Mukhlis Tanveer Jan writer.

Economics With Tanveer.

Production Possibilities Curve

Constructing a Production Possibilities Curve

To construct a production possibilities curve, we will begin with the case of a hypothetical firm, Alpine Sports, Inc., a specialized sports equipment manufacturer. Christie Ryder began the business 15 years ago with a single ski production facility near Killington ski resort in central Vermont. Ski sales grew, and she also saw demand for snowboards rising—particularly after snowboard competition events were included in the 2002 Winter Olympics in Salt Lake City. She added a second plant in a nearby town. The second plant, while smaller than the first, was designed to produce snowboards as well as skis. She also modified the first plant so that it could produce both snowboards and skis. Two years later she added a third plant in another town. While even smaller than the second plant, the third was primarily designed for snowboard production but could also produce skis.

We can think of each of Ms. Ryder’s three plants as a miniature economy and analyze them using the production possibilities model. We assume that the factors of production and technology available to each of the plants operated by Alpine Sports are unchanged.

Suppose the first plant, Plant 1, can produce 200 pairs of skis per month when it produces only skis. When devoted solely to snowboards, it produces 100 snowboards per month. It can produce skis and snowboards simultaneously as well.

The table in Figure 2.2 “A Production Possibilities Curve” gives three combinations of skis and snowboards that Plant 1 can produce each month. Combination A involves devoting the plant entirely to ski production; combination C means shifting all of the plant’s resources to snowboard production; combination B involves the production of both goods. These values are plotted in a production possibilities curve for Plant 1. The curve is a downward-sloping straight line, indicating that there is a linear, negative relationship between the production of the two goods.

Neither skis nor snowboards is an independent or a dependent variable in the production possibilities model; we can assign either one to the vertical or to the horizontal axis. Here, we have placed the number of pairs of skis produced per month on the vertical axis and the number of snowboards produced per month on the horizontal axis.

The negative slope of the production possibilities curve reflects the scarcity of the plant’s capital and labor. Producing more snowboards requires shifting resources out of ski production and thus producing fewer skis. Producing more skis requires shifting resources out of snowboard production and thus producing fewer snowboards.

The slope of Plant 1’s production possibilities curve measures the rate at which Alpine Sports must give up ski production to produce additional snowboards. Because the production possibilities curve for Plant 1 is linear, we can compute the slope between any two points on the curve and get the same result. Between points A and B, for example, the slope equals −2 pairs of skis/snowboard (equals −100 pairs of skis/50 snowboards). (Many students are helped when told to read this result as “−2 pairs of skis per snowboard.”) We get the same value between points B and C, and between points A and C.

Applications of the Production Possibilities Model

The production possibilities curve gives us a model of an economy. The model provides powerful insights about the real world, insights that help us to answer some important questions: How does trade between two countries affect the quantities of goods available to people? What determines the rate at which production will increase over time? What is the role of economic freedom in the economy? In this section we explore applications of the model to questions of international trade, economic growth, and the choice of an economic system.

Comparative Advantage and International Trade

One of the most important implications of the concepts of comparative advantage and the production possibilities curve relates to international trade. We can think of different nations as being equivalent to Christie Ryder’s plants. Each will have a comparative advantage in certain activities, and efficient world production requires that each nation specialize in those activities in which it has a comparative advantage. A failure to allocate resources in this way means that world production falls inside the production possibilities curve; more of each good could be produced by relying on comparative advantage.

If nations specialize, then they must rely on each other. They will sell the goods in which they specialize and purchase other goods from other nations. Suppose, for example, that the world consists of two continents that can each produce two goods: South America and Europe can produce food and computers. Suppose they can produce the two goods according to the tables in Panels (a) and (b) of Figure 2.12 “Production Possibilities Curves and Trade”. We have simplified this example by assuming that each continent has a linear production possibilities curve; the curves are plotted below the tables in Panels (a) and (b). Each continent has a separate production possibilities curve; the two have been combined to illustrate a world production possibilities curve in Panel (c) of the exhibit.

