Production Possibilities
Curve (PPC)
I.���� Production possibilities curves show
opportunity costs
A.��� Def'n: Opportunity costs = the
highest-valued alternative foregone in making a decision
B.��� Examples
1.��� the opportunity cost of holding money =
foregone interest
2.��� the opportunity cost of college education =
foregone income
C.��� Prices are the opportunity costs established
in markets for scarce goods, services, and resources.
II.�� Production Possibilities Curves
A.��� Def'n: shows the maximum possible
combinations of goods an economy produces when resources and technology are
fully employed and fixed in supply.
B.��� Assumptions
1.��� Efficient economy
a.��� economy is at full production
b.��� economy is at full employment
2.��� The supply of resources fixed
a.��� land
b.��� capital
c.���� labor
d.��� entrepreneurship
3.��� Technology fixed.
4.��� Two good world
C.��� An example PPC
1.��� Two goods: guns and butter
2.��� Points A, B, C, D, and E are equally
feasible, indicating full employment and production.
3.��� Referring to points A, B, C, D, and E, which
point is best?� This is a
nonscientific question.� The �best point�
depends on society�s tastes.� All an
economist can say is that these points are equally feasible and efficient.�
4.��� Point F is unobtainable, given current
resources and technology.
5.��� Point G is obtainable, but it indicates
inefficiency and unemployed resources.� (More
of both goods can be produced with the same resources.)
6.��� The opportunity cost of increased butter
(gun) production = foregone guns (butter)
D.��� Shifts in the PPC
1.��� Economic growth vs economic decay
2.��� Shifts in the PPC caused by change in
resources or technology
3.��� What causes an outward (inward) shift?
a.��� Increased (decreased) labor
b.��� Increased (decreased) capital
c.���� Increased (decreased) education
d.��� Increased (decreased) technology
4.��� Technological progress in gun (butter)
production, but not butter (gun) production
5.��� What happens to the PPC if:
a.��� society decides to produce more of one good
and less of the other
b.��� decrease in unemployment
E.��� Slope of the PPC
1.��� Straight line production possibilities curve
a.��� constant opportunity cost: straight line
==> constant slope ==> constant opportunity cost
b.��� resources are not specialized, resources
equally well suited for butter and gun production
2.��� Concave or bowed‑outward PPC
a.��� exhibits increasing opportunity costs
b.��� resources are specialized, some resources
are more suited for gun (butter) production than butter (gun) production
c.���� exhibits the law of increasing opportunity
costs‑‑as the production of one good increases, its opportunity
costs also increases. If the production of one good increases by one unit
each at a time, the more and more of the other good is given up.
d.��� Specialization = the performance of a
specific task
i.���� advantage: perform task at lower cost
ii.��� disadvantage: job boredom
F.��� Exercise: The trade off between capital and
consumer goods ==> the impact on economic growth
III.� The PPC and international trade
A.��� Some key definitions and results
1.��� Def'n:�
Comparative advantage is the ability to produce something at a lower
opportunity cost than other producers
2.��� Countries will specialize in their
comparative advantage and they will export that product
3.��� International trade makes both counties
better off.
B.��� An example
1.��� Assume both the US and the UK produce food
and cloth.� Their production
possibilities curves are as follows:
The US PPC����������������
A���� B���� C���� D���� E���� F
Food����� 60��� 48��� 36��� 24��� 12��� 0����
Cloth����� 0���� 6���� 12��� 18��� 24��� 30���
The UK PPC
A���� B���� C���� D���� E���� F
Food����� 20��� 16��� 12��� 8���� 4���� 0
Cloth����� 0���� 8���� 16��� 24��� 32��� 40
2.��� Draw the PPCs.� Since each countries' PPC is a straight-line,
this example assumes that resources in the UK and US are not specialized and
they are equally well suited for cloth or food production.
3.��� Calculate before trade opportunity costs
a.��� The US:� 1
food = � cloth; 1 cloth = 2 food
b.��� The UK: 1
food = 2 cloth; 1 cloth = � food
4.��� Determine comparative advantage
a.��� The US has a comparative advantage in food
b.��� The UK has a comparative advantage in cloth
5.��� Each country will specialize in that good
where they have a comparative advantage.
a.��� The US will produce 60 units of food and
trade with the UK for cloth.
b.��� The UK will produce 40 units of cloth and it
will trade with the US for food.
6.��� The Terms of Trade
a.��� Def'n:�
The terms of trade is the ratio is the ratio at which one product is exchanged
for another.
b.��� The terms of trade will always lie between
the two trading parties' opportunity costs.�
Exactly where the terms of trade fall between those limits depends on
the relative strength of demand for both products in both countries.
c.���� In this example, assume the terms of trade
will be 1 unit of food = 1 unit of cloth.
i.���� The US will agree to this price because if
it produced cloth internally, then 1 unit of cloth would involve a sacrifice of
2� units of food.� With foreign trade, it now can obtain 1 unit
of cloth by only giving up 1 unit of food.
ii.��� The UK will agree to this price because if
it produced food internally, then 1 unit of food would involve a sacrifice of 2
units of cloth.� With foreign trade, it
now can obtain the same unit of food by only giving up 1 unit of cloth.
6.��� The after-trade consumption possibilities
curve
a.��� Def'n:�
A line showing the consumption combinations attainable through foreign
trade.
b.��� Returning to the example, draw the
after-trade consumption possibilities curves for the UK and the US.
c.���� Since the after-trade consumption
possibilities curves for both countries lie above their production
possibilities curves, both countries are better off because they can consume
more of both goods.
C.��� The presence of specialized resources and
increasing costs limit the gains from specialization ==> Can�t completely
specialized in comparative advantage