The Production Possibilities Curve Summarized in 6 Points

Here’s all you need to know about the PPC :

Point 1 : Master Its Definition.

Before you go about blindly memorizing it, I urge you to first deduce the meaning of the PPC by yourself. You will have a much easier time recalling its definition. Now let me guide you through its definition. Have a look at  the following diagram, Figure 1.

Figure 1.

Ignoring the boundaries set by the PPC, plot a single point anywhere on the graph above. Its pretty easy to deduce that the point you plotted simply represents a combination of some units of cars and corn produced by an economy. If that point was Point A, that point represents a combination of 20 units of cars and 45 units of corn produced. The production Possibilities Curve, as the name suggests, indicated all the possible combinations of cars and corn that an economy can produce. Given limited resources and constant state of technology, the economy can only produce points within the PPC, and not a point out if i.e. Point C in the diagram. Now for the formal definition of the PPC: The PPC represents the maximum combination of 2 goods that an economy can produce give full utilization of resources and constant state of technology.

 

Point 2 : Illustrate the concepts of scarcity, choice, and opportunity cost.

All 3 concepts can be explained using the same diagram above. Scarcity, the central problem of economics, refers to the situation of unlimited human wants chasing limited resources. Scarcity can easily be explained using Point C in the diagram, and choice can also be easily explained using Points A and B. To explain opportunity cost, assume that the economy is currently producing at Point A. Suppose the economy wants to produce more corn and hence switches to Point B, the opportunity cost (or next best alternative forgone) of making such a switch would be 20 – 8 = 12 units of cars. That’s all.

 

Point 3 : Explain the shape of the PPC.

This would be the toughest point in this point. In Microeconomics, the shape of the PPC is concaved outwards. But why not a straight line? Note that in the International Trade topic in MAcroeconomics, the PPC is drawn with a straight line. The truth is that the concaved-shaped PPC in Microeconomics is specifically used to teach students the law of increasing opportunity costs and the non-homogeneity of resources. Click here for the full explanation. A common confusion lies between the explanation of the law of increasing opportunity costs and the illustration of opportunity cost in section 2 of this post. Avoid it!

 

Point 4 : There are 2 ways of labeling the PPC.

The first way is to label the axes with any 2 goods, for example, corn and cars as in the graph in section 1. Most concepts related to the PPC can be explained using this way of labeling, with the exception of the concept of an outward shift of the PPC. While this shift  can be illustrated using the first way of labeling, a better way would be to lavel the axes with ‘Capital’ and ‘Consumption’ goods. The reason is because the latter way is pretty versatile when dealing with questions relating to Macroeconomics. It could be used to accurately illustrate the following concepts which the first way of labeling is unable to deal with:

  • Degree of outward shift of the PPC
  • Short term and long term economic growth
  • Material standard of living (using the axis labeled with ‘Consumption Good’
  • Rationale behind increasing investments in an economy

Point 5 : The PPC is similar to the LRAS curve.

The LRAS (vertical portion of the AS curve) represents the full capacity of the economy, how much it can produce given full employment of its resources. It tells us that actual growth of national output is limited by the LRAS, and in order to expand the economy, the LRAS has to be increased. A similar explanation can used using an outward shift of the PPC.

 

Point 6 : The PPC in International Trade.

In explaining the law of comparative advantage, the straight-lined PPC is used. If you understand section 3, then you can easily deduce that the reason for it being straight in this case is due to the assumption of homogeneous resources used in production. Note for H1 students: Officially, you are not required to use graphs or tables to illustrate the law of comparative advantage in your exams. But it is important to understand it using the straight-line PPC graph! And for your information, most schools teach it to H1 students anyway, both graphs and tables.

Please feel free to contact me at 9299 4734 or email me at jlow.economics@gmail.com if you have any questions !