Notes: Production Possibility Curves

Notes: Production Possibility Curves

Production Possibility Curve

To clarify some confusion that exists in distinguishing between increasing, decreasing, and constant opportunity costs, the examples which follow are offered.

Case 1: Increasing Opportunity Costs

Production Alternatives

Product A B C D

Good X 9 8 5 0

Good Y 0 3 6 8

GoodX A

5 C

PPC

1 D

0 1 2 3 4 5 6 7 8 9 10 Good Y

On the diagram above, if we read the curve backwards, that is, from DA, note the following:

Move D C give up 2 Good Y to gain 5 Good X (or 2/5 Y to gain 1X).

Move C  B give up 3 Good Y to gain 3 Good X (or 1Y to gain 1X).

Move B  A give up 3 Good Y to gain 1 Good X (or 3Y to gain 1X).

The law of increasing opportunity costs is demonstrated in the move from D  A. This time to gain equivalent units of Good X increase amounts of Y must be given up. Thus, the “bowed-out” or concave, shape of the production possibility curve illustrates increasing costs.

Note:Resources transferred from production of Good X to production of Good Y are not completely adaptable. This point provides an explanation for the law of increasing opportunity costs.

Alternatively, when moving from A  D, note the following:

Move A  B give up 1/3 Good X to gain 1 Good Y (or 1 X to gain 3 Y).

Move B  C give up 1 Good X to gain 1 Good Y (or 3 X to gain 3 Y).

Move C  D give up 5/2 Good X to gain 1 Good Y (or 5 X to gain 2 Y).

This demonstrates the law of increasing cost, that is, in order to get equal units of one good, society must sacrifice ever-increasing units of the other good. Again, opportunity costs show foregone or sacrificed production which in this case increase as we move down the curve from point A to point D.

Case 2: Decreasing Opportunity Costs (This is NOT theoretically , or practically possible)

Production Alternatives

Product A B C D

Good X 9 7 2 1

Good Z 2 3 8 10

Good X

9 A

7 B

NOT A PPC

0 1 2 3 4 5 6 7 8 9 10 Good Z

In the diagram above when moving from A  D, note the following:

Move A  B give up 2 Good X to gain 1 Good Z (or 2 X to gain 1Z).

Move B  C give up 5 Good X to gain 5 Good Z (or 1X to gain 1Z).

Move C  D give up 1 Good X to gain 2 Good Z (or 1/2 X to gain 1Z).

This demonstrates a case of decreasing opportunity costs, that is from A  D in order to gain equal units of Good Z fewer and fewer units of Good X must be sacrificed.

If we read the curve backwards, that is, from D  A, note the following:

Move D  C give up 2 Good Z to gain 1 Good X (or 2 Z to gain 1X).

Move C  B give up 5 Good Z to gain 5 Good X (or 1Z to gain 1X).

Move B  A give up 1 Good Z to gain 2 Good X (or 1/2Z to gain 1X).

Again: The example above moving from D to A demonstrates a case of decreasing opportunity costs. An explanation for this would be that resources are more than completely adaptable in production when transferred from producing one good to another. If decreasing opportunity costs exist it would seem to imply that resources were not properly utilized in their initial application. This is not to say that they were not used to their full capacity, but, rather, that they were not in their best application initially. This case is offered to clear up confusion and is not often found in practice.

Case 3: Constant Opportunity Costs

The graph for constant opportunity costs is a straight line representing perfect adaptability in transferring resources from production of one good to production of another good. Linear, or constant, opportunity costs need not be depicted by a one to one ratio, i.e. it may be 3 to 1, 4 to 1, 500 to 1. Typically constant opportunity costs are found when there is a strong similarity between the two goods.

Production Alternatives

Product A B C D E

Good R 16 12 8 4 0

Good S 0 1 2 3 4

Good R

16 A

8 PPC

4 D

0 1 2 3 4 Good S

In the diagram above when moving from A  D, note the following:

Move A  B give up 4 Good R to gain 1 Good S.

Move B  C give up 4 Good R to gain 1 Good S.

Move C  D give up 4 Good R to gain 1 Good S.

Move D  E give up 4 Good R to gain 1 Good S.

This demonstrates that opportunity costs do not change, or they are constant, as we move down the production possibilities curve from A  D. The same conclusion can be drawn from reading the curve backwards from D  A.