Running head: POSSIBILITIES
1
Possibilities
Pallavi Bhardwaj
Capella University
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POSSIBILITIES
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Production Possibilities of an Economy
The study of macroeconomics raises three fundamental questions: What to produce, how
to produce, and for whom to produce. These questions highlight the principal issues of scarcity
and choice faced by an economy.
An economy cannot produce an infinite quantity of goods and services because of the
scarcity of resources. Hence, the economy has to choose what it should produce and in what
quantity. This choice is represented by a production possibilities curve (PPC). A production
possibilities curve can be defined as “a curve showing the maximum possible combinations of
two goods that can be efficiently produced given a nation’s resources” (Rutherford, 2013).
Suppose an economy produces only bread and bullets. The various combinations that the
economy can produce are tabulated in the production possibilities table given below.
Production Production Production Production Production Production Production
Type of
Alternative Alternative Alternative Alternative Alternative Alternative Alternative
Production
A
B
C
D
E
F
G
Bread
0
1
2
3
4
5
6
Bullets
16
14
12
10
7
4
0
The following graph represents the PPC for the different combinations of bread and
bullets in the table given above.
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A country’s PPC is drawn on the basis of some important assumptions. The assumptions
that underlie a country’s PPC are developed and discussed below.
1. An economy can produce only two goods in various proportions. This assumption keeps
analysis simple. As shown in the graph, the horizontal axis measures the units of bread produced
in the economy and the vertical axis measures the units of bullets produced in the economy. On
the PPC, point G (6,0) represents the possibility of producing only bread, whereas point A (0,16)
represents the possibility of producing only bullets. Besides points A and G, the economy can
produce various combinations of both the goods, represented by points B, C, D, E, and F.
2. The economy has a fixed amount of resources. At a given point of time, the amount of land,
labor, capital, and entrepreneurship that an economy can use for production is limited. Given the
existing amount of resources, the economy can produce only those combinations that lie on the
PPC, which are A, B, C, D, E, F, and G. It cannot produce 5 units of bread and 10 units of
bullets, which is the production possibility represented by point M on the graph.
3. Resources are not equally efficient in the production of both the goods. Some resources could
be better suited to produce bullets. If they were transferred to the production of bread, the
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POSSIBILITIES
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productivity of such resources would decline. Suppose the economy is at point E (4,7), where it
produces 4 units of bread and 7 units of bullets. If it wants to move to point F (5,4), then it has to
transfer some resources that are employed in the production of bullets to the production of bread.
To produce an additional unit of bread, the economy has to give up 3 units of bullets. If the
economy wants to move from point F (5,4) to point G (6,0), then it has to give up 4 units of
bullets to produce an additional unit of bread. Therefore, for the economy to continue
transferring resources from the production of bullets to the production of bread, it has to give up
more and more units of bullets.
4. Every point on the PPC (A to G) represents full employment of resources. Suppose the
economy is at point E (4, 7). This implies that the economy has employed all the resources
available at a given point of time to produce 4 units of bread and 7 units of bullets. If they were
not fully employed, then the economy would not be able to produce at point E. If the economy is
unable to employ all the resources, then it will produce any combination that lies inside the PPC,
which is denoted by point L in the graph. This highlights the assumption that there should be full
employment of resources to produce the combinations of the goods that lie on the PPC
(MsWorldEconomy, 2010).
A movement along the PPC of a country shows the opportunity cost of producing the
goods. “The opportunity cost of an item is what you give up to get that item” (Mankiw, 2010, p.
6). The slope of the PPC determines the opportunity cost of producing the good that is
represented on the horizontal axis. For the economy discussed above, the slope is calculated by
dividing the change in the production of bullets by the change in the production of bread.
Between points B and C, the slope of the PPC would be −2 (−2/1). This means that to produce an
additional unit of bread, the economy has to reduce the production of bullets by 2 units.
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Comment [N1]: Analyzes data to
develop assumptions and includes a
thorough examination of the variables
that can affect an economy . Well done
POSSIBILITIES
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Therefore, the opportunity cost of producing an additional unit of bread is 2 units of bullets.
“Each point on this curve shows the TRADE-OFF between the output of the two goods, or the
OPPORTUNITY COST of producing more of one good” (Rutherford, 2013).
