Production Possibilities Curve

PPC

• This illustrates the fundamental problem of scarcity. Since wants will always exceed available resources, people living in a given economy must make production choices. Therefore the economy must decide how many of certain items they will produce to try to maximize their return.

PPC

• Since this is a simple model we are assuming a few things:• only two things will be produced by this simple economy (this makes

the economic trade-off very clear: the increased production of one good can be achieved only by sacrificing some quantity of the alternative product).

• The economy has fixed technology and resources (this model is over a short period of time so we are assuming that the economy cannot acquire new technology or obtain or import more resources).

• The economy is at full employment (so we can’t just add more workers to produce more products).

PPC

• Combinations that lie inside (below) the curve represent an inefficient use of resources

• Combinations that lie outside (above) the curve represent production impossibilities (given existing technologies)

PPC

• In the Real world, technology and the factors of production do not remain constant

• When improvements in technology occur or new resources become available, the entire production possibilities curve changes

• A new curve is formed to the right/left of the original curve.• This curve has “SHIFTED.”

Production Possibilities

Item #1Ex. Tablets

Item #2Ex. Cell Phones

Opportunity Cost of Additional Tablet Production (quantity of cell phones that must be given up)

Relative Cost to Society (what are they going to gain and give up as the level of production of each good changes)

A 0 150 10 The production of 1 more tablet = 10

less cell phones that can be produced.B 1 140 20 The production of 1 more tablet = 20

less cell phones that can be produced.C 2 120 30 The production of 1 more tablet = 30

less cell phones that can be produced.D 3 90 40 The production of 1 more tablet = 40

less cell phones that can be produced.E 4 50 50 The production of 1 more tablet = 50

less cell phones that can be produced.F 5 0

A Different Example:Productuion Possibilities Curve

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Production of Luxury Cars (in millions)

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ProductuionPossibilitiesCurve

The Law of Increasing Relative Costs

• The economic cost of one tablet relative to cell phones is not given in a dollar amount but by the number of cell phones that have to be given up in order to make one tablet. This is called the tablet’s relative cost.

• This table shows the law of increasing relative cost. This is when in order to get greater amounts of one product you must sacrifice an ever-increasing amount of another product. These graphs will have a bowed out or concave shape to them. This happens because although tablet production changes by a constant amount each time cell phone production changes by an increasingly larger amount each time.

The Law of Increasing Relative Costs

• The production possibility schedule (the table listing tablet and cell phone production) contains the maximum potential output that can be produced for each of the two products. The curve that these points would form creates the outer limit or frontier of production possibilities. Therefore anything above the line is unattainable and anything below the line is not an efficient use of resources (they could be making more products).

Law of Diminishing Returns

• The law of increasing relative cost deals with the relationship between two outputs (ex. products that have been created: in our case tablets and cell phones) while the law of diminishing returns deals with the relationship between an input (ex. resources that are used to create a product such as labour) and an output (what is being created).

• The law of diminishing returns – outputs will increase when a particular input is increased, but only to a point. After this point has been reached, increasing inputs will not have a significant effect on the production of outputs.

Law of Diminishing Returns

• Think of “too many cooks in the kitchen” if you have one person trying to create a meal for 25 people it will take them a long time – let’s say 5 hours, if they get another person to help maybe it will take 3 hours, 3 people 2 hours, 4 people 1.5 hours, 5 people 1 hour 20 minutes,

• At 4 or more people the benefit is not as large as it once was so the benefit of the return they are providing is diminishing (decreasing). This is assuming that they all have to use the same resources (ex. you can’t use two kitchens etc.).

The Law of Increasing Returns to Scale• This tells us what happens when all productive resources are

increased at the same time. • Example: (using the cooks in the kitchen) being able to increase the

kitchen space (ex. Building or renting another kitchen space) and increasing the number of workers at the same time.

• In this case the scale of the operation has increased.• However in the real world we can’t always continue to increase the

amount of kitchen space we have and the number of workers (we don’t have the money to pay the workers and buy new kitchen space).