Scarcity, choice and the production possibility curve
Key terms
Define each term.
Multiple choice
Circle the correct answer.
An economy is producing at a point inside its production possibility curve. This shows that:
Why is the PPC normally drawn concave to the origin rather than as a straight line?
A government pays for a national apprenticeship scheme that trains young workers as electricians. This is best described as an investment in:
Which of the following is a positive statement?
Worked problems
Show your working.
Identifying opportunity cost in three different decisions. State the opportunity cost in each case. (a) A government spends $50m building a hospital; its alternatives were a school worth $50m of benefit or road repairs worth $30m. (b) A worker turns down a job paying $28,000 to stay in one paying $25,000 with better conditions. (c) A firm uses a warehouse it already owns rather than renting it out for $40,000 a year.
Chains of reasoning
The steps are in the wrong order. Write the letters in the order that makes a linked chain.
How the choice on the PPC today determines the curve tomorrow
- A Productive capacity increases, so the PPC shifts outwards.
- B The opportunity cost of present consumption was therefore future growth, and the choice between the two is a distribution question between present and future generations.
- C Producing capital goods means fewer consumer goods now, so present living standards are lower than they could be.
- D A larger capital stock means each worker has more equipment to work with, so labour productivity rises.
- E The capital goods produced add to the economy's capital stock, net of depreciation.
- F An economy chooses a point on its PPC weighted towards capital goods rather than consumer goods.
- G The economy can now produce more of both goods than before, so future living standards are higher.
Diagrams
Draw a PPC for consumer goods and capital goods. Mark a point on the curve, one inside and one outside, and label what each represents. Then show three separate changes on fresh copies: an outward shift from new technology, a movement from inside the curve towards it after a recovery in demand, and a pivot where only capital goods output can rise.
Draw two PPCs for capital goods and consumer goods, representing two economies with identical current output levels. Mark Economy A at a point heavily weighted towards consumer goods and Economy B at a point heavily weighted towards capital goods. Then sketch each economy's PPC ten years later.
Answers
The basic economic problem: Unlimited human wants set against finite resources, which makes scarcity unavoidable and forces choices about what to produce, how to produce it and for whom.
Opportunity cost: The value of the next best alternative forgone when a choice is made.
B. A point inside the curve means output is below what current resources allow, so resources are idle or misallocated. Notably, moving from inside towards the curve can raise output of both goods at once, which means the opportunity cost of that particular move is zero, unlike movements along the curve.
B. The shape reflects rising opportunity cost. As production shifts towards one good, the resources transferred are progressively less suited to it, so each additional unit costs more of the other good. A straight line would imply resources are perfectly substitutable and opportunity cost is constant.
B. The scheme adds to the skills and knowledge of the workforce, which is human capital. Physical capital would be equipment such as machinery or buildings. Enterprise is the organising and risk-taking factor, and land is natural resources.
C. The third statement makes a factual claim that could be checked against data, which makes it positive whether or not it is accurate. The other three contain the value judgements 'ought', 'too high' and 'worse', none of which can be settled by evidence alone.
Step (a). The government's opportunity cost. The alternatives were the school and the road repairs. The next best is the school, since its benefit is higher. The opportunity cost is the school, not the school and the roads together, and not the $50m of money.
Step (b). The worker's opportunity cost. The next best alternative was the job paying $28,000, so the opportunity cost is the $3,000 of extra earnings forgone. The worker judged the better conditions to be worth more than $3,000, which is why the choice was rational.
Step (c). The firm's opportunity cost. The warehouse appears free because it is already owned and no payment is made. But using it means forgoing $40,000 of rent, so the opportunity cost of using it is $40,000 a year. This is why economic cost exceeds accounting cost.
Step 4. Draw out the general rule. Opportunity cost is about alternatives forgone, not about money spent. Case (c) has an opportunity cost with no expenditure at all, and this is why economists insist that using an owned resource is never free. That distinction underlies the concept of normal profit at A Level.
Case (c) is the one that separates candidates. Any resource with an alternative use has an opportunity cost even when nobody writes a cheque, and examiners choose scenarios of that kind deliberately.
F, C, E, D, A, G, B
- An economy chooses a point on its PPC weighted towards capital goods rather than consumer goods.
- Producing capital goods means fewer consumer goods now, so present living standards are lower than they could be.
- The capital goods produced add to the economy's capital stock, net of depreciation.
- A larger capital stock means each worker has more equipment to work with, so labour productivity rises.
- Productive capacity increases, so the PPC shifts outwards.
- The economy can now produce more of both goods than before, so future living standards are higher.
- The opportunity cost of present consumption was therefore future growth, and the choice between the two is a distribution question between present and future generations.
The final step is what turns a diagram into an argument. This chain reappears in the growth topic as the investment channel and in development as the savings gap, so it is worth learning once properly.
The pivot is worth practising because it appears less often and catches candidates out. A technological improvement affecting only one industry rotates the curve outwards along that axis while the intercept on the other axis is unchanged, since the maximum possible output of the unaffected good has not altered.
Economy B's curve has shifted further out, because capital goods are the inputs to future production, so choosing them today raises tomorrow's capacity. Economy A enjoyed higher living standards over the decade. Neither choice is a mistake, which is the point: the PPC shows the opportunity cost of present consumption is future growth, and how to weigh those is a normative question.