Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
What You Will Learn!
Reading and creating a production possibilities curve. SS.912.E.1.2.
Showing scarcity on a production possibilities curve. SS.912.E.1.2.
Finding opportunity cost on a production possibilities curve. SS.912.E.1.2.
The law of increasing opportunity costs states that when you switch from one
item of production to another, it will cost more and more to do so, or why the
production possibilities curve is curved, and not straight. SS.912.E.1.2.
Mona Lisa
Man
The Mona Lisa is arguably the most
famous painting in the world. It is housed at
the Louvre in Paris, an enormous museum
that showcases a variety of art from around
the world. Take a look at the painting for a
moment. What do you see?
Obviously, there’s the smile, and the gaze off in the distance. The two very
different landscapes in the background. A
little deeper might reveal the thin veil
covering her head, and the lean in towards
the artist as she poses in the chair.
It’s easy to see a picture, a painting,
or a sculpture. It’s much more difficult to interpret it. Look at the painting again. Can
you see if there’s any meaning in the picture? What does it mean to you?
Whatever meaning you try to have
from it is personal, it’s yours. And you’ll be joining millions of other people who have
looked into this mysterious portrait and tried
to figure out the look on her face. The
meaning, whatever it is, belongs to you, and
you alone. It is subjective, and no one can
tell you that you’re wrong.
Now take a look at the second
picture. This is the Chinese character for
“man.” At first glance, it’s indecipherable. Two lines randomly connected to another.
However, when you learn the meaning of it,
you begin to see certain features. Two
legs, perhaps a head. Millions of Chinese
would interpret this character similarly as
“man,” and depending on context, “human,” “person,” and even “individual.” This is verifiable, it’s objective.
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Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
Now take a look at the final picture.
This is the production possibilities curve.
The production possibilities curve (PPC)
shows the choices of a hypothetical
economy, what it could possibly produce
C
given its resources. The economy in the
graph generally makes two different types of
products, and shows how scarcity affects a
hypothetical economy.
Additionally, the
graph can also show the opportunity cost in
this economy when it decides to make one
product instead of another.
Notice in this picture, or graph, there
are no numbers. That’s no accident. It’s easy to focus on the math, and come up
with the answer. In Economics, it’s not always about the math, it’s about the Graph 1. Production Possibilities Curve
picture. It’s about the interpretation of the
picture. And you can interpret the picture rather easily.
Key Point #1. Any point along the PPC itself is efficient because the
economy is using all of its resources to produce the maximum amount of
goods.
First off, take a look at the axes (plural of “axis”). On the x-axis, it says consumer
goods per year and on the y-axis, it says capital goods per year. Consumer goods are
typically those goods we use on a regular basis. Food, clothing, gasoline. Capital
goods typically tend to be more industrial. Cars, computers, machinery. Generally, for
comparison, however, we look at two different kinds of goods.
Notice point B. Point B is on the curve itself. Any point along that curve is
efficient. What we mean by efficient is that the resources are used to produce the
maximum amount of goods and services. In other words, nothing is going to waste. In
this graph, all resources are being used to make both consumer and capital goods.
Key Point #2. Any point inside the PPC itself is inefficient because the
economy is not using all of its resources to produce the maximum amount
of goods. This is called underutilization.
Now look at point A. Point A is below the curve. In this case, we would say that
Point A, and for that matter, any point below the curve, is inefficient. What we mean by
inefficient is that the resources are not being used to produce the maximum amount of
goods and services. In other words, something is going to waste. We would also say in
the case of point A that this economy is underutilizing its resources. Underutilization
happens when an economy is not using its resources to maximum potential.
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Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
Key Point #3. Any point outside the PPC itself is impossible because the
economy has maximized—used—all of its resources to produce the
maximum amount of goods. To achieve that point, the economy would have to
expand in terms of new resources, new technology, or both.
Finally, look at point C. Point C is
above the curve. In this case, we would
say that Point C, and any point above the
curve is impossible. Why? At Point A, we
saw that the economy was not using up
all its resources to make the maximum
amount of goods.
At Point B, the
economy has used up all its resources
available. If we’ve maximized all our resources all along the curve, then we
can’t actually make more than what we
actually have.
Point C would be
impossible because we have used up all
of our resources. It is possible to achieve
Graph 2. Expanding PPC
Point C, but only if we were to find new
resources. In that case, the entire curve would shift outward. Without those resources,
however, production at Point C would be impossible.
Now let’s take a look at another PPC, this time with numbers. This particular PPC compares wine and cars. The same thing that we stated above still holds true.
Any point inside the curve is inefficient because the economy is underutilizing its
resources to make products. Any point along the curve is efficient because the
economy has maximized its resources to make products. Any point outside the curve is
impossible to achieve in this economy because we’ve already maximized our resources.
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Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
Graph 3. Cars vs. Wine PPC
Cars
Wine
15
0
12
9
9
12
6
13
3
14
0
15
Take a look at the table next to the graph. The table shows the trade-offs when
this economy produces either cars or wine. At 15 cars, this economy uses all the
resources it has to make cars, but no wine. When the economy chooses to make 6
cars, it can then make 13 cases of wine. You can also read this table in terms of wine.
