Skip to main content

Macroeconomics: production possibilities curve (PPC)

  • Production possibilities curve (PPC): an economic model that depicts the trade-off an individual agent, or a country has when it allocates its resources between two goods or services.
    • PPC models scarcity because only a specific amount of the two goods can be produced and consumed at any point on the curve.
    • A country, or individual can produce/ consume efficiently if they are on the curve. They can produce and consume anywhere inside its PPC, but they would be under utilizing their resources.
    • PPC models opportunity cost, by showing how much one good must be given up in order to produce one additional unit of the other good.
  • An individual PPC: The PPC below shows the relationship between the amount of time spent on relaxing and working in a day.
    • At point A, the individual is willing work 5 hours and relax for 19 hours. This choice involves an opportunity cost which is the benefit she would have gained by working more and relaxing less (and vice versa...).
    • At point B, the individual is working 18 hours and relaxing for 6 hours. The opportunity cost of working 13 extra hours is the 13 fewer hours they get to spend relaxing.
  • A country's PPC (constant opportunity cost): assume this country only produces two goods; deep dish pizzas and regular pizzas.
    • Since the slope was arbitrarily chosen to be -2x, the opportunity cost of one more  deep dish pizza will always be two regular pizzas (and vice versa).
  • A country's PPC (increasing opportunity cost): using the same country, this time the two goods will be computers and deep dish pizzas. 
    • The production of pizza is land intensive, its ingredients require a lot of land use. Furthermore, this production requires two types of specialized labor; farmers and cooks.
    • the production of computers require a type of labor that is highly skilled, for example engineers. Also, the production of computers is less land intensive than pizza. 
    • Because land and labor resources are  not perfectly adaptable to making computers or pizza, the opportunity cost  to increase the production of computers rises in terms of pizzas the more computers are produced.
    • The law of increasing opportunity cost states that as the output for one good increases, the opportunity cost of producing another unit rises. Then, the PPC must have a convex shape.
    • Notice that the opportunity cost of producing the first computer is one pizza, but the cost of producing the fourth computer is 7 pizzas.
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 28-33.

Labels:
Location: Chicago, IL, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Macroeconomics: Fiscal Policy and short run effects of fiscal and monetary policies

  Fiscal Policy: government spending and taxation, aimed at expending or contracting the level of macroeconomic activity in a nation. A tax increase (decrease) will raise (lower) households' disposable income, leading to more (less) consumption. Furthermore, firms will increase (decrease) the number of investment as they get to keep a larger (smaller) share of their profits. An increase (decrease) in government spending affects the variable G that defines the aggregate demand. Government spending also leads to a change in household income, affecting the level of consumption. Tax multiplier: just like any multiplier so far, it is just the sum of a converging geometric series: Say the MPC is equal to 70%, then it must be the case that the MPS is 30%. Thus, the tax multiplier, t, is equal to about -2.32. In other words, for every dollar that goes to tax revenue, total spending decreases by about 2.32 dollars. Note that a tax decrease would be negative, and thus have a positi...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more