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?
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.
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.
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.
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.
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.