production possibilities

Production Possibilities

When faced with SCARCITY of resources, decisions have to

be made about how to use those resources

Trade-offs

Opportunity Costs

Trade-Offs

• This is the decision making process that is occurring in your mind right now!

• Am I going to pay attention to what Mr. Hayward is saying, or am I going to daydream?

• Am I going to come to class or go buy a lottery ticket? • Am I going to stay in school or go find a full time job?• Each and every decision you make has a cost!! Not

necessarily a cost in dollar terms, but a cost in that you must give up something in order to get more of something else.

Opportunity Cost

• The “price you pay” for each decision you make is called the OPPORTUNITY COST.

• Opportunity cost is vital to the understanding of economics.

• “The amount of a product or service that must be forgone (given up) in order to obtain more of the next best alternative product or service”

Production Possibilities Frontier

• Used to illustrate:– Productive Capacity– Opportunity Costs– Efficiency

• Productive • Allocative

– Economic Growth/Decline– Vital Link to Aggregate Supply (short/long run)

Wheat

Rice

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Production Possibilities FrontierIncreasing Opportunity Costs

Wheat Rice

NOTE: The GAIN in Rice isCONSTANT while the LOSSIn Wheat is INCREASING each Time…What is going on???

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Production Possibilities FrontierIncreasing Opportunity Costs

• The type of land resource suitable for growing Wheat is DIFFERENT than the land resource for growing Rice.

• If a society wants MORE Rice, then as you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy) it will become MORE costly to do that, in terms of Wheat production

• We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat


• Economy’s produce MORE that just Wheat and Rice.

• We produce LOTS of goods of many different types.

• We can broadly categorize goods into TWO categories– Capital Goods and Consumer Goods

The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production

Possibilities Curve

The PPC shows the relationship between two goods:

1. Capital Goods (Investment Goods) Goods that satisfy our wants

INDIRECTLY and promote future growth or “happiness” – Delayed gratification.

2. Consumer GoodsGoods that satisfy our wants DIRECTLY. Instant Gratification

Lesson 1 Act 1

Capital Goods

Consumer Goods

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Capital Goods “Stuff you use to make other Stuff” Tools, equipment, factories, other infrastructure

Consumer Goods“Stuff” for immediate Consumption. Food, consumerElectronics, etc.

Allocative EfficiencyWhere a society decides to Produce on its PPF. A value Decision based on values/politics

Productive EfficiencyFull-employment of resources And producing at the lowest cost

.A

.B.C

.D

.E


Production Possibilities Curve (Frontier)

• The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.

• At Point “A” the economy gives up 10 capital goods in order to get 400 consumer goods.

• 400 Consumer goods = 10 Capital goods• 1 Consumer good = 10 Capital goods/400• 1 Consumer good = .025 Capital good

Consumer Goods

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• The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.

• At Point “B” the economy gives up 10 Capital goods in order to get 200 more Consumer goods.

• 200 Consumer goods = 10 Capital goods

• 1 Consumer good = 10 Capital goods/200

• 1 Consumer good = .05 Capital good Consumer Goods

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• The bowed nature of the PPC is due to INCREASING OPPORTUNITY COSTS

• Not all resources are adaptable to alternative uses.

• Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa)

• Marsh land suitable for growing rice could not easily be converted for use as a an airport. It would be much more costly than using farmland in Kansas.

Consumer Goods

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• Lets take a closer look at the PPC.

• What do the different points on the PPC represent?

Consumer Goods

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.A

.B

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.D


• Each point represents Productive Efficiency

• This means that this economy is allocating ALL of it productive resources in the least costly way

Consumer Goods

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.A

.B

.C

.D


• There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency– This represents the

combination of Capital and Consumer Goods most desired by the society

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• The WHOLE PPC represents

• “FULL PRODUCTION”– Productive Efficiency– Full-Employment of

Resources

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.A

.B

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.D


Do economy’s always produce on the PPC?

