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.

Comments

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 ...

Exercise: short and long run effects of a fiscal policy

You are in charge of the government budget for the year 2021. You are told that schools and public roads need to be updated, and you estimate an appropriate budget in order to carry out the task. Describe what will happen in the short run to the economy, and what type of inflation do we see? Describe the supply side effect from this policy, explain what happens in the long run. Assume that there is no crowding out effect. First, note that updating public infractures, assuming taxes stay the same, will require an increase in government spending, which will also have an impact on the investment and consumption level in the economy (remember the spending multiplier?). Therefore, the aggregate demand curve will shift to the right. This will cause inflation (i.e positive change in the price level) and a higher output in the short-run. Note that if we were to assume a large crowding out effect, the short run aggregate supply curve would shift to the left (increase in production c...

Exercise: maximizing profit

Assume that you are the owner of a small business that produces T-shirts. Your the total revenue for your business can be modeled by the following equation: and your total cost corresponds to this function: Find the point at which your firm maximizes its profit. Then, find how much profit the firm if able to earn at that point. Using the total cost and total revenue functions we can set up the profit function: Then, realize that if you want to find the maximum profit, take the derivative of the function and set it up equal to zero, and solve for Q. This is equivalent of taking the derivative of the total cost and total revenue functions and setting them equal to each other. In this problem, I chose the latter option as it was explained in the previous lessons. Notice that profit is often denoted by a capital pi. We are assuming that the TR>TC for some positive value, you can check for yourself. However, if we did not know that, we would first take the first ...

Economics and Statistics

Search This Blog