Microeconomics-Curve Line Week 4 PDF

The Production Possibilities Curve and Opportunity Cost By Dr Lama BN  What is a production possibilities graph? How do production possibilities graphs show efficiency, growth, and cost? Why are production possibilities frontiers curved lines?  A production possibilities graph shows...

The Production Possibilities Curve and Opportunity Cost By Dr Lama BN  What is a production possibilities graph? How do production possibilities graphs show efficiency, growth, and cost? Why are production possibilities frontiers curved lines?  A production possibilities graph shows alternative ways that an economy can use its resources. The production possibilities frontier is the line that shows the maximum possible output for that economy. A production possibilities graph (PPG) is a model that shows alternative ways that an economy can use its scarce resources This model graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency. 4 Key Assumptions 1- Only two goods can be produced Production Possibilities Graph 2- Full employment of resources 3- Fixed Resources (Ceteris Paribus) Clothes Food 4- Fixed Technology A 14 0 A B 12 2 14 B C 9 4 12 D 5 6 Clothes 10 C E 0 8 8 Efficient 6 D 4 2 E 0 0 2 4 6 8 10 Food 4  Efficiency Efficiency means using resources in such a way as to maximize Impossible/Unattainable the production of A (given current resources) 14 goods and services. B 12 An economy G 10 C producing output Clothes levels on the 8 H D production 6 possibilities frontier 4 Inefficient/ is operating 2 Unemployment efficiently. E 0 0 2 4 6 8 10 Food Productive Efficiency: Products are being produced in the least costly way. This is any point ON the Production Possibilities Curve Each point represents a specific combination of goods that can be produced given full employment of resources. (H)A point of underutilization Inefficient/ Unemployment (G) A point Desirable Future production Possibilities frontier But Impossible/Unattainable (given current resources) The production possibilities curve has a negative slope; this means that an increase in the production of one good can only occur at the expense of reducing the production of the other.  Why does the Production Possibility Curve take the shape of a curve rather than a straight line? Diminishing Returns: When we allocate more resources to produce a certain good, the additional returns we obtain from that good tend to decrease. This means that as we increase the production of one good, we need to sacrifice increasingly larger amounts of the other good to achieve a small increase in the production of the first good. Resource Allocation: When moving from producing one good to another, some resources may be more suitable for producing one type of good. This means that when we transfer resources, we face varying opportunity costs, As production diversification increases, it becomes necessary to reallocate resources more efficiently, which initially leads to increasing costs, which leads to a downward-sloping curve rather than a straight line. In summary, the curved shape of the Production Possibility Frontier reflects changes in opportunity costs and the variability in resource efficiency, making it difficult to achieve a sustainable increase in the production of one good without incurring a high cost of sacrificing other goods.  How much each marginal unit costs = Opportunity Cost Units Gained Opportunity Cost is an economic concept that refers to what you give up or forgo when choosing one option over another. It can be defined as follows: Definition: It is the benefits or profits that could have been obtained from the better option that was not chosen. Application: This concept is used in decision-making, whether financial, business, or personal decisions. For example, if you decide to invest money in a specific project, the opportunity cost is the profits you could have earned if you had invested the money in another project. Importance of the Concept of Opportunity Cost: It helps individuals and companies evaluate different options more effectively. It contributes to improving the decision-making process by considering what might be lost  Opportunity Cost 1. The opportunity cost of moving from a to b is…2 2.The opportunity cost of moving from b to C is…3 3.The opportunity cost of moving from C to d is…4 4.The opportunity cost of moving from d to e is…5 A Production Possibilities 14 Graph B 12 Clothes Clothes Food COST C 10 8 A 14 0 0 D B 12 2 2 6 C 9 4 3 4 D 5 6 4 E 2 E 0 8 5 0 2 4 6 8 10 0 Food  Productive and Allocative Efficiency Which points are productively efficient? Which are allocatively efficient? Allocative Efficiency refers to the preference of society as a whole regarding A 14 the quantities and goods that satisfy their B G desires. 12 It occurs at the point where the social 10 preference curve intersects the production Clothes possibilities frontier. 8 This point signifies the achievement of the C maximum possible output that aligns with 6 E social preferences. 4 SIC F 2 D 0 0 2 4 6 8 10 Food 11  Growth Growth If more resources Production Possibilities Graph become available, or if 25 Future production technology improves, an T Possibilities frontier 20 economy can increase its level of output and grow. 15 S Food a (0,15) When this happens, the b (8,14) c (14,12) 10 entire production d (18,9) possibilities curve “shifts to 5 e (20,5) the right.” f (21,0) 0 5 10 15 20 25 Weapon  Production Possibilities 4 Key Assumptions Revisited Only two goods can be produced Full employment of resources Fixed Resources (4 Factors) Fixed Technology What if there is a change? 3 Shifters of the PPC 1. Change in resource quantity or quality 2. Change in Technology 3. Change in Trade 13  Production Possibilities What happens if there is an increase in population? Clothes Food 14  Production Possibilities What happens if there is an increase in population? Clothes Food 15  Production Possibilities What if there is a technology improvement in in food clothes Food 16  Production Possibilities What if there is a new technology is introduced into agriculture? clothes What if there is a new technology is introduced into clothes? Food 17 Theory: Theory provides a general framework that explains the relationships between different economic variables and how they interact. In the case of the Production Possibility Curve, the theory is based on the principle of scarcity and the efficient allocation of resources, assuming that resources are limited and should be allocated to achieve the best possible combination of goods and services. Hypothesis: A hypothesis is a proposal or assumption based on the theory, aimed at testing its validity. In the context of the Production Possibility Curve, a hypothesis might be: “If all available resources are used efficiently, there is a maximum production limit of two different goods.” The PPC can then be used to test this hypothesis and verify assumptions related to efficiency and scarcity. Model: A model is a simplified representation of the theory that helps to clarify and apply it. In the case of the PPC, a graphical model is used as a visual tool to illustrate how resources can be allocated between two goods at maximum efficiency. The model shows the inverse relationship between the production of the two goods and the concept of opportunity cost. The link between theory, hypothesis, and model in the PPC is established by relying on the general theory that resources are limited and must be used efficiently to achieve optimal production, then proposing hypotheses about how these resources are distributed, and finally using the model (the curve) to illustrate the results and apply the theory practically 18