Suppose the world consists of two continents: South America and Europe. They can each produce two goods: food and computers. In this example, we assume that each continent has a linear production possibilities curve, as shown in Panels (a) and (b). South America has a comparative advantage in food production and Europe has a comparative advantage in computer production. With free trade, the world can operate on the bowed-out curve GHI, shown in Panel (c). If the continents refuse to trade, the world will operate inside its production possibilities curve. If, for example, each continent were to produce at the midpoint of its production possibilities curve, the world would produce 300 computers and 300 units of food per period at point Q. If each continent were to specialize in the good in which it has a comparative advantage, world production could move to a point such as H, with more of both goods produced.

The world production possibilities curve assumes that resources are allocated between computer and food production based on comparative advantage. Notice that, even with only two economies and the assumption of linear production possibilities curves for each, the combined curve still has a bowed-out shape. At point H, for example, South America specializes in food, while Europe produces only computers. World production equals 400 units of each good. In this situation, we would expect South America to export food to Europe while Europe exports computers to South America.

But suppose the regions refuse to trade; each insists on producing its own food and computers. Suppose further that each chooses to produce at the midpoint of its own production possibilities curve. South America produces 100 units of computers and 200 units of food per period, while Europe produces 200 units of computers and 100 units of food per period. World production thus totals 300 units of each good per period; the world operates at point Q in Figure 2.12 “Production Possibilities Curves and Trade”. If the two continents were willing to move from isolation to trade, the world could achieve an increase in the production of both goods. Producing at point H requires no more resources, no more effort than production at Q. It does, however, require that the world’s resources be allocated on the basis of comparative advantage.

The implications of our model for trade are powerful indeed. First, we see that trade allows the production of more of all goods and services. Restrictions on trade thus reduce production of goods and services. Second, we see a lesson often missed in discussions of trade: a nation’s trade policy has nothing to do with its level of employment of its factors of production. In our example, when South America and Europe do not engage in trade and produce at the midpoints of each of their respective production possibilities curves, they each have full employment. With trade, the two nations still operate on their respective production possibilities curves: they each have full employment. Trade certainly redistributes employment in the two continents. In South America, employment shifts from computer production to food production. In Europe, it shifts from food production to computer production. Once the shift is made, though, there is no effect on employment in either continent.

Of course, this idealized example would have all of South America’s computer experts becoming farmers while all of Europe’s farmers become computer geeks! That is a bit much to swallow, but it is merely the result of assuming linear production possibilities curves and complete specialization. In the real world, production possibilities curves are concave, and the reallocation of resources required by trade is not nearly as dramatic. Still, free trade can require shifts in resources from one activity to another. These shifts produce enormous benefits, but they do not come without costs.

Nearly all economists agree that largely unrestricted trade between countries is desirable; restrictions on trade generally force the world to operate inside its production possibilities curve. In some cases restrictions on trade could be desirable, but in the main, free trade promotes greater production of goods and services for the world’s people. The role of international trade is explored in greater detail in subsequent chapters of this book.

Economic Growth

An increase in the physical quantity or in the quality of factors of production available to an economy or a technological gain will allow the economy to produce more goods and services; it will shift the economy’s production possibilities curve outward. The process through which an economy achieves an outward shift in its production possibilities curve is called economic growth. An outward shift in a production possibilities curve is illustrated in Figure 2.13 “Economic Growth and the Production Possibilities Curve”. In Panel (a), a point such as N is not attainable; it lies outside the production possibilities curve. Growth shifts the curve outward, as in Panel (b), making previously unattainable levels of production possible.

An economy capable of producing two goods, A and B, is initially operating at point M on production possibilities curve OMR in Panel (a). Given this production possibilities curve, the economy could not produce a combination such as shown by point N, which lies outside the curve. An increase in the factors of production available to the economy would shift the curve outward to SNT, allowing the choice of a point such as N, at which more of both goods will be produced.

