The Production Possibility Curve PDF

The Production Possibility Curve (PPC) The Production Possibility Curve (PPC) is a graphical representation that shows all possible combinations of two goods or services an economy can achieve when all resources are fully and efficiently utilized. The curve illustrates the concept of scarcity (t...

The Production Possibility Curve (PPC) The Production Possibility Curve (PPC) is a graphical representation that shows all possible combinations of two goods or services an economy can achieve when all resources are fully and efficiently utilized. The curve illustrates the concept of scarcity (the fundamental economic problem of having limited resources to meet unlimited wants). Scarcity and Choice The PPC highlights the scarcity of resources which forces economies to make choices about what to produce. Every point on the curve represents a combination of two goods that can be produced using all available resources. Opportunity Cost The slope of the PPC represents the opportunity cost, which is the value of the next best alternative foregone when making a choice. Efficiency Points on the PPC represent efficient production levels, where resources are fully utilized. Points inside the curve indicate inefficiency, where resources are underutilized. Points outside the curve are unattainable with the current resources and technology. Economic Growth An outward shift of the PPC indicates economic growth, which can occur due to an increase in resources, improvements in technology, or better education and training of the workforce. Figure 1.1. A production possibility curve and increasing opportunity cost. Source: J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), p. 15. The Figure above shows that if the country devotes all its resources to producing food it can produce 8 million units of food but no clothing. If they produce 6 million units of food (at point x), they can produce 4 million units of clothing. If they produce 7 million units of clothing, they will have no resources to produce food. Consider moving from point x to point y. If you produce an extra 1 million units of clothing, you will produce 1 million less units of food. If you then produce another extra 1 million of clothing and move to point z, you will sacrifice 2 million units of food. This illustrates the phenomenon of increasing opportunity costs. Reading problem If the country originally produces 3 million units of food, what would be the opportunity cost of producing an extra 2 million units of food? We can see that when the country produces 3 million units of food, they can produce the maximum of 6 million units of clothing. Producing an extra two million units of food will mean producing 5 million units of food. In this case the country will produce 5 million units of clothing. So, the opportunity cost of producing 2 extra million units of food is 1 million units of clothing. Shifts in the PPC Outward Shift occurs when there is economic growth. Factors that can cause an outward shift:  Technological advancements  Increase in resources (e.g., labour, capital)  Better education and training Inward Shift occurs when the economy’s capacity to produce decreases. Factors that can cause an inward shift:  Natural disasters  Depletion of resources  Decline in the workforce To conclude, the Production Possibility Curve helps to illustrate the concepts of scarcity, choice, opportunity cost and efficiency. Understanding the PPC allows appreciating the trade-offs involved in economic decision-making and the factors that influence economic growth and productivity. Further reading J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), pp. 14-16. Figure 2. Features of the market structures. Source: J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), p. 196. Figure 3. The circular flow, withdrawals and injections. Source: J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), p. 472. The Kinked Demand Curve (adapted from J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), p. 238) Developed in 1939, independently, by Paul Sweezy, and R. L. Hall and C.J. Hitch, the kinked demand theory has become the most famous of all theories of oligopoly. The model seeks to explain how it is that, even when there is no collusion at all between oligopolists, prices can nevertheless remain stable. The theory is based on two asymmetrical assumptions: 1. If an oligopolist cuts its price, its rivals will feel forced to follow suit and cut theirs, to prevent losing customers to the first firm. 2. If an oligopolist raises its price, however, its rivals will not follow suit since, by keeping their prices the same, they will gain customers from the first firm. The logic that follows from these assumptions is that each oligopolist will face a demand curve that is kinked at the current price and output. A rise in price will lead to a large fall in sales as customers switch to the now relatively lower-priced rivals. The firm will thus be reluctant to raise its price. Demand is relatively elastic above the kink. On the other hand, a fall in price will bring only a modest increase in sales, because the rivals lower their prices too; therefore, customers do not switch. The firm will thus also be reluctant to lower its price. Demand is relatively inelastic below the kink. In general, oligopolists will be reluctant to change prices at all. To summarize, the kinked demand theory posits that oligopolists face a demand curve that is kinked at the current price, demand being significantly more elastic above the current price than below. The effect of this is to create a situation of price stability. Figure 4. Kinked demand for a firm under oligopoly. Source: J. Sloman, D. Garratt, J. Guest, Economics (Pearson, 2022), p. 238