Introduction to Budget Lines and

Production Possibilities Curves

Introduction

Introduction

Budget Lines Definition:

A budget line is an economic model that illustrates all the possible combinations of goods and services that could be purchased given a fixed amount of time

Budget Lines Each economic model has a set of well-

defined assumptions to assist in simplifying the economic behavior expressed by the model. Only 2 goods can be purchased

In this model- pizza and hamburgers The price of the goods is set

In this model the set price is $1.00 each Income is set

In this model income or allowance is set at $5.00 a week

All income must be spent on goods Ceteris Paribus

Budget Lines The line in the

model represents the budget line.

It shows a maximum (possible) combinations of hamburgers and pizzas that can be purchased for $5 For example at point

C, you can purchase: 3 hamburgers and 2 pizzas

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5

5

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A

B

C

D

E

F

H

GHAMBURGERS

PIZZAS

Budget Line Practice Given the

assumptions of the model, which one of the following statements is true? It is possible to

purchase either five hamburgers or five pizzas

It is possible to purchase 5 hamburgers and 5 pizzas

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5

5

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A

B

C

D

E

F

H

GHAMBURGERS

PIZZAS

Budget Line Practice

4

5

5

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A

B

C

D

E

F

H

GHAMBURGERS

PIZZAS

Given the assumptions of the model, which one of the following statements is true? At point B, 4

hamburgers and 1 pizza can be purchased

At point D, 2 hamburgers and 3 pizza can be purchased

All of the above

Budget Line PracticeHint: Opportunity cost- what is given up

Given the assumptions of the model, which one of the following statements is true? The opportunity cost

of purchasing at point A is 5 hamburgers

The opportunity cost of purchasing at point A is 5 Pizzas

There is no opportunity cost for purchasing at point A

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5

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A

B

C

D

E

F

H

GHAMBURGERS

PIZZAS

Budget Line Practice Given the

assumptions of the model, which one of the following statements is true? The opportunity cost

of moving from point B to D is 2 hamburgers

The opportunity cost of moving from point B to D is 2 pizzas

There is no opportunity cost of moving from B to D

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5

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A

B

C

D

E

F

H

GHAMBURGERS

PIZZAS

Budget Line Practice Given the

assumptions of the model, which one of the following statements is true? For each pizza

purchased, one hamburger is given up

The cost of pizzas in terms of hamburgers is constant

All of the above are true

HAMBURGERS

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5

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A

B

C

D

E

F

H

G

PIZZAS

Budget Line Practice

F

4

5

5

3

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1

4321

0

0

A

B

C

D

EH

GHAMBURGERS

PIZZAS

Given the assumptions of the model, which one of the following statements is true? Point G is impossible

to purchase given the income available

More income would be needed to purchase at G because it is outside of the budget line

All of the above are true

Budget Line Practice Given the

assumptions of the model, which one of the following statements is true? Point H is impossible

to purchase given the income available

Point H is possible but would mean that not all given income would be spent

All of the above are true

F

4

5

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A

B

C

D

EH

GHAMBURGERS

Production Possibilities Curves Definition:

A production possibilities curve is an economic model that illustrates all the possible combinations of output that could be produced by an economy given the resources available

Differences? What is the difference between PPC and

Budget Lines? Budget Lines show what can be purchased PPC show what can be produced

Assumptions of PPC Only two products can be produced

In this example guns and butter All resources are fixed

Resources are land, labor, capital and entrepreneurship

All technology is fixed All resources are used fully and efficiently Ceteris paribus

Production Possibilities Curve The curved line

represents all the possible combinations of guns and butter that could be produced under the assumptions of the model

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice All resources are

fully and efficiently utilized, Points A, B, C, D

Not possible given the resources Point E

Not full employment/use of resources Point F

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice If all resources are

used fully and efficiently utilized, which one of the following combinations could be produced? Points A, B, C, or D Point F only Point E only None of the above

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice If all resources are

fully and efficiently utilized, which one of the following is true concerning point E? There would still NOT

be enough resources to produce a point such as E which is outside the PPC

Point E would be possible if less guns or less butter were produced

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice To produce the

combination of guns and butter at point E would require More resources

(L,L,C,E) than currently available

New technology to more efficiently use resources

All or either of the above

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice Producing the

combination of guns and butter at point F indicates that…. All resources are

being fully and efficiently utilized

Resources are not being fully and efficiently utilized. Unemployment of resources is occurring

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice Point F is under the PPC

because it represents a combination of guns and butter that is less than what could be possible if all resources were fully and efficiently used. When an economy

produces below its PPC, it means that resources are available but not used.

This can happen during a recession or slowdown in the economy.

High unemployment means that labor is not being used fully and efficiently.

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A

B

C

D

E

F

GUNS

BUTTER

PPC Practice If production were

changed by society from point A to point C, the opportunity cost of the decision would be The two units of

butter The two units of

guns given up None of the above

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A

B

C

D

E

F

GUNS

BUTTER

gained

PPC Practice If production were

changed by society from point D to point C, which one of the following would be true? One gun would be

gained but 1/4th of a unit butter would be given up

2 3/4ths units of butter would be gained and 1 gun would be given up

None of the above

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A

B

C

D

E

F

GUNS

BUTTER 2 ¾

PPC Practice

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A

B

C

D

E

F

GUNS

BUTTER

If production were changed by society from point C to point B, which one of the following would be true? One gun would be

gained but 3/4ths of a unit butter would be given up

2 units of butter would be gained and 1 gun would be given up

None of the above 2 ¾

PPC Practice

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A

B

C

D

E

F

GUNS

BUTTER

If production were changed by society from point B to point A, which one of the following would be true? One gun would be

gained but 2 units butter would be given up

3 units of butter would be given up and 1 gun would be gained

None of the above

Law of Increasing Costs Note that each time

in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased

The first gun cost ¼th unit of butter

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A

B

C

D

E

F

GUNS

BUTTER 2 ¾

Law of Increasing Costs Note that each time

in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased

The second gun cost ¾ths unit of butter

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A

B

C

D

E

F

GUNS

BUTTER 2 ¾

Law of Increasing Costs Note that each time

in the preceding questions that a unit of guns was added to production, the cost in terms of butter increased

The third gun cost 2 units of butter

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A

B

C

D

E

F

GUNS

BUTTER

Law of Increasing Costs This is due to the LAW OF INCREASING

COSTS

The law of increasing costs states: As more of a product is produced, each

additional unit has a higher opportunity cost.

Effects of lifting the assumptions of the PPC

If we lift the assumptions of fixed resources and/or technology, what will happen to the curve? The curve will shift to

the left (inward) or to the right (outward)

The shape of the curve will change from bowed out to bowed in

Society will be forced to produce at a point below its PPC.

Lifting the assumptions of the curveAdding more resources or discovering new technology

A shift to the right indicates that the economy can now produce more of both good X and Y.

A shift to the right increases the productive potential of the economy by adding new resources or technology

Lifting the assumptions of the curveDeclining resources or technology

A shift to the left indicates that the economy’s productive potential has been reduced

Its possibilities have been diminished

Lifting the assumptions of the curveProducing below the curve is different from a shift of the curve to the left

A shift to the left indicates that the economy cannot produce as much X or Y as before

The resources are no longer available for use; thus, the economy’s production possibilities decreases

A point under (below) the curve means that resources are available to produce the maximum indicated by the curve; however, these resources are not being used fully or efficiently

Unemployment of resources- i.e., unemployment of labor