Production_Possibilities_Curve.pdf

Production Possibilities Curve to continue to do so for another year would mean You also pay the price of foregoing other enjoyments, sacrificing the $10,000 difference. such as a hamburger and soda. Similarly, when society This example, however, is t...

Production Possibilities Curve to continue to do so for another year would mean You also pay the price of foregoing other enjoyments, sacrificing the $10,000 difference. such as a hamburger and soda. Similarly, when society This example, however, is the simplest possible sce- chooses to allocate its land, labor, and capital to the nario: the opportunity cost only involves the $10,000 in production of one type of good (cars, for example), it revenue that the business sacrifices to make cards instead gives up other possible uses of those resources (the pro- of notebooks. There are usually many more factors in- duction of computers, for example). An increase in car volved, making it much more complicated to calculate production may mean a decrease in computer produc- opportunity costs. For instance, in the above example, tion. The unproduced computers represent the oppor- card production would probably carry different business tunity costs imposed on society by choosing cars. expenses than notebook production (perhaps the raw The production possibilities curve is a visual aid materials for one of the products would cost less). The allowing us to understand scarcity, choice, and opportu- entrepreneur would have to take these expenses into ac- nity cost. We can devise a PPC that will show us the count. Other factors might include different ways that the amount by which computer production will decrease as business could be cutting its expenses (such as adopting car production decreases, and vice versa. We can graph different production techniques and finding ways to pay the tradeoff between any two goods using the PPC. It is less business tax) and different ways it could spend the money it usually puts into the business (for instance, by important to note, however, that PPCs are used only to investing some of it). Companies have increasingly been employing business analysts with specific training in de- termining opportunity costs. Production Possibility Table Soap Soda Pop (thousands of bars) (thousands of bottles) $ Production Possibilities Curve 0 30 10 28 What It Means 18 24 In economics the production possibilities curve (PPC), 24 18 also called the production possibilities frontier (PPF), is a 28 10 tool for illustrating the idea of trade-off by showing the 30 0 maximum quantities of two goods that can be produced at a given time from an existing, finite pool of resources. Production Possibilities Curve The fundamental quality dictating the economy is scarcity: the resources that we as a society draw on to produce goods and services are limited. Most of us probably see scarcity at work in our daily lives. Someone 35 with a weekly salary of $500 understands that the quan- tity of purchases he can make with that amount of money 30 is limited. He may allocate part of that sum to rent, part b to a car payment, part to groceries, and part to enter- 25 tainment, allocating different amounts of money to dif- 20 Soda Pop ferent uses in an attempt to create maximum well-being. a A business, likewise, is faced with limited resources. A car 15 company is limited in the number and variety of cars it can produce by the amount of land, labor, and capital 10 (equipment and money for doing business) in its pos- session. The company must make choices based on its 5 limited pool of resources, and it will allocate its resources 0 in a way that will bring the maximum amount of profit. 0 5 10 15 20 25 30 35 The same goes for the entire economy. An economic system takes limited quantities of resources and assigns Soap them to certain uses as opposed to other uses. Instead of The production possibility curve, or frontier, offers a visual well-being or profit, an economy’s goal, in the eyes of illustration of the various trade-offs a company or an economy economists, is efficiency. must make if it devotes its limited resources to producing two Any time we as individuals, businesses, or a society different products. As the production possibility curve for soap and choose one way of allocating resources over another, we soda pop indicates, an increase in production of one product pay what are called opportunity costs. If you buy a movie necessitates a decrease in production of the other. Illustration by ticket for $10, the cost to you is not strictly monetary. GGS Information Services. Cengage Learning, Gale. 176 EVERYDAY FINANCE: Economics, Personal Money Management, and Entrepreneurship  Production Possibilities Curve give us a hypothetical understanding of these economic conditions. PPCs are intentionally simplified illustrations of what happens when one good is produced instead of AT THE COMPANY LEVEL another. In reality, there are many goods in most econ- omies, and the complexity of the economy as a whole The production possibilities curve (PPC) is a graph most com- cannot be reduced to the impact of simple tradeoffs. monly employed to show the different quantities of two goods Nevertheless, examining these tradeoffs leads to signifi- that an economy can produce while using resources most effi- cant insights