The production possibilities curve is downward sloping because of the scarcity of the
resources in an economy, and it is concave to the origin, or bowed out, because of increasing
opportunity costs. According to one of the underlying assumptions of the PPC, resources are not
equally efficient in the production of both bread and bullets. Resources that are efficient in the
production of bullets are employed to produce them, thereby maintaining low cost. If an
economy wants to increase the production of bullets, it must transfer resources that are efficient
in the production of bread to the production of bullets. The employment of inefficient resources
in the production of bullets increases the cost of producing an additional unit of bullet. As shown
in the graph given above, the opportunity cost of producing an additional unit of bread increases
as we move downward along the PPC (Johnson, 2011).
Production at any point on the PPC requires full employment of resources. At point B,
the economy has employed all its resources to produce 1 unit of bread and 14 units of bullets.
This further implies that more resources are employed in the production of bullets than in the
production of bread. By contrast, production at any point inside the PPC, such as point L, implies
underemployment of resources. If the economy produces 2 units of bread, then it can produce 12
units of bullets, given that all resources are efficiently employed. At point L, however, it
produces 2 units of bread and 6 units of bullets. Hence, at point L, the resources of the economy
are underutilized. For example, at the time of the Great Depression, unemployment was
widespread. People who were capable of being employed in the production of goods and services
were unable to get jobs because of a halt in investments. In this scenario, the economy did not
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POSSIBILITIES
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produce on the PPC. However, the economy could have moved to any point on the PPC by
employing idle resources in the production of goods and services (MsWorldEconomy, 2010).
An economy can expand its production and consumption possibilities by shifting the PPC
to the right. Increases in the factors of production, advanced techniques of production,
improvements in technology, increased human capital, and so on, can lead to a rightward shift in
the PPC, thereby expanding production possibilities. For instance, after the Industrial
Revolution, there was a tremendous increase in the mechanization of the production process.
This enabled an increase in the global production of goods (MsWorldEconomy, 2010). Apart
from shifting the PPC to the right, an economy can participate in trade with other economies to
expand its consumption possibilities.
Can a Country Consume beyond its PPC?
International trade can prove to be mutually beneficial for countries. Every country
produces a variety of goods. However, a country can be better off if it specializes in the
production of the goods in which it has a comparative advantage. A country is said to have a
comparative advantage in the production of a good if it is able to produce the good at a lower
opportunity cost than other countries. Suppose Japan and the United States produce only
computers and apples. Japan has a comparative advantage in producing computers as it has to
give up fewer units of apples to produce an additional unit of computers. Similarly, the United
States has a comparative advantage in producing apples over computers. If both Japan and the
United States employ all their resources in the production of the good in which they have a
comparative advantage, then both the countries can increase the production of the respective
good at a low cost. In such a scenario, Japan would export computers to and import apples from
the United States. Consumption in both countries would increase with the help of international
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trade, without shifting the PPC to the right. In this example, each country chooses to produce the
good that has a low opportunity cost (Rittenberg & Tregarthen, 2016). In addition to
international trade, the concept of opportunity cost plays a significant role in economics.
The Study of Economics and Opportunity Cost
“Economics is a social science that examines how people choose among the alternatives
available to them” (Rittenberg & Tregarthen, 2016, para. 1). The need to make a choice arises
because of scarcity. “Scarcity means that society has limited resources and therefore cannot
produce all the goods and services people wish to have” (Mankiw, 2012, p. 4). People face
scarcity while making decisions. They have to choose among available alternatives. While
choosing one alternative over another, they forgo the benefits they might have received by
choosing the other. The value of the next best alternative forgone is called opportunity cost.
Suppose an individual buys a book for $30. He or she could have spent the $30 to eat in a
restaurant or to watch a movie. If he or she prefers watching a movie to eating out, then the
opportunity cost of buying the book would be equal to the utility he or she would have derived
from watching the movie.
Scarcity, choice, and opportunity cost are closely related. Suppose a company has
$200,000 to finance its investment plans. It can invest in either an advertisement campaign or a
new plant. Investing in the advertisement campaign would increase the demand for its product,
increasing sales revenue by $350,000. Assuming a cost of $200,000, the net benefit of investing
in advertisements would be $150,000. If the company invests in the new plant, the production
capacity of the company would increase, thereby reducing the cost of production. Because of
economies of scale, the company would be able to save $250,000, which is the benefit of
investing in the new plant. Considering the cost of investment is $200,000, the net benefit would
Copyright ©2016 Capella University. Copy and distribution of this document is prohibited.
Comment [N2]: Analyzes data to
develop assumptions and includes a
thorough examination of the variables
that can affect an economy. You need to
support your analysis with proper
references and resources as per APA
guidelines.
