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AS Economics

“Production Possibility Curves”

Starter

Make a table with two columns – “WANTS” and “NEEDS”

In each column write down ten things that you, right now in your life, want or need and write a price (estimate) for each

Total the price at the bottom of your table Then below this total, write down your

monthly income

The Economic Problem

Most of us want better food, clothing, housing, schooling, holidays, hospital care, and entertainment – Unlimited wants and needs

But there is not enough to go around – Limited resources

This gives rise to the basic economic problem of choice under conditions of scarcity.

If we cannot have everything we want, we must choose what we will and will not have.

Economy’s Resources

An economy’s resources fall into four main categories:

Land – Land, forests, minerals Labour – Human resources Capital – Tools, machinery, factories Entrepreneurs – People who take risks by

introducing new products and new ways of making old products

Production Possibility Curve

We are now going to illustrate on a diagram some of the issues surrounding economic choices.

Production Possibility Curve – Shows the maximum amount of two products that can be made in this time period with current resources and technology

Drawing a Production Possibility Curve

Let us construct a simple Production Possibility Curve to assess the options open to a farmer who can use land to grow either wheat or maize:

Q Maize

0

Each axis shows quantity of goods made

L

M

LM is a production possibility curve (PPC)

Q Wheat

One Possible Resource Allocation

Q Maize

M

Q Wheat0

L

Resource Allocation – a given use of land, labour and capital

For instance, the farmer can opt to use all resources to produce combination A:

AR

S

•OR maize and•OS wheat

R

An Alternative Resource Allocation

Q Maize

M

Q Wheat0

L Alternatively the farmer can use all current resources and be at point B on PPC and produce:

•OT maize and

BT

V

•OV wheat

Resource Reallocation

Q Maize

M

Q Wheat0

L

BT

V

A

S

R

Switching factors of production to alternative uses is called reallocation of resources

For instance, reallocating land, labour and capital from sugar production into wheat means moving from A to B

How much wheat is gained and how much maize is lost?

Opportunity Cost

Q Maize

M

Q Wheat

L

B

AR

0 VS

T

The economic decision to move from A to B and product more wheat involves a sacrifice –LOST MAIZE

Opportunity Cost – Measurement of cost by reference to the alternatives forgone

The opportunity cost of SV extra wheat is RT maize

forgone

GAIN

LOS

S

Continued…

Q Maize

M

Q Wheat

L

AR

0 S

The farmer is at point A

What is the opportunity cost of producing OR maize?

At A - OS wheat is being produced

SM extra wheat could be produced if all resources are put into wheat

The opportunity cost of OR maize

is SM wheat

PPC and Economic Growth

The PPC is drawn assuming: A fixed amount of resources Constant state of technology

What happens to the PPC if there is an increase in the quantity or quality of resources available?

Shifts in the PPC

Q Maize

M

Q Wheat

L

0

LM is the initial position of the PPCMore resources are acquired e.g. another field

PPC shifts outwards to the right to UV

U

V

Continued…

Q Maize

Q Wheat

L

0M

LM is the initial position of the PPCThe productivity of staff and machinery producing wheat increases but productivity of resources producing maize is unchanged

PPC pivots around L and becomes LZ

Z

PPC and Efficiency

Q Maize

M

Q Wheat

L

0

E

I

U

Point E is efficient: all resources are fully employed

Point I is inefficient: some resources are unemployed

Point U is unattainable given current resources and technology

Can You Use the PPC to show:

Resource Allocation Resource Reallocation Opportunity Cost Economic Growth Changes in Productivity Changes in Efficiency