about different facets of the economy. ciently. The PPC can also be applied to the decisions of a single company. When, for example, a technology company wants to When Did It Begin branch out from the production of computers to produce laser The concept that came to be known as the production printers as well, it could graph the different options for the quantities of each that it could produce, based on its current possibilities curve was first outlined by the Austrian-born supply of raw materials, equipment, and labor. Just because a American economist Gottfried von Haberler (1900-95). firm is using its resources efficiently, however, does not mean it Von Haberler was best known for his writings on inter- is using them in the most profitable way possible. Any point national trade, and he first came to prominence with the along a production possibility curve represents an equally effi- publication, in 1937, of The Theory of International cient use of resources, but consumers will likely have more Trade. In this book von Haberler formulated the notion specific desires. A company would thus be short-sighted if it of opportunity cost and showed what happens when relied exclusively on the PPC to determine how many computers different choices are made about what to produce in an and how many printers to manufacture. It must balance its economy. He called the visual representation of his ideas production possibilities with consumer demand. the production substitution curve, but today it is known as the production possibilities curve (or frontier). More Detailed Information of the second product is given up. At first, producing five The production possibilities curve, or PPC, shows us the dozen computers requires giving up only one car (car different ways we might balance production of two dif- production goes from 15 to 14), but with the production ferent products. To make PPC analysis easier to under- of an additional four dozen computers (for a total of nine stand, we have to make some simplifying assumptions. dozen), two more cars must be given up. This is another Assume, for example, that we live in a country whose way of saying that the opportunity cost of producing economy produces only two items, cars and computers. computers grows as we produce more of them. The The economy might be able to produce cars in the fol- reason that this happens is that the economy must retrain lowing combinations: 15 cars and 0 computers; 14 cars workers and make changes in how it uses resources. and 5 dozen computers; 12 cars and 9 dozen computers; These shifts result in decreased productivity. In a situa- 9 cars and 12 dozen computers; 5 cars and 14 dozen tion in which two very similar products are being mea- computers; 0 cars and 15 dozen computers. By placing sured (such as wooden chairs and wooden tables), the cars on the vertical axis and computers on the horizontal PPC would more closely resemble a straight diagonal line axis and then graphing these different combinations of car from one axis to the other. and computer production, we would create a production But what if the basic conditions of the economy possibilities curve for these goods in our economy. changed? What if, for instance, new technologies made it The curve illustrates all of the potential efficient cheaper to manufacture computers, while the car industry combinations of car and computer production. If the remained unchanged? If computer productivity doubled, economy produces these goods at a point anywhere on the PPC would shift dramatically to the right. What if the curve, then the resources necessary to make cars and new technologies made car-production cheaper, while computers are being used with maximum efficiency. The the computer industry remained unchanged? The PPC economy in its current form cannot produce combined would shift dramatically upward. Technology thus allows numbers of cars and computers that fall outside of the for an outward expansion of the PPC. PPC, because there are not sufficient resources to allow Another way that the PPC for any two goods can production at such levels. The curve thus represents the shift outward is when resources increase. For example, an furthest “frontier” that production may reach. The influx of immigrants who are willing and able to work in economy’s output of cars and computers might, however, the automotive industry might result in an upward shift be located at a point inside the curve. This would mean on the PPC for our two-product economy. that the economy is not utilizing its resources as effi- During times of economic growth, the PPC in a ciently as possible. country shifts outward. A PPC can also shift inward if The PPC is usually concave rather than straight. This resources are depleted. For example, if our hypothetical is a result of the law of increasing costs, which says that as country went to war and lost one-third of its labor force, more of one product is produced, an increasing amount the number of cars and computers the economy would be EVERYDAY FINANCE: Economics, Personal Money Management, and Entrepreneurship 177 Technology able to generate afterward would fall, and the curve would move downward and to the left. $ Technology What It Means Recent Trends For many people technology refers to advances in the One common use for PPCs today is to illustrate