-Use our limited resources to produce a mix of goods and services.
-The production possibilities model shows us all the various combinations of output an economy can achieve.[break]
-Two good economy: Keeps us from drawing crazy graphs and avoids tough mathematics while still getting the key concept across. We’ll say that there is a capital good and a consumer good.
-Fixed resources: The quality and amount of resources available to an economy (land, labor, capital, and entrepreneurial ability) do not change.
-Fixed technology: The productive efficiency of this economy does not change, i.e. they cannot produce more output using the same number of resources.
-Full employment: For now, this economy is utilizing all of its available resources to the best of its ability.
-Time period of one year: Economic analysis are meaningless without time frames attached to them. We’ll arbitrarily pick one year.
-Closed economy: No trading with others.[break]
Graphing the Model
-Taking our assumptions into account, we can create the productions possibilities curve (PPC).
-The PPC shows us all the different combinations of output we can have, given our resources and technology.
-The full employment of resources means that this economy can produce anywhere on the line.
-Note: We cannot tell with the given information what combination of goods will be produced; we only know the different combinations that could be produced. The actual mix of output will be determined by the society and their preference for consumer and capital goods.
-If we strip away the full employment assumption, i.e. an economy is not utilizing all of its available resources, then the point in which this economy will produce will lie somewhere inside the curve.
-It is not possible for an economy to produce outside of its production possibilities curve.
-Note the concave nature of the curve: as more and more consumer goods are produced, fewer and fewer capital goods are produced and vice versa. This is due to increasing opportunity costs.
-For each successive unit of good X this economy wants to produce, it has to give up more and more units of good Y. For each successive unit of good Y this economy wants to produce, it has to give up more and more units of good X.
-This is because certain resources are better producing one thing than another. Some land is better suited for farming rice while other land is better suited for corn. Some people are better artists while others are better accountants. The more of one good or service that is produced, the fewer suitable resources there are to produce it, so it will take more resources to produce the next successive unit.
-The only way for an economy to produce more of one good without giving up some of the other is for it to be inside the PPC, in other words when this economy is not fully utilizing its resources.
-For example, in this case this economy can choose to produce more X, more Y, or more of both.
-As it was mentioned earlier, an economy cannot produce outside of its PPC. However, this does not mean that an economy is forever limited to its current output potential.
-Over time, the resources an economy has will change, as well as the technology available.
-If one or both of these factors change for the better, the PPC will shift to the right increasing the output potential.
-If one or both of these factors change for the worse, the PPC will shift to the left, decreasing the output potential.
-Another way for an economy to change its productive capabilities is by opening itself up to trade and specializing in production, but that’s a whole other subject on its own.
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