Production Possibilities and Opportunity Costs

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Production Possibilities and Opportunity Costs

• Unit 1
• Lecture Notes

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Production Possibilities

• Trade-offs are necessary because of the basic
  economic problem of scarcity.
• Production Possibilities is the representation of
  scarcity in table or graphical form
• The table/graph shows that a society can not have
  everything it desires and must trade some of one
  good to get more of another good
• Production Possibilities involve opportunity costs

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PPC 4 Assumptions

• Full employment and productive efficiency
• Fixed resources in both quantity and quality
• Fixed state of technology
• Only two goods or two classifications of goods
  (i.e. capital vs. consumer goods)

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Production Possibilities Table

• PP table lists different combinations of two
  products which can be produced with a specific
  set of resources
• Scarcity prohibits having more of both
  goods--must sacrifice some of one good for more
  of another

Production choice B allows 1 thousand pizzas and
9 thousand robots to be produced
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Production Possibilities Curve

• Graphical representation of the trade-offs that
  must be made as a result of scarcity

Capital Goods
Unattainable
Production Possibilities Frontier
Attainable but undesirable
Consumer Goods
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Understanding the Curve

• Any point inside the curve reflects that which is
  attainable but undesirable. Society is not using
  all the resources available to it in the most
  productive way, thereby causing less of both
  goods to be able to be produced
• Any point on the curve reflects that society is
  at full employment and full productivity.
• Any point outside the curve reflects that which
  is currently unattainable.

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• The goal of all societys is to push out the PPC
  so that they will be capable of increasing their
  production of both goods.
• Generally speaking and overtime, changes in
  technology, worker training, population growth,
  etc. push out the curve.
• Economic growth is reflected in a PPC which has
  been pushed out beyond its former position.
• Societies can effectively push out their curve by
  engaging in comparative advantage trade with
  other countries or by borrowing economic
  resources of other nations

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Law of Increasing Opportunity Costs

• Scarcity forces societys to choose among
  alternative goods and services.
• The amount of other goods/services which must be
  forgone or sacrificed to obtain an additional
  unit of the next best alternative good is called
  opportunity cost.
• The production possibilities curve reflects
  opportunity costs of this trade-off in its
  concave shape

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Law of Increasing Opportunity Costs (cont.)

• Economic resources arent completely transferable
  or adaptable to other uses -- they lack perfect
  flexibility
• As a result, marginal opportunity costs increase
  as we produce more of one good at the expense of
  another
• This reality is seen in the bowed out PPC

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Determining the best or optimal output mix on the
curve
Allocative efficiency requires that the economy
produce at the most valued or optimal point on
the PPC. In order to determine this point, a
Marginal Benefit/Marginal Cost (MB/MC) comparison
is needed.
Costs to produce additional units of the
good/service
MC
Allocative Efficiency MBMC
Value of additional units of the good/service
MB
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Optimal point MCMB

MC
Overallocation MCgtMB
Underallocation MBgtMC
MB
Consumer Goods
Overallocation means society is producing more of
the good/service then is desired and deemed
beneficial to society. Underallocation is the
opposite problem. Not enough of the desired good
is being produced.
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Economic Growth is a goal of societythe ability
to produce a larger total output

• Unemployment and failure to achieve productive
  efficiency cause the economy to operate inside
  its PPC
• Increases in resource supplies, improvements in
  technology, improvements in resource quality
  cause economic growth and shift the curve outward
• A societys present choice of capital vs.
  consumer goods helps determine the future PPC
  location
• International specialization and trade enable
  nations to have more goods than indicated by the
  curve