the computer sciences and electronics that have produced tradeoff between consumption and investment (or sav- such things as cell phones, the Internet, and TiVo. While ings) in a society. When people make money, they have these inventions are all examples of technology, they do two choices about what to do with it, assuming they do not adequately explain the term. Technology comes from not want to hide it under a mattress or in a sock drawer: the Greek root techne, which means craft, or the skill and they can spend it, or they can invest it. Consumer experience in making objects. Thus, any human invention spending, of course, contributes to economic growth, (such as the screwdriver, the wheel, or the ball point pen) since the money is spent on goods produced by the that gives people control over their environment is an economy. Spending promotes growth in the short term. example of technology. To save money, on the other hand, is to invest it in future Because of its capacity to introduce new products economic growth. When people put money in the bank, and services—while at the same time improving the the bank uses it to finance loans that commonly enable production, distribution, and exchange of these goods businesses to grow. Similarly, when an investor buys and services—technology has always played an important shares of stock (portions of company ownership), she is role in the economy. Technology primarily contributes to giving that company money that can be used for expan- the economy by introducing new objects, inventions, or sions that will allow it to become more productive in the ideas that help a society produce and distribute more future. Investing promotes growth over the long term. goods and, in the process, create a higher standard of Since there is a finite quantity of money to begin living. For example, the development of the assembly line with (the money people earn from their jobs and by Henry Ford (1863–1947) at the beginning of the investments), and it can only be allocated in two ways twentieth century made it possible for the United States (consumption or investment), the nature of the tradeoff to produce more cars. This new technology helped between these two uses of money can be analyzed using a improve the American economy by creating more jobs, PPC. Consumption and investment would be considered which meant that more people could buy the cars. Most goods that society provides, and the resulting PPC would people agreed that having a car improved one’s standard illustrate the different ways in which these two goods can of living. In contemporary society the Internet is an ex- be combined. ample of a new technology that has expanded the econ- Further, economists can compare the outward omy. This development created new jobs and made movement of PPCs (outward movement indicates eco- shopping easier for consumers, who can now go online to nomic growth) under conditions when more money is purchase anything from books to laptop computers. spent, versus conditions when more money is invested. Using PPCs in this way, economists have made the case When Did It Begin that weighting the economy more heavily toward In order for a group of people living in the same area to investing than consumption will ultimately allow not only be considered a civilization (a complex, interactive soci- for long-term growth but for more rapid growth overall. ety), some people in the community must devote them- This is one way to explain why many poor countries have selves to activities other than producing food for slow economic growth and why many rich countries themselves. This means that the food-producing mem- enjoy high rates of economic growth. The poorest bers must produce a surplus of food and trade that extra countries have to allocate all their resources and spending food for the various goods and services that the other to basic consumption, leaving little available for invest- members of the civilization provide. For example, a per- ment. This is a major contributor to low rates of eco- son who makes arrowheads would trade his arrowheads nomic growth. Rich countries can afford to save more, for food and other goods and services he requires for have higher rates of investment, and, as a result, grow survival. This organized system of trade is an economic more rapidly. system, and such systems require technology. The pro- But while it is true that the PPC provides a helpful cesses and equipment used to grow and store extra food way of visualizing the effects of the tradeoff between are examples of required technology. Thus the advance- savings and investment, these are only two among many ment of technology and the development of economic factors that fuel the economy. The United States econ- systems have coincided with each other since the begin- omy grew enormously during the 1990s, for example, ning of recorded civilization. even though Americans at that time were notoriously The earliest civilizations existed in the sixth millen- irresponsible spenders, saving a smaller proportion of nium BC in Mesopotamia between the Tigris and their incomes than people in any other comparable Euphrates Rivers in what is now Iraq, Syria, and Turkey. country. Among the ancient technology discovered there, 178 EVERYDAY FINANCE: Economics, Personal Money Management, and Entrepreneurship