insight into a particular aspect of that behavior. This process inherently ignores important aspects of real-world behavior, making the modeling process an art as well as a mathematical exercise.An economic model attempts to abstract from complex human behavior in a way that sheds some insight into a particular aspect of that behavior. This process inherently ignores important aspects of real-world behavior, making the modeling process an art as well as a mathematical exercise.

Opportunity Cost Def: loss of the next best alternative use of your time, money, or resources (best opportunity lost) Ex. The opportunity cost of going on a date with your boyfriend is giving up the opportunity to watch the True Blood finale

Production Possibilities Curve The PPC is a graph which shows the various combinations of goods and services that can be produced by an economy

Assumptions in Economics We make assumptions to simplify complicated economic scenarios.We make assumptions to simplify complicated economic scenarios.

4 Assumptions of the PPC Efficiency – economy is operating a full employment and achieving full production Fixed Resources – factors of production are fixed in quantity and quality Fixed Technology – there are no new technological innovations Two Products – economy produces only 2 outputs (or categories of outputs)

About the graph… all points ON the curve are possible and show a maximum efficient use of resourcesall points ON the curve are possible and show a maximum efficient use of resources All points INSIDE the curve are possible but inefficientAll points INSIDE the curve are possible but inefficient

Could result from… Unemployment Strikes Inefficient System

More about the graph… all points OUTSIDE the curve are unattainableall points OUTSIDE the curve are unattainable -- beyond the current productive capacity of this economy

Moving between points on the PPC shows our opportunity cost Opportunity cost = highest value alternative foregone Rarely see a shack in a desirable location because owner could sell property to buy a better house in a less desirable location What’s wrong with this picture?

Constant Opportunity Cost Linear PPCLinear PPC No change in the amount of capital goods society gives up to gain more consumer goodsNo change in the amount of capital goods society gives up to gain more consumer goods Means resources are equally good at producing tools and TVsMeans resources are equally good at producing tools and TVs

Increasing Opportunity Cost Concave PPC As production of a good (computers) increases the opportunity cost of producing an additional unit rises Means resources are specialized

Decreasing Opportunity Cost Convex PPC As production of a good (computers) increases the opportunity cost of producing an additional unit decreases

Capital v. Consumer Goods Capital goods, are goods used in production. Consumer goods are for the final consumer, as a person. Example, an industrial mixer is a capital good because it is used to produce muffins. Muffins are a consumer good, because they are purchased by a consumer.

How do we produce beyond the PPC? WE DON’T Unless… One of our assumptions changes 1.Fixed resources 2.Fixed technology 3.Efficiency (But we are already perfectly efficient) 4.2 products (actually, this one won’t help)

We get more resources Draw new PPC to the right of old PPCDraw new PPC to the right of old PPC Previously unattainable positions are now attainablePreviously unattainable positions are now attainable

Technological innovation MORE STUFFMORE STUFF Ability to produce capital goods has not changedAbility to produce capital goods has not changed

Produce More Capital Goods The more capital goods we produce now (more current consumption forgone) the more productive capacity we will have later