Chapter 1- Production Possibility Frontier.pptx

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1. Limits Alternatives and Choices McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 1 Slope of the Curve and Production Possibility Curve Economics Principles, Problems and Policies McConnell, Brue, Flynn

2. Slope of the curve defines the nature of the curve in the graph Zero slope means that the curve is as flat as x axis Infinite slope means that the curve is as steep / vertical as the y axis line Slope tells how much item in y axis is increased if the item in x axis is increased by 1 unit and vice versa. 2 In this Session you will

3. From C to D , “rise” = –200 mangos (800 mangoes to 600 mangoes) “run” = +50 fish ( 100 fish to 150 fish) Slope = – 4 = (-200/50) Hence if 1 fish is increased 4 mangoes decrease Quantity of Fish D C Quantity of Mangos The Slope of the Curve

4. First topic to discuss in micro economic is how we can manage our increasing unlimited needs (consider it more and more goods and services for us) and our limited and scarce resources (workers, machinery or fuel). So we will make a criteria which will define what is efficient production (maximum production with minimum resources) and what will happen if conditions can change Deciding how much to Produce

5. Production – output of goods and services Possibility – maximum attainable amount (for simplification we use two type of output) Frontier – border or boundary PPF is the curved boundary shows maximum possible number of different combinations of output that a society can produce at a given time when there is full utilization of economic resource and fixed technology Assumptions : Full employment , Resources are fully used, technology is constant, two types of goods are produced, capital and consumer good. Production Possibility Curves (Frontier) PPF

6. Resources Economist classify the economic resources into four general categories Land: Include all natural resources “ gift of nature” used in the production process. Labor : consist of the physical actions and mental activities that people contribute to the production of goods and services. The work-related activities of logger, retail clerk, teacher and engineer etc. Capital: Include all manufacturing aid s used in producing consumer good and services Entrepreneur: Is the special human resource, distinct from labor called entrepreneur Entrepreneur takes initiative in combining the resources of land, labor, capital to produce goods and services Make strategic business decision Innovates Bear risks

7. The production possibility frontier depicts not only limited capability and as per our unlimited needs we cannot go beyond PPF hence it represents scarcity. While moving on the curve there are alternative combinations representing opportunity cost. Any point inside the curve – suggests resources are not being utilised efficiently Any point outside the curve – not attainable with the current level of resources Production Possibility Curves (Frontier) PPF

8. Alternative Outputs Guns (000 units) Butter (million units) A 22 B 2 19 C 5 15 D 9 7 E 10 Here points A to E are on the PPF boundary are best possible that country can produce we call them efficient Point F is not best possible but it is less than efficient, so we call it inefficient Point G is beyond efficient, under current situation it is unattainable . Moving from D to C the benefit is 8 extra units of butter and the opportunity cost is 4 less units of guns Production Possibility Curves (Frontier) PPF

9. Why is points inside the PPF are inefficient? As it is assumed in the PPF that it is the point with full utilization of resources, but if we see point F country can improve in terms of butter or gun. It means the resources are not being used fully. What defines PPF to be negative sloped The scarcity of resources forces us to trade off between two possible outputs. Because of this the PPF is negatively sloped What can be the factors that can shift the PPF In the definition, it is assumed that total resources are fixed and technology is fixed . Hence any one of then change the PPF will change. And shift depends on the nature of change in assumption. Production Possibility Curves (Frontier) PPF

10. Butter Gun 0 2 4 6 8 10 12 14 16 18 20 22 24 12 11 10 9 8 7 6 5 4 3 2 1 E D C B A What if overall Technology is improved? If there is better technology, we will be able to produce more of both type of output using less resources hence our capacity will increase and PPF go outward At same time we will be able to make more guns and more butter If technology is reduced PPF will shift inward PPF Shifting Production Possibility Curves (Frontier) PPF

11. Butter Gun 0 2 4 6 8 10 12 14 16 18 20 22 24 12 11 10 9 8 7 6 5 4 3 2 1 E D C B A What will happen if the resource (labor) used for producing butter are increased or become more skilled? Extra labor will be able to produce more and more skilled labor will be able to work faster This will rotate the PPF outward from the butter end but Gun end will remain fixed. Similarly if Labor are reduced or there are less skilled then the curve will rotate inward PPF Shifting Production Possibility Curves (Frontier) PPF

12. Consider country is producing two types of product, one is wheat and other is computers. For wheat we have farmers and for computer we have computer engineers as resource. Here resources are specialized, means farmer do not know how to make computers and engineers do no know how to grow wheat. And we assume that the number of farmers and engineers are equal So they are good in their field but they will take time to learn the other field. Why PPF are Bent outward?

13. Set Wheat Computers I 100 II 60 60 III 100 Set I is : when we use all resource to grow wheat Set II is : when we use half resource to produce wheat and half to build computer Set III is : when we use all resource to build computers Why PPF are Bent outward?

14. In reality all resources do not have same kind of ability , there might be some farmers and some engineers if there are only two types of product produced (Wheat & Computer) Forcing resource to work in other field like farmer to make computer or engineer to grow wheat. They will take time to learn the new process. Since engineer will not be as good as a farmer in growing wheat and vice versa. So there will be some loss in production If both resources are working in the field where they are efficient. Then there will be more output produced. Hence the PPF is bent outward because of the principle of Increasing Costs. Why PPF are Bent Outward ?

15. So we came to know that because of specialization of resources PPF is bent outward Prompting us that the mixed combination is more fruitful than the extreme combination. It seems very easy to find the maximum benefit point if the PPF shape is known but how we will find it when it is not known. Selection of Maximum Benefit point

16. In reality all resources do not have same kind of ability, there might be some farmers and some engineers if there are only two types of product produced (Wheat & Computer) Forcing resource to work in other field like farmer to make computer or engineer to grow wheat. They will take time to learn the new process. Since engineer will not be as good as a farmer in growing wheat and vice versa. So there will be some loss in production If both resources are working in the field where they are efficient. Then there will be more output produced. Hence the PPF is bent outward because of the principle of Increasing Costs. Why PPF are Bent outward?

17. Conclusion Circular Flow Diagram

18. Production of the country faces scarcity We have limited resources and our need to produce and get profit is unlimited We have to choose the best possible output combination and trade off other combinations This way we are able to manage our resources in an efficient way to try to maximize the fulfillment of our needs and wants. Conclusion