The Sources of Economic Growth

Economic growth implies an outward shift in an economy’s production possibilities curve. Recall that when we draw such a curve, we assume that the quantity and quality of the economy’s factors of production and its technology are unchanged. Changing these will shift the curve. Anything that increases the quantity or quality of the factors of production available to the economy or that improves the technology available to the economy contributes to economic growth.

Consider, for example, the dramatic gains in human capital that have occurred in the United States since the beginning of the past century. In 1900, about 3.5% of U.S. workers had completed a high school education. By 2006, that percentage rose almost to 92. Fewer than 1% of the workers in 1900 had graduated from college; as late as 1940 only 3.5% had graduated from college. By 2006, nearly 32% had graduated from college. In addition to being better educated, today’s workers have received more and better training on the job. They bring far more economically useful knowledge and skills to their work than did workers a century ago.

Moreover, the technological changes that have occurred within the past 100 years have greatly reduced the time and effort required to produce most goods and services. Automated production has become commonplace. Innovations in transportation (automobiles, trucks, and airplanes) have made the movement of goods and people cheaper and faster. A dizzying array of new materials is available for manufacturing. And the development of modern information technology—including computers, software, and communications equipment—that seemed to proceed at breathtaking pace especially during the final years of the last century and continuing to the present has transformed the way we live and work.Look again at the technological changes of the last few years described in the Case in Point on advances in technology. Those examples of technological progress through applications of computer technology—from new ways of mapping oil deposits to new methods of milking cows—helped propel the United States and other economies to dramatic gains in the ability to produce goods and services. They have helped shift the countries’ production possibilities curve outward. They have helped fuel economic growth.

Table 2.1 “Sources of U.S. Economic Growth, 1948–2002” summarizes the factors that have contributed to U.S. economic growth in the past half century. When looking at the period of 1948–2002 as a whole we see that about 60% of economic growth stems from increases in the quantities of capital and labor and 40% from increases in the qualities of the factors of production and improvements in technology. In the most recent period, 1995–2002, however, these percentages are essentially reversed, with a little less than 30% explained by increases in quantities of the factors of production and a whopping 70% explained by improvements in factor quality and technology.

Table 2.1 Sources of U.S. Economic Growth, 1948–2002

Year Percentage contribution to growth Period growth rate

Years 1948–2002 3.46%

Increase in quantity of labor 21%

Increase in quantity of capital 41%

Increase in quality of labor 10%

Increase in quality of capital 20%

Improved technology 25%

Years 1948–1973 3.99%

Increase in quantity of labor 15%

Increase in quantity of capital 44%

Increase in quality of labor 11%

Increase in quality of capital 5%

Improved technology 25%

Years 1973–1989 2.97%

Increase in quantity of labor 31%

Increase in quantity of capital 39%

Increase in quality of labor 7%

Increase in quality of capital 12%

Improved technology 10%

Years 1989–1995 2.43%

Increase in quantity of labor 26%

Increase in quantity of capital 33%

Increase in quality of labor 15%

Increase in quality of capital 17%

Improved technology 11%

Years 1995–2002 3.59%

Increase in quantity of labor 19%

Increase in quantity of capital 8%

Increase in quality of labor 5%

Increase in quality of capital 47%

Improved technology 20%

Total output during the period shown increased sixfold. The chart shows the percentage of this increase accounted for by increases in the quantity of labor and of capital and by increases in the quality of labor and of capital and improvements in technology. In the 1995–2002 period, the incorporation of information technology led to improvements in the quality of capital and technology that greatly contributed to growth.

Source: Based on Dale W. Jorgenson, “Accounting for Growth in the Information Age,” Handbook of Economic Growth, Phillipe Aghion and Steven Durlauf, eds. Amsterdam: North Holland, 2005.

Another way of looking at these data for the most recent period is to notice that the increase in the rate of economic growth between the 1989 to 1995 period and the 1995 to 2002 period of more than one percentage point per year is largely explained by better-quality capital and better technology. The study by economist Dale Jorgenson on which the data shown in Table 2.1 “Sources of U.S. Economic Growth, 1948–2002” are derived notes that these two main contributors to higher economic growth can be largely attributed to the development of information technology and its incorporation in the workplace.