POSSIBILITIES
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be $50,000. To determine which alternative has a greater opportunity cost, the net benefits of
both should be compared. On comparing net benefits, it can be seen that the opportunity cost of
investing in advertising is $50,000 and the opportunity cost of investing in the new plant is
$150,000. Therefore, the opportunity cost of investing in the new plant is greater. After
comparing the benefits and costs of each option, the company should invest in advertisements.
Weighing Marginal Benefits and Marginal Costs
People might not realize that they perform a small analysis when making decisions in
their everyday lives. They make decisions after assessing the positive and negative effects.
Similarly, in economics, decisions are made after weighing marginal benefits and marginal costs.
Marginal benefit refers to the additional utility received by an individual by consuming one more
unit of a good. It tends to decrease as an individual consumes more of a good (“Marginal
Benefit,” n.d.). Marginal cost refers to an incremental increase in the costs incurred by an
individual by consuming an additional unit of a good. In contrast to marginal benefit, marginal
cost tends to increase with the consumption of a good.
The concept of marginal benefits and costs applies to a variety of real-life situations. For
example, I went out to eat pizza last month. After eating a pizza, I thought of ordering another
pizza. Before placing the order, I considered both the marginal benefits and costs of eating
another pizza. The marginal benefits of consuming another pizza included the taste, the flavor,
and the happiness I would have got from eating the pizza. On the other hand, the marginal costs
included the price of a pizza and the extra calories and cholesterol I would have consumed after
eating the pizza. I realized that the first pizza was enough. Even though I craved for more, I
knew that consuming the second pizza would not be healthy. Hence, I decided not to have
Copyright ©2016 Capella University. Copy and distribution of this document is prohibited.
Comment [N3]: Analyzes the concept of
opportunity cost in terms of the
relationship to economics. Well done
POSSIBILITIES
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another pizza. I made this decision because the marginal costs of eating another pizza
outweighed its marginal benefits.
I also weighed marginal benefits and marginal costs while preparing for my final exams.
After studying for a few hours, I took a break and watched my favorite TV series. After watching
one episode, I was tempted to watch another one. The marginal benefit of watching another
episode included the entertainment I might have received. The marginal cost included the low
grades I might have got in my exams. For me, the marginal cost of watching the show was higher
than its marginal benefit. Therefore, I continued studying after watching one episode. These are
two instances where I made a decision after analyzing marginal benefits and costs. Likewise,
there are many such incidences in everyone’s lives that are also influenced by marginal benefits
and costs.
Conclusion
Given the scarcity of resources and fixed technology, an economy faces restrictions in the
production of goods and services. The PPC of a country represents the combination of goods and
services that the country can produce and hence determines its consumption. However, trade
between countries can help them consume beyond their PPC. Moreover, a country can shift its
PPC to the right if technology advances or if it has access to higher-quality factors of production.
Every decision involves an inevitable choice among different alternatives, and this choice
incurs a hidden cost referred to as the opportunity cost of that choice. Opportunity cost is quite
subjective. An individual’s valuation of opportunity cost depends on his or her marginal benefit
and cost. Accordingly, an alternative with a higher marginal benefit or lower marginal cost is
selected among available alternatives.
Copyright ©2016 Capella University. Copy and distribution of this document is prohibited.
Comment [N4]: Applies the concepts of
marginal cost and marginal benefit to
real world decisions However, you still
need to work on properly citing your in
text references and resources as per
APA guidelines/
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References
Johnson, K. [Karl Johnson]. (2011, April 17). Production possibilities curve 1 [Video file].
Retrieved from https://youtube.com/watch?v=hHz77q5JBTk
Marginal benefit. (n.d.). Retrieved from http://investopedia.com/terms/m/marginalbenefit.asp
Mankiw, N. G. (2012). Principles of economics. Mason, OH: South-Western Cengage Learning.
MsWorldEconomy. (2010, November 23). Production possibilities frontier part 2 [Video file].
Retrieved from https://youtube.com/watch?v=OhTZTP53e_A
Production possibility frontier. (2013). In D. Rutherford, Routledge dictionary of economics.
London, UK: Routledge. Retrieved from
http://library.capella.edu/login?url=http://search.credoreference.com/content/entry/routso
bk/production_possibility_frontier/0
Rittenberg, L. & Tregarthen, T. (2016). Principles of microeconomics, v.1.0. Retrieved from
http://catalog.flatworldknowledge.com/bookhub/21?e=rittenberg-ch02_s03
Slope, production possibilities curve. (n.d.). Retrieved from http://amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=slope, production possibilities curve
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