Production Possibility Curve

Chapter 2-1

Laugher Curve

Q. How many Marxists does it take to

screw in a light bulb?
A. None.
The bulb contains within itself the
seeds of its own revolution.

Introduction

„ An economic system has to solve

three coordination problems:
{ What, and how much, to produce.
{ How to produce it.
{ For whom to produce it.

1
 Introduction

„ All economic knowledge can be boiled

down to a single phrase:
There ain’t no such thing as a free lunch.

Introduction

„ Every decision has an opportunity

cost – the cost in foregone
opportunities.

Introduction

„ A production possibility curve is used

to illustrate opportunity cost.

2
 The Production Possibilities
Model

„ The production possibilities curve

shows the trade-offs among choices
we make.

The Production Possibility

Table

„ A production possibility table lists a

choice's opportunity costs by
summarizing what alternative outputs
you can achieve with your inputs.

The Production Possibility

Table

„ Output – an output is simply a result

of an activity.
„ Input – an input is what you what you put
into a production process to achieve an
output.

3
 The Production Possibility
Curve for an Individual

„ A production possibility curve

measures the maximum combination
of outputs that can be achieved from a
given number of inputs.
„ It slopes downward from left to right.

The Production Possibility

Curve for an Individual
Hours of study Grade in Hours of study Grade in
in history history in economics economics
20 hours of economics
20 98 0 40
19 96 1 43 100 A 0 hours of history
18 94 2 46
Economics grade

17 92 3 49 B
16 90 4 52 88
15 88 5 55
14 86 6 58
13 84 7 61
12 82 8 64 C
11 80 9 67 70
10 78 10 70 20 hours of
9 76 11 73 history
8 74 12 76
7 72 13 79 0 hours of
6 70 14 82 economics
5 68 15 85 D
4 66 16 88 46
3 64 17 91 40 E
2 62 18 94 58 66 78 94 98
1 60 19 97 History grade
0 58 20 100

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

The Production Possibility

Curve for an Individual

„ The production possibility curve not

only represents the opportunity cost
concept, it also measures the
opportunity cost.

4
 The Production Possibility
Curve for an Individual

„ The production possibility curve

demonstrates that:
{ There is a limit to what you can achieve,
given the existing institutions, resources, and
technology.
{ Every choice made has an opportunity
cost—you can get more of something only by
giving up something else.

A Production Possibility Curve

for a Society

„ The production possibility curve is

generally bowed outward.
{ Some resources are better suited for the
production of some goods than others.

A Production Possibility Curve

for a Society
Y
10
9 If the slope of the production
8 curve is -2 at A, the
A
7 2Y opportunity cost
.
6 of 1X is 2Y.
5 1X
4
3
2
1
0
1 2 3 4 5 6 7 8 9 X
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

5
 A Production Possibility Curve
for a Society

„ Comparative advantage explains why

opportunity costs increase as the
consumption of a good increases.
{ Some resources are better suited for the
production of some goods than to the
production of other goods.

A Production Possibilities
Table and Curve

% of resources % of resources
devoted to devoted to
production Number production Pounds
of guns of guns of butter of butter Row

0 0 100 15 A
20 4 80 14 B
40 7 60 12 C
60 9 40 9 D
80 11 20 5 E
100 12 0 0 F

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

A Production Possibilities
Table and Curve
1 pound A
of butter 15 B
14
2 pounds C
of butter 12
D
Butter

5 E
5 pounds
of butter
F
0 4 7 9 11 12 Guns
4 guns 3 guns 1 gun
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

6
 Increasing Marginal
Opportunity Cost

„ The principle of increasing marginal

opportunity cost states that
opportunity costs increase the more
you concentrate on an activity.
„ In order to get more of something, one
must give up ever-increasing
quantities of something else.

Increasing Marginal
Opportunity Cost

A Slope is flat at A. Low

opportunity cost of
guns.
Butter

Slope is steep at B. High

opportunity cost of guns.
B

Guns

Efficiency

„ In production, we’d like to have

productive efficiency – achieving as
much output as possible from a given
amount of inputs or resources.

7
 Efficiency

„ Efficiency involves achieving a goal as

cheaply as possible.
„ Efficiency has meaning only in relation to
a specified goal.

Efficiency

„ Any point within the production

possibility curve represents
„ inefficiency.
Inefficiency – getting less output from
inputs which, if devoted to some other
activity, would produce more output.

Efficiency

„ Any point outside the production

possibility curve represents something
unattainable, given present resources
and technology.

8
Efficiency and Inefficiency

Unattainable point,
10 given available technology,
resources and labor force
8
Efficient C D
Guns

6
points
B
4
A
2 Inefficient
point
0
2 4 6 8 10
Butter

Shifts in the Production

Possibility Curve

„ Society can produce more output if:

{ Technology is improved.
{ More resources are discovered.
{ Economic institutions get better at
fulfilling our wants.

Shifts in the Production

Possibility Curve

„ More output is represented by an

outward shift in the production
possibility curve.

9
Shifts in the Production
Possibility Curve

Neutral Technological Change

Butter

C
A

0 B D Guns

Shifts in the Production

Possibility Curve

Biased Technological Change

Butter
C
B

0
A Guns

Distribution and Production

Efficiency

„ The production possibilities curve

focuses on productive efficiency and
ignores distribution.

10
Distribution and Production
Efficiency

„ In our society, more is generally

preferred to less and many policies
have relatively small distributional
effects.

Examples of Shifts in the

Production Possibility Curve

„ Test your understanding:

{ A meteor hits the world and destroys half
the earth’s natural resources.
{ Nanotechnology is perfected that lowers
the cost of manufactured goods.

Examples of Shifts in the

Production Possibility Curve

„ Test your understanding:

{ A new technology is discovered that doubles
the speed at which all goods can be
produced.
{ Global warming increases the cost of
producing agricultural goods.

11
 Examples of Shifts in the
Production Possibility Curve

(a) (b) (c) (d)

12