Production Production Possibility CurvePossibility CurveApplying Theories of Economic Applying Theories of Economic

Choice to Maximize the Choice to Maximize the Welfare of a Nation and its Welfare of a Nation and its

CitizensCitizens

Fundamental ProblemFundamental Problem

ScarcityScarcity– Wants will always exceed available Wants will always exceed available

resources.resources.– Therefore must make production Therefore must make production

choices.choices.

The CurveThe Curve

‘‘Provides a visual of the production Provides a visual of the production choices faced by people in a simple choices faced by people in a simple economy.’economy.’

Assumptions of the CurveAssumptions of the Curve

1.1. Only two products can be produced Only two products can be produced by this simple economy.by this simple economy.

• Trade-offTrade-off• Consumer vs. Capital GoodsConsumer vs. Capital Goods

2.2. The economy has fixed technology The economy has fixed technology and resources.and resources.

3.3. The economy is at full employment.The economy is at full employment.

Law of Increasing Relative Law of Increasing Relative CostCost

The opportunity to get greater amounts of The opportunity to get greater amounts of one product, sacrifices an ever-one product, sacrifices an ever-increasing amount of other products.increasing amount of other products.

Production Production PossibilitiePossibilitie

s s (alternativ(alternativ

es)es)

Assembly Assembly Line Line

MachineMachineiPodsiPods

Opportunity Cost Opportunity Cost of Additional of Additional

Computer Computer Production Production (quantity of (quantity of iPods that iPods that

must be given must be given up)up)

Relative Cost to Relative Cost to SocietySociety

AA 00 15 15 000000

1 0001 000 1 Computer = 1 1 Computer = 1 000 iPods000 iPods

BB 11 14 14 000000

2 0002 000 1 Computer = 2 1 Computer = 2 000 iPods000 iPods

CC 22 12 12 000000 3 0003 000 1 Computer = 3 1 Computer = 3

000 iPods000 iPods

DD 33 9 0009 000

4 0004 000 1 Computer = 4 1 Computer = 4 000 iPods000 iPods

EE 44 5 0005 000

5 0005 000 1 Computer = 5 1 Computer = 5 000 iPods000 iPods

FF 55 00

Production Possibility CurveProduction Possibility Curve

iPods

Assembly Line Machine

If the opportunity cost of each computer were constant at 1000, then the line would be straight. Therefore, the curve is represented by a ‘bowed-out’, or concave line.

Why Concave?Why Concave?

As production moves from iPods to As production moves from iPods to Assembly Line Machines, the labour Assembly Line Machines, the labour has to be transferred. has to be transferred.

Therefore, people who are more Therefore, people who are more suited to producing iPods are now suited to producing iPods are now producing large, more complicated producing large, more complicated assembly line machines.assembly line machines.

Why Concave? cont.Why Concave? cont.

Those who are less suited to these Those who are less suited to these machines are transferred first, followed machines are transferred first, followed by those who are more skilled. As the by those who are more skilled. As the transfer of these workers occur, less, transfer of these workers occur, less, and less iPods may be made.and less iPods may be made.

Therefore, a much larger amount of Therefore, a much larger amount of iPods must be sacrificed in order to iPods must be sacrificed in order to produce the last 2 assembly line produce the last 2 assembly line machines.machines.

FrontierFrontier

The curve illustrates the ‘Maximum The curve illustrates the ‘Maximum Potential’ Output that can be produced Potential’ Output that can be produced for each of the two products.for each of the two products.

Therefore, the curve is the outer limit Therefore, the curve is the outer limit or Frontier, of production possibility.or Frontier, of production possibility.

Only attainable if all productive Only attainable if all productive resources are fully employed.resources are fully employed.

Are resources always fully employed?Are resources always fully employed?

iPods

Assembly Line Machine

Point A illustrates most economies – operating inefficiently.

Point M illustrates an unattainable point at this time. But may be attained through changes.

A

M

Production Possibility Production Possibility CurveCurve

Law of Increasing Diminishing Law of Increasing Diminishing ReturnsReturns

The relationship between an input The relationship between an input (labour) and the resulting output.(labour) and the resulting output.

Outputs will increase when a Outputs will increase when a particular input is increased, but only particular input is increased, but only to a point.to a point.

When point has been reached, When point has been reached, increasing inputs will not have an increasing inputs will not have an effect on the production of outputs.effect on the production of outputs.

YearYear FactoriesFactories LabourLabourTotal Total

Production Production (iPods)(iPods)

Increase in Increase in YieldagYieldag

ee

11 1010 11 10001000

22 1010 22 20002000 10001000

33 1010 33 28002800 800800

44 1010 44 34003400 600600

55 1010 55 38003800 400400

66 1010 66 39003900 100100

77 1010 77 39003900 00

Law of Increasing Returns to Law of Increasing Returns to ScaleScale

Illustrates what happens when all Illustrates what happens when all productive resources are increased productive resources are increased simulataneouslysimulataneously

Using our example:Using our example:

YearYear FactoriesFactories LabourLabour Total Production Total Production (iPods)(iPods)

Increase in Increase in YieldageYieldage

11 1010 11 10001000

22 2020 22 20002000 10001000

33 3030 33 32003200 12001200

44 4040 44 46004600 14001400

55 5050 55 62006200 16001600

66 6060 66 80008000 18001800

77 7070 77 1000010000 20002000

Why has this happened?Why has this happened?– Owner has increased all productive Owner has increased all productive

resources at the same time and in the resources at the same time and in the same quantity.same quantity.

– They have increased their They have increased their SCALESCALE of of operations.operations.

– The net result is a conversion to a larger The net result is a conversion to a larger scale of operations and a steady increase scale of operations and a steady increase in the rate of extra output.in the rate of extra output.

– Increased returns to scale is termed – Increased returns to scale is termed – ECONOMIES OF SCALEECONOMIES OF SCALE

Law of Increasing Returns to Law of Increasing Returns to ScaleScale