Waiting for Growth

One key to growth is, in effect, the willingness to wait, to postpone current consumption in order to enhance future productive capability. When Stone Age people fashioned the first tools, they were spending time building capital rather than engaging in consumption. They delayed current consumption to enhance their future consumption; the tools they made would make them more productive in the future.

Resources society could have used to produce consumer goods are being used to produce new capital goods and new knowledge for production instead—all to enhance future production. An even more important source of growth in many nations has been increased human capital. Increases in human capital often require the postponement of consumption. If you are a college student, you are engaged in precisely this effort. You are devoting time to study that could have been spent working, earning income, and thus engaging in a higher level of consumption. If you are like most students, you are making this choice to postpone consumption because you expect it will allow you to earn more income, and thus enjoy greater consumption, in the future.

Think of an economy as being able to produce two goods, capital and consumer goods (those destined for immediate use by consumers). By focusing on the production of consumer goods, the people in the economy will be able to enjoy a higher standard of living today. If they reduce their consumption—and their standard of living—today to enhance their ability to produce goods and services in the future, they will be able to shift their production possibilities curve outward. That may allow them to produce even more consumer goods. A decision for greater growth typically involves the sacrifice of present consumption.

Arenas for Choice: A Comparison of Economic Systems

Under what circumstances will a nation achieve efficiency in the use of its factors of production? The discussion above suggested that Christie Ryder would have an incentive to allocate her plants efficiently because by doing so she could achieve greater output of skis and snowboards than would be possible from inefficient production. But why would she want to produce more of these two goods—or of any goods? Why would decision makers throughout the economy want to achieve such efficiency?

Economists assume that privately owned firms seek to maximize their profits. The drive to maximize profits will lead firms such as Alpine Sports to allocate resources efficiently to gain as much production as possible from their factors of production. But whether firms will seek to maximize profits depends on the nature of the economic system within which they operate.

Classifying Economic Systems

Each of the world’s economies can be viewed as operating somewhere on a spectrum between market capitalism and command socialism. In a market capitalist economy, resources are generally owned by private individuals who have the power to make decisions about their use. A market capitalist system is often referred to as a free enterprise economic system. In a command socialist economy, the government is the primary owner of capital and natural resources and has broad power to allocate the use of factors of production. Between these two categories lie mixed economies that combine elements of market capitalist and of command socialist economic systems.

No economy represents a pure case of either market capitalism or command socialism. To determine where an economy lies between these two types of systems, we evaluate the extent of government ownership of capital and natural resources and the degree to which government is involved in decisions about the use of factors of production.

Figure 2.14 “Economic Systems” suggests the spectrum of economic systems. Market capitalist economies lie toward the left end of this spectrum; command socialist economies appear toward the right. Mixed economies lie in between. The market capitalist end of the spectrum includes countries such as the United States, the United Kingdom, and Chile. Hong Kong, though now part of China, has a long history as a market capitalist economy and is generally regarded as operating at the market capitalist end of the spectrum. Countries at the command socialist end of the spectrum include North Korea and Cuba.

Some European economies, such as France, Germany, and Sweden, have a sufficiently high degree of regulation that we consider them as operating more toward the center of the spectrum. Russia and China, which long operated at the command socialist end of the spectrum, can now be considered mixed economies. Most economies in Latin America once operated toward the right end of the spectrum. While their governments did not exercise the extensive ownership of capital and natural resources that are one characteristic of command socialist systems, their governments did impose extensive regulations. Many of these nations are in the process of carrying out economic reforms that will move them further in the direction of market capitalism.

The global shift toward market capitalist economic systems that occurred in the 1980s and 1990s was in large part the result of three important features of such economies. First, the emphasis on individual ownership and decision-making power has generally yielded greater individual freedom than has been available under command socialist or some more heavily regulated mixed economic systems that lie toward the command socialist end of the spectrum. People seeking political, religious, and economic freedom have thus gravitