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Macroeconomics
Course: Macroeconomics > Unit 1
Lesson 2: Opportunity cost and the Production Possibilities Curve- Production possibilities curve
- Opportunity cost
- Increasing opportunity cost
- PPCs for increasing, decreasing and constant opportunity cost
- Production Possibilities Curve as a model of a country's economy
- Lesson summary: Opportunity cost and the PPC
- Opportunity cost and the PPC
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Lesson summary: Opportunity cost and the PPC
In this lesson summary, review the key concepts, key terms, and key graphs for understanding opportunity cost and the production possibilities curve.
The Production Possibilities Curve (PPC) is a model used to show the tradeoffs associated with allocating resources between the production of two goods. The PPC can be used to illustrate the concepts of scarcity, opportunity cost, efficiency, inefficiency, economic growth, and contractions.
For example, suppose Carmen splits her time as a carpenter between making tables and building bookshelves. The PPC would show the maximum amount of either tables or bookshelves she could build given her current resources. The shape of the PPC would indicate whether she had increasing or constant opportunity costs.
Key terms
| Term | Definition |
|---|---|
| production possibilities curve (PPC) | (also called a production possibilities frontier) a graphical model that represents all of the different combinations of two goods that can be produced; the PPC captures scarcity of resources and opportunity costs. |
| opportunity cost | the value of the next best alternative to any decision you make; for example, if Abby can spend her time either watching videos or studying, the opportunity cost of an hour watching videos is the hour of studying she gives up to do that. |
| efficiency | the full employment of resources in production; efficient combinations of output will always be on the PPC. |
| inefficient use (under-utilization) of resources | the underemployment of any of the four economic resources (land, labor, capital, and entrepreneurial ability); inefficient combinations of production are represented using a PPC as points on the interior of the PPC. |
| growth | an increase in an economy's ability to produce goods and services over time; economic growth in the PPC model is illustrated by a shift out of the PPC. |
| contraction | a decrease in output that occurs due to the under-utilization of resources; in a graphical model of the PPC, a contraction is represented by moving to a point that is further away from, and on the interior of, the PPC. |
| constant opportunity costs | when the opportunity cost of a good remains constant as output of the good increases, which is represented as a PPC curve that is a straight line; for example, if Colin always gives up producing 2 fidget spinners every time he produces a Pokemon card, he has constant opportunity costs. |
| increasing opportunity costs | when the opportunity cost of a good increases as output of the good increases, which is represented in a graph as a PPC that is bowed out from the origin; for example Julissa gives up |
| productivity | (also called technology) the ability to combine economic resources; an increase in productivity causes economic growth even if economic resources have not changed, which would be represented by a shift out of the PPC. |
Key model
The Production Possibilities Curve (PPC) is a model that captures scarcity and the opportunity costs of choices when faced with the possibility of producing two goods or services. Points on the interior of the PPC are inefficient, points on the PPC are efficient, and points beyond the PPC are unattainable. The opportunity cost of moving from one efficient combination of production to another efficient combination of production is how much of one good is given up in order to get more of the other good.
The shape of the PPC also gives us information on the production technology (in other words, how the resources are combined to produce these goods). The bowed out shape of the PPC in Figure
We can also use the PPC model to illustrate economic growth, which is represented by a shift of the PPC. Figure
Key Equations and Calculations: Calculating opportunity costs:
To find the opportunity cost of any good X in terms of the units of Y given up, we use the following formula:
Common Misperceptions
- Not all costs are monetary costs. Opportunity costs are expressed in terms of how much of another good, service, or activity must be given up in order to pursue or produce another activity or good. For example, when you head out to see a movie, the cost of that activity is not just the price of a movie ticket, but the value of the next best alternative, such as cleaning your room.
- Going from an inefficient amount of production to an efficient amount of production is not economic growth. For example, suppose an economy can make two goods: chocolate donuts and cattle prods. But half of their donut machines aren’t being used, so they aren’t fully using all of their resources. Graphically, that would be represented by a combination of goods in the interior of their PPC. If they then put all of those donut machines to work, they aren’t acquiring more resources (which is what we mean by economic growth). Instead, they are just using their resources more efficiently and moving to a new point on the PPC.
- On the other hand, if this economy is making as many donuts and cattle prods as it can, and it acquires more donut machines, it has experienced economic growth because it now has more resources (in this case, capital) available. This would be represented in a PPC graph as a shift outward of the entire PPC curve.
Discussion Questions
- How would you show with a PPC that a country has constant opportunity costs of production?
- Using a correctly labeled PPC model, show an economy that has increasing opportunity costs that can produce cattle prods and chocolate donuts that is underutilizing its labor.
Want to join the conversation?
Helloooo,
For discussion question number 1, is it correct if I say: with two product variables in the two axis, it can be shown by a straight line going down from left to right on the graph?(21 votes)
Yes, but with a small additional needed element.
For example, suppose you can produce either 20 paper airplanes in a day or 40 drawings of puppies in a day and you had constant opportunity costs. On one axis you would label "number of paper airplanes" and on the other you would label "number of puppy drawings". Then you would draw a straight, downward sloping line connecting those two axes that connects at 40 on the puppy axis and connects at 20 on the paper airplane axis.(20 votes)
How can scarcity be represented in the graph of PPC?(9 votes)
Answer by example - In the example of rabbits and berries, you have to allocate a scarce resource, namely time, in order to acquire other resources. Maybe in that way rabbits and berries are scarce (since you are willing to give up your time in exchange, and you are a rational being).
Please correct me if I'm wrong.(8 votes)
- Hi,
I'm not quite sure that I understand the Opportunity Cost equation. It says X=(Y1-Y2)/(X1-X2) But in the iPhones and Watch example, it seems to use this equation
X=(Y1-Y2)/(X2-X1). The X1 and X2 variables ares interchanged.
Is there a reason for this?
Thanks!(7 votes)- The number itself will be the same in either case. What changes is the sign of the equation (in this case negative). This should make sense because in order for our iPhones production to increase, we need our watch production to decrease. The difference between two x values will be the same, what changes is the direction (or the sign).(2 votes)
In the definition of productivity it is written that it is (also called technology) ." However, this is not a universally accepted definition. In most cases, productivity and technology are considered to be two separate concepts.
Here the term "technology" is used in a more general sense. In this sense, technology refers to any tool or technique that can be used to improve the production of goods and services. This includes both physical tools, such as machines and robots, and intangible tools, such as software and knowledge.
In this sense, it is true that productivity can be increased by using technology. However, it is important to remember that technology is not the only factor that affects productivity. Other factors, such as the skills and training of workers, the availability of capital, and the overall economic environment, also play an important role.
So, while it is true that productivity and technology are related, they are not the same thing. Productivity is a measure of output, while technology is a tool that can be used to improve productivity.(7 votes)- I just got a question wrong, the answer stating that a bowed curve of PPC meant different resources allocation.
In no way was it suggested in video or read-through.
Confused please elaborate.(5 votes) - What is the difference between opportunity cost and marginal cost? I heard him mentioned the term of 'marginal cost' but did not really comprehend it.(4 votes)
Marginal Cost is simply the opportunity cost of 1 more unit while opportunity cost is not restricted to just one unit(3 votes)
Why does it mean when opportunity cost is constant along the ppc?
I know it’s because of the linear curve, but what is the underlying concept?(2 votes)- Hmmm…
other things about a Constant Opportunity Cost of a Production Possibilities Frontier, PPF, or Curve PPC…
So I believe you already understand that…
A PPF w/Constant Opportunity Cost is a linear line, meaning the line is straight (not curved), and…
•To be linear means the change between any two points anywhere on the line will be consistent.
The Slope of any two points, is the same as the slope of any other two points.
So it is constant because the slope is constantly the same.
•Which means it's constantly the same opportunity cost no matter how many units you make of either item.
Neither small batches nor bulk creation will change the opportunity cost, (make the y/x or PPF line differ).
We will always give up the same amount of x to make a certain amount of y, or vice versa.
•A PPF w/Constant Opportunity Cost indicates that the conditions are equally suited to make either product, so the resources are interchangeable!
•A deeper look…
(by example comparison)
Since PPF displays the possible product combinations that can/could be made limited by finite resources (time, ingredients, labor, money, supply, whatever…), and…
•Any core conditions change brings extra costs, to produce x that significantly differs from y will curve the line…
So the PPF will often be curved because frequently production of products differs in fundamental ways.
Blankets to Flooring, both using eco-friendly bamboo and hemp fibers, but a different skill set, (required retraining costs: production time loss, skilled workers loss (from the other product), profit loss, and instructor pay, each taken from the finite total allocated for both x and y)…
each changing the y/x balance,
so the PPF line curves…
or transformation of materials (instead of spun fiber threads to weave, they need fine mulch to mold and emboss patterns)…
so the PPF line curves…
•Without new investment, most x or y exchanges will curve the line, reflecting the higher opportunity cost of production differences…
-Bulging out convex, an 'increasing opportunity cost' (for growing vexing issues), or…
-Caving in concave, a 'decreasing opportunity cost' (for shrinking issues).
•So resources need to be swappable for a Constant Opportunity Cost, (straight/linear PPF), to have no new costs, it does not have to be a one-to-one, just consistently the same quantities of y/x exchanged throughout production of either item.
Perhaps a paper producer with very versatile automated machinery, is considering between: uncut paper rolls or pre-sliced sheets, or comparing different weights of paper (thinner to thicker), or legal to standard length, or posters to postcards…
if they're still using the same skilled workers, materials, machines, etc…
the same y/x balance,
the PPF is straight!
Perhaps a chocolates creator considering between similar already producible products: bonbons to full bars, if they're using the same ingredients, the chocolatiers, the same tempering and cooling methods and technology, etc…
it keeps the y/x constant,
the PPF is straight!
•Therefore a Constant Opportunity Cost would more likely occur in an established production situation of similar possible products.
When switching between x and y is just reallocating the 'what/where/how' conditions that are equally suited to create either potential product, the PPF is a straight line.
So in specialty fields, with superficial distinction between products, resources are interchangeable, so the Opportunity Cost stays the same constant price.
For production purposes the only difference will be the quantity created of x or y.
(≧▽≦) I hope that helps someone!(6 votes)
- how can scarcity can be determined in ppc(4 votes)
Discussion Questions:
1. In order to show a country having constant opportunity cost, the PPC curve for that country would have to be linear.
2. In order to draw a PPC curve with an increasing opportunity cost, but not working efficiently, the slope of the line would have to be exponential while the productivity is somewhere below that curve.(4 votes)- How does the concept of opportunity cost help explain the trade-offs depicted by points inside, on, and outside the production possibilities curve PPC in an economy?(3 votes)
- Inside the PPC: Inefficient, missing out on potential production of both goods.
On the PPC: Efficient, maximizing production of both goods.
Outside the PPC: Currently unattainable, involves sacrificing one good to produce more of the other.(2 votes)