When the economy decides to make all wine, it uses all of its resources to make 15
cases of wine, but 0 cars. At 12 cases of wine, the economy can also make 9 cars.
This economy is making choices about what it can produce, and what it can’t produce. This should sound familiar. Remember, the opportunity cost is the value of
the best alternative not chosen. It’s ultimately what the economy has to give up to make a decision.
Take a look at the PPC again. Let’s say that production in this economy is currently producing 12 cars and 9 cases of wine. And now let’s say that this economy wants to make more wine and less cars, and chooses to make 14 cases of wine and 3
cars. We’re choosing to make more wine, in fact, 5 more cases of wine. To make that
additional 5 cases of wine, how many cars did we have to give up? The answer is 9
cars. Nine cars is the opportunity cost of producing the additional five cases of wine.
Let’s do another example, this time producing more cars than wine. Let’s say the economy currently produces 9 cars and 12 cases of wine, but now wants to produce 15
cars, and no wine. We’re choosing to make more cars, in fact 6 more cars. To make
that additional 6 more cars, how much wine did we have to give up? The answer is 12
cases. Twelve cases of wine is the opportunity cost of producing the additional 6 cars.
Here’s the thing, you can confirm this by using either the table or the graph. If you trace your finger along the graph from one point to another, you can count how
much you give up to see how much you gain. Similarly, on the table, you can use
subtraction to find how much you give up to see how much you gain. In the first
example, we produced 12 cars and 9 cases of wine, and we decided to make 3 cars
and 14 cases of wine. To make more wine, we have to give up 9 cars. 12 cars minus 3
cars is 9. Nine cars is the opportunity cost of producing the additional five cases of wine
(14 wine – 9 wine = 5 wine).
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Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
Key Point #4. The law of increasing opportunity costs states that when you
switch from one item of production to another, it will cost more and more to
do so.
Now that we’ve taken a look at how to find opportunity cost on the production possibilities curve, let’s ask a question that’s less obvious. Why is the production
possibilities curve curved? Or rather, why isn’t it straight?
Well, a better question to ask first is what would it mean if the curve was straight?
If the PPC was straight then we would see that the trade-off between cars and wine
would be a one-to-one exchange. Rarely, if ever, would that be the case either in a
class or in real life. In fact, it’s not a free or one-to-one exchange because resources
are not perfectly adaptable.
Excellent.
You have no idea what I’m talking about, do you?
That’s okay. You’ll be translating Economese to English a lot in this course.
Let’s put it another way. TINSTAAFL. There Is No Such Thing As A Free Lunch. Now
that’s a phrase you’ve probably heard before. The origin of that phrase comes from
Economics, and the idea is similar to what you probably already know—that whatever
comes your way, you don’t get something for nothing. In the production possibilities
context, an economy can’t just simply choose to make more wine and not have to give
up making some cars.
Okay, TINSTAAFL, got it. Nothing’s free, there’s always a cost. But why? Why can’t it just be a free lunch? The answer is that the resources
Wine
Cars
are not perfectly adaptable. Let’s take a hypothetical economy that makes only cars and
wine, represented by the box to the left. Let’s say that we’ve decided to make more cars instead of wine. Where do we start? Well, why
not start with the factors of production, our resources? What do we have to trade off to
make this work?
Land. To make more cars, we’re not going to need as much farmland. In fact, whatever
natural resources we might need to make cars,
Wine
Cars
those resources are not likely to be the same as
those used to make wine. For example, oil might
be useful in a car engine, but it would make wine
undrinkable. Oil’s not the only thing we need for cars. Leather, rubber, iron ore (to make steel), and more. None of these are things
we’re going to get from wine. Then there’s the land itself. It must be prepped for construction of new factories, which means it will have to be cleared, bulldozed, and
more.
Labor. Winemakers are not going to have the same skills as autoworkers. So
what happens to them? In this economy, we’ll retrain them to be able to rivet steel, to become mechanics, and other related tasks to the auto industry. However, we’re assuming that the labor force available for both vineyards and car factories would not
change. In reality, that’s unlikely. More likely the winemakers would lose their jobs, and
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Unit 1: Economic Decision Making
Lesson 3: Production Possibilities Curve
other workers would come into the market who likely already know how to build cars
and have the skills the factories need.
Capital. For human capital, we don’t really need knowledge of agriculture to
make a Ford Mustang. As for physical capital, it is unlikely that the tractors used to
maintain the vines would be of use to the factories. Even if you were to sell the tractors,
you wouldn’t get back the money you paid for them, taking a loss. Not to mention
shovels, fertilizer, and other things needed to make wine. Car factories are going to
need completely different equipment.
Now here’s the question you need to ask yourself: is any of this—selling
equipment, retraining workers, modifying natural resources—is any of it free? The
answer, of course, is no. This is what the law of increasing opportunity costs tells us.
The law of increasing opportunity costs states that when you switch from one item of
production to another, it will cost more and more to do so. In other words, when you
switch from wine to cars, the more cars you wish to make the more it will cost you to do
so because of what you have to give up in wine. All those resources dedicated to
farming now have to be adapted to make cars—and none of it is free. There is no such
thing as a free lunch.
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