Understanding the Production Possibilities Curve
Opportunities at what cost? In our lives, we face many opportunities, and have choices to make…where we live, where we will go to school, when we will switch jobs, when we buy a new or used car, etc. Every choice we make has both benefits and consequences.
Opportunity costs are a part of every decision and activity. By choosing one course of action, we ‘miss out’ on other possibilities. Opportunity cost is basically the highest valued alternative that must be given up when a choice is made. For instance, a person may have to choose whether to use their personal capital to…
Build Savings? Or Buy a Home?
These choices each come with a cost or trade off, the trade off is the opportunity cost.
For example, would it more beneficial to… Have a simpler meal at home bonding with family…Or Spend quality time dining out with your spouse?
By choosing one path and ‘missing out’ on other opportunities, we identify a topic at the foundation of economics, called scarcity. Scarcity identifies the concept that states ‘while wants are unlimited, money, time, and resources are not.’ Factors of Productions. Factors of production are the resources available in an economic unit (such as a country) to produce goods and services. There are several ways to categorize the factors. In this case, we need to divide production factors into four categories: Capital goods (C), Entrepreneurial Ability (E), Land (L): C-E-L-L. Capital Goods (C), Entrepreneurial Ability (E), Land (L), and Labor (L) – C-E-L-Lrepresent the four factors of production. Countries, companies, and individuals all face scarcities and must make choices about how best to utilize their resources. To graphically visualize the full potential of a country company, or individual resources, it’s necessary to represent this using a Production Possibilities Curve. This representation shows the maximum quantity of goods and services that can be produced using limited resources to the FULLEST extent possible. Factors of production combined are the borders for the Production Possibilities Curve (PPC).
Let’s look at an example at the company level. Assume that our company is a large commercial bakery that has to make a decision between producing cakes or muffins.
Our company has a supply of wheat, sugar, apples, and coal to fuel our ovens.
We also have 10 cake makers, 10 muffin makers, and 20 unskilled workers. Finally, we have a building, ovens, and operating capital (cash in the bank). Because our resources are scarce (not unlimited) we have to make a decision on how to allocate these resources for production. As we make decisions for production, we can choose to make all cakes, all muffins, or the most efficient use of our resources to determine production using this curve. If we envision all possible combined production scenarios using all resources to their maximum degree of efficiency, the resulting points would appear as a curve. Remember, the curve represents the maximum that we can produce using all combinations of the resources we have available…but at the maximum efficiency possible. For one reason or another, we are unlikely to produce consistently at maximum levels.
Let’s assume that we are regularly producing 85 cakes and 500 muffins. Now suppose we had 3 workers call in sick. How does our chart change?
Now let’s suppose the following occurred: Our cakes have not been selling great, but still bring a fair profit and we’ve had some success in the health food market with our whole-grain muffins. The company has decided to make fewer cakes and shift production to make more muffins. How does our chart change?
But can we produce OUTSIDE the curve? Ceteris paribus (or all things being equal), we cannot produce outside the curve. By definition, the curve is the maximum we can produce with all of our existing resources. However, we could take the company public (raising more capital), buy more ovens, hire more workers, and so forth to expand our factors of production, and generate a new curve encompassing greater production possibilities.
Self-Check If unemployment in the US is at 5 million and the military recruits an additional 1 million young people, would this expand the PPC, make no difference to the PPC, or shrink the PPC?