The Production Possibilities Curve Model (PPC) (HL IB Economics)

An Introduction to the PPC

• The Production Possibility Curve (PPC) is an economic model that considers the maximum possible production (output) that a country can generate if it uses all of its factors of production to produce only two goods/services
  

• Any two goods/services can be used to demonstrate this model
  

• Many PPC diagrams show capital goods and consumer goods on the axes

  • Capital goods are assets that help a firm or nation to produce output (manufacturing). For example, a robotic arm in a car manufacturing company is a capital good

  • Consumer goods are end products and have no future productive use. For example, a watch
     

A PPC for an economy demonstrating the use of its resources to produce capital or consumer goods

Diagram Explanation

• The use of PPC to depict the maximum productive potential of an economy

  • The curve demonstrates the possible combinations of the maximum output this economy can produce using all of its resources (factors of production)

  • At A, its resources are used to produce only consumer goods (300)

  • At B, its resources are used to produce only capital goods (200)

  • Points C and D both represent full (efficient) use of an economy's resources as these points fall on the curve. At C, 150 capital goods and 120 consumer goods are produced

• The use of PPC to depict opportunity cost

  • To produce one more unit of capital goods, this economy must give up production of some units of consumer goods (limited resources)

  • If this economy moves from point C (120, 150) to D (225, 100), the opportunity cost of producing an additional 105 units of consumer goods is 50 capital goods

  • A movement in the PPC occurs when there is any change in the allocation of existing resources within an economy such as the movement from point C to D

• The use of PPC to depict efficiency, inefficiency, attainable and unattainable production

  • Producing at any point on the curve represents productive efficiency

  • Any point inside the curve represents inefficiency (point E)

  • Using the current level of resources available, attainable production is any point on or inside the curve and any point outside the curve is unattainable (point F) 

Assumptions of the Model

• The PPC Model is a simplified version of reality and so makes the following assumptions about the state of resources in an economy at a particular moment in time

1. Only two goods are produced: any two goods can be used to illustrate the underlying principle. In reality, an economy produces many goods/services but focussing on two makes the analysis possible

2. Scarcity of resources exists: the factors of production are limited so choices have to be made about how they are used

3. Production is efficient: it is assumed that there is no wastage and that all resources are used in such a way that the maximum output is attained from the inputs used. In reality, this is often not the case

4. The state of technology is fixed: as the model represents a particular moment in time, it is assumed that the technology is not changing. In reality, improvements in technology are continuously occurring and they create the potential to increase the output using the scarce resources

Increasing Versus Constant Opportunity Cost

• Two different types of opportunity cost can be illustrated using PPC curves

• Constant opportunity cost occurs when all of the factors of production used to produce one good can be switched to producing the other good without any loss/wastage of resources

  • One unit given up one of good results in one unit gained of the other

• Increasing opportunity cost occurs when the factors of production cannot be perfectly switched between the two products

  • One unit given up of one good results in less than one unit gained of the other
     

Constant opportunity cost occurs when switching production from T-shirts to hoodies while there is increasing opportunity cost when switching production from consumer goods to capital goods

Diagram Analysis

• For a country producing only T-shirts and hoodies, the factors of production can easily be switched between the two products e.g. the same labour and land (cotton) can be used to make both products

  • Changing production from point F to G decreases the production of T-shirts from 4 to 3 and increases the production of hoodies from 3 to 4

  • There is constant opportunity cost when production is switched

• For a country producing consumer goods and capital goods, the factors of production cannot easily be switched between the two products e.g. the labour required to make a washing machine may not have the skill to produce a robotic arm used in car manufacturing

  • Changing production from point A to point C results in a decrease of 130 consumer goods but yields an increase of 180 capital goods

  • Changing production from point C to point B results in a decrease of 120 consumer goods but only yields an increase of 20 capital goods

  • There is an increasing opportunity cost as production moves closer and closer to any particular axis

Changes in Production Possibilities

• As opposed to a movement along the PPC described above, the entire PPC of an economy can shift inwards or outwards thereby changing its production possibilities

Outward shifts of a PPC show potential economic growth and inward shifts show economic decline

Diagram Explanation

• Economic growth occurs when there is an increase in the productive potential of an economy

  • This is demonstrated by an outward shift of the entire curve. More consumer goods and more capital goods can now be produced using all of the available resources

• This shift is caused by an increase in the quality or quantity of the available factors of production

  • One example of how the quality of a factor of production can be improved is through the impact of training and education on labour. An educated workforce is a more productive workforce and the production possibilities increase

  • One example of how the quantity of a factor of production can be increased is through a change in migration policies. If an economy allows more foreign workers to work productively in the economy, then the production possibilities increase

• Economic decline occurs when there is any impact on an economy that reduces the quantity or quality of the available factors of production

  • One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated the production possibilities of Japan for many years. It shifted their PPC inwards resulting in economic decline