Question

A. Draw the production possibilities curve for automobiles and breakfast cereal, and explain how the concept of trade-off could be applied to the production possibilities curve you created, using at least 100 words.(Graphical analysis required) B. Explain two possible factors that could shift the production possibilities curve for automobiles and breakfast cereal outward, using at least 100 words and graph.(Graphical analysis required) C. Should you go to the movie theatre this Saturday or do something else? Explain this using the concept of opportunity cost, using at least 100 words.

Answer 1

A. (Refer Figure 1)

A production possibility curve (PPC) shows the combinations of goods that can be produced with the available resources in the economy. For example, in our model of production with two goods (automobile and cereal), the PPC shows if we produce 50 units of cereal, then, with the given resources in the economy (for e.g, labor, machine, land etc.), that are left, how much automobile we can produce (here 5 units of automobile).

At points inside the curve like D, some inputs (labor, machines) are unemployed or not used efficiently. On the other hand, at points outside the frontier, like E, is not possible to achieve (requires more inputs than are available to the economy).

Simply put, tradeoff means - more of one good must mean less of the other. In the graph it is shown by movement along the curve (i.e., from point A to B to C). It means shifting output from cereal to automobile or vice versa, which means more of one must mean less of the other, so a tradeoff. Negative slope of the curve means that if we want to produce more cereal we will have to take away resources away from automobile production, thus reducing amount of automobile produced and vice-versa.

Note we have drawn a concave PPC which shows that slope increases (in absolute value) as we move to the right. Concave PPC implies that opportunity cost of additional cereals (measured in terms of automobile) rises as we produce more cereals, i.e., increasing marginal cost of production of cereals. In our case as we can see in the diagram, in order to produce more automobile (movement from A to B to C), we have to give up more and more units of cereal.

B. (Refer Figure 2)

Note that over time, PPC may shift out due to growth in the resources available in the economy. This is shown in the diagram by right outward shift of the PPC. This may happen due to growth in labor force, new machinery (capital) or introduction of new technology in the production process.

For e.g., if labor force increases then we will have more workers who can be used for further production of both or atleast one of the two goods. Similarly, if new machinery or new technology is introduced then for producing the same quantity of output we will require less input which means additional resources are made available for other use. These additional resources can be again be used for further production of both or atleast one of the two goods.

C.

Opportunity cost refers to the value forgone in order to make one particular investment instead of another. In other words, it is the value of what you have to give up in order to choose something else.

Now if I am to go for a movie this Saturday, I will have to spend both my time and money. Time, because I cannot spend that time at home reading a book, and money because I can't spend the money on something else. If my next-best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the opportunity I will miss to score a better grade in the next exams.