Thus, the slope of a PPF starts flat and becomes increasingly steeper. In the real world, of course, we have more than two goods and services, and we have more resources than just labor, but the general rule still holds.
For consumers, there is only one scarce resource: budget dollars. As we choose more of one good and less of another, we are simply spending dollars on different items, but every dollar is worth the same in purchasing any item. For society, there are many scarce resources. In our simple example above, there were two different resources: doctors and teachers, and each resource is better at one job than at the other.
In other words, each resource is not worth the same at producing different products. The general rule is when one is allocating only a single scarce resource, the trade-off e. Watch this video to see another explanation as to why the PPF is curved. Figure 2. The lesson is not that society is likely to make an extreme choice like devoting no resources to education at point A or no resources to health at point F.
Instead, the lesson is that the gains from committing additional marginal resources to education depend on how much is already being spent. If, on the one hand, very few resources are currently committed to education, then an increase in resources used can bring relatively large gains. On the other hand, if a large number of resources are already committed to education, then committing additional resources will bring relatively smaller gains. This pattern is so common that it has been given a name: the law of diminishing returns.
This law asserts that as additional increments of resources are devoted to a certain purpose, the marginal benefit from those additional increments will decline. For example, after not spending much at all on crime reduction, when a government spends a certain amount more, the gains in crime reduction could be relatively large. But additional increases after that typically cause relatively smaller reductions in crime, and paying for enough police and security to reduce crime to zero would be tremendously expensive.
The curve of the production possibilities frontier shows that as additional resources are added to education, moving from left to right along the horizontal axis, the initial gains are fairly large, but those gains gradually diminish. Similarly, as additional resources are added to health care, moving from bottom to top on the vertical axis, the initial gains are fairly large but again gradually diminish. In this way, the law of diminishing returns produces the outward-bending shape of the production possibilities frontier.
Privacy Policy. Skip to main content. Module 2: Choice in a World of Scarcity. Search for:. Learning Objectives Explain the production possibilities frontier. Try It. Glossary law of diminishing returns: as additional increments of resources are devoted to a certain purpose, the marginal benefit from those additional increments will decline production possibilities frontier or curve : a diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available.
Licenses and Attributions. The gains from specialization and trade are based on absolute advantage. You just studied 30 terms! If a country produces a combination of goods that uses all of the resources available in the economy, then the country is producing on its production possibilities frontier.
When a country produces on its PPF, it is fully utilizing its scarce resources, but it has not eliminated scarcity. The end result is increased standards of living.
Canada is a strong proponent of the multilateral trading system, with the WTO at its core. Creating opportunities for Canadian workers and businesses through WTO participation is a central part of our trade strategy. The WTO provides a framework for pursuing those objectives on a global scale. Begin typing your search term above and press enter to search. Press ESC to cancel.
Social studies. But if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B, and C all represent the most efficient allocation of resources for the economy. The nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production.
Markets play an important role in telling the economy what the PPF ought to look like. Consider point X on the figure above. Being at point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine, given the potential of its resources.
On the other hand, point Y, as we mentioned above, represents an output level that is currently unattainable by this economy. If there were an improvement in technology while the level of land, labor, and capital remained the same, the time required to pick cotton and grapes would be reduced. The output would increase, and the PPF would be pushed outwards.
A new curve, represented in the figure below on which Y would fall, would show the new efficient allocation of resources. When the PPF shifts outwards, it implies growth in an economy.
When it shifts inwards, it indicates that the economy is shrinking due to a failure in its allocation of resources and optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology. An economy can only be produced on the PPF curve in theory.
In reality, economies constantly struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo some choice in favor of others, the slope of the PPF will always be negative.
That is, if the production of product A increases then the production of product B will have to decrease. The Pareto Efficiency states that any point within the PPF curve is inefficient because the total output of commodities is below the output capacity.
Conversely, any point outside the PPF curve is impossible because it represents a mix of commodities that will require more resources to produce than are currently obtainable. Therefore, in situations with limited resources, only the efficient commodity mixes are those lying along the PPF curve, with one commodity on the X-axis the other on the Y-axis.
Consider a hypothetical world that has only two countries Country A and Country B and only two products cars and cotton. Suppose that Country A has very little fertile land and an abundance of steel. Country B has an abundance of fertile land but very little steel. If Country A were to try to produce both cars and cotton, it would need to split its resources and put a great deal of effort into irrigating its land to grow cotton. That would mean it can produce fewer cars, which it is much more capable of doing.
The opportunity cost of producing both cars and cotton is high for Country A. Similarly, for Country B, the opportunity cost of producing both products is high because of the effort required to produce cars given its lack of steel.
An economy may be able to produce for itself all of the goods and services it needs to function using the PPF as a guide. However, this may actually lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trade are considered.
Through specialization , a country can concentrate on the production of just a few things that it can do best, rather than trying to do everything on its own.
Each country in our example can produce one of these products more efficiently at a lower cost than the other. We can say that Country A has a comparative advantage over Country B in the production of cars, and Country B has a comparative advantage over Country A in the production of cotton.
Or, both countries could decide to specialize in producing the goods for which they have a comparative advantage. Each can trade its specialized product to the other and both countries will be able to enjoy both products at a lower cost. Quality will improve, too, since each country is making what it makes best. Determining how countries exchange goods produced by comparative advantage "the best for the best" is the backbone of international trade theory.
This method of exchange via trade is considered an optimal allocation of resources. It means that national economies, in theory, will no longer be lacking anything that they need. Like opportunity cost, specialization and comparative advantage also apply to the way in which individuals interact within an economy. At least in modern times, few people try to produce everything they consume.
Sometimes a country or an individual can produce more than another country, even though countries both have the same amount of inputs. For example, Country A may have a technological advantage that, with the same amount of inputs good land, steel, labor , enables the country to easily manufacture more of both cars and cotton than Country B. A country that can produce more of both goods is said to have an absolute advantage.
Better access to natural resources can give a country an absolute advantage, as can higher levels of education, skilled labor, and overall technological advancement.
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