No! Often they operate inside their production possibilities

Consumer Goods

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E



Point “E” represents a point inside the PPC.

Notice that this point “E” represents a lower bundle of Capital and Consumer Goods

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The area between point “E” and the PPC represents underutilization of resources or under-employment of resources or unemployment. The economy is being inefficient.

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This economy could be doing better…

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How about point “F”?

Point F is outside our PPC

It represents a combination of Capital and Consumer Goods that is currently not possible with this economies resources

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.F



How about point “F”?

Point F is outside our PPC

This point is desirable (more “stuff”) but currently not attainable.

Consumer Goods

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.A

.B

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Capital Goods

Consumer Goods

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Capital Goods “Stuff you use to make other Stuff” Tools, equipment, factories, other infrastructure

Consumer Goods“Stuff” for immediate Consumption. Food, consumerElectronics, etc.

Allocative EfficiencyWhere a society decides to Produce on its PPF. A value Decision based on values/politics

Productive EfficiencyFull-employment of resources And producing at the lowest cost

.A

.B.C

.D

.E

.F

.G


Production Possibilities CurveThe PPC shows ALL possible combinations of two goods that can be produced if ALL available resources are fully

employed (used) with the best technology currently available

Robotics(Capital Good)

Compact Discs (Consumer Good)

B

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E

F

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G

How do we get to point G??1. Technological advancement which increases Productivity2. Discover new resources3. Take resources (War)4. Trade for Resources

D

“OUR ECONOMY IS DRIVEN BY TECHNOLOGICAL ADVANCEMENT”

CAN YOU THINK OF AN EXAMPLE IN HISTORY WHEN WE WERE INSIDE THE PPC?

PPossibilitiesossibilities-A, B, C, D, & E-A, B, C, D, & E

ImpossibilityImpossibility[more/better resources, better technology]

Economic resources are not completely adaptable to alternative uses.The “curve”“curve” indicates a “changing trade-off.”“changing trade-off.”Obtaining more of one goodmore of one good requires giving upgiving up larger amounts of the alternative goodlarger amounts of the alternative good..

So, How Is So, How Is Economic GrowthEconomic Growth Demonstrated Demonstrated on aon a PPC Graph? PPC Graph?

Economic GrowthEconomic Growth

e

[Ability to produce a larger[Ability to produce a largertotal output over time]total output over time]

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Two Examples of Economic GrowthTwo Examples of Economic Growth

FAVORING PRESENT GOODSFAVORING PRESENT GOODS

Goods for the Present

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CONSUMPTIONCONSUMPTION

PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES

Two Examples of Economic GrowthTwo Examples of Economic Growth

FAVORINGFAVORINGPRESENT GOODSPRESENT GOODS

FAVORINGFAVORINGFUTURE GOODSFUTURE GOODS


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FUTUREFUTURECURVECURVE

CONSUMPTION


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PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES

Going to War (U.S.)Going to War (U.S.) When the U.S. entered WWI, we had severe unemployment. We were able to step up production of consumer goods and war materials simply by getting to full production. We went from 14.6% unemployment in 1940 to 1.2% in 1944. Over 7 million people went to work that were not working in 1940.

Going to War(Russia)Going to War(Russia). Russia, on the other hand, entered WWII at full capacity. So their preparedness entailed a shifting of resources from civilian goods and a drop in their standard of living.

The U.S. position was similar as we entered the Viet Nam War at full employment.We increased both military spending and domestic spending on the “War on Poverty.” Our attempt to achieve more “guns and butter” in a FE economy was doomed. We were trying to spend beyond capacity and ended up with double digit inflation in the 1970s.

Civilian GoodsCivilian Goods

FF

CC United StatesUnited States[Beginning of WWII][Beginning of WWII]

War GoodsWar Goods

Civilian GoodsCivilian Goods

War GoodsWar GoodsDD

CC RussiaRussia[Beginning of WWII][Beginning of WWII]

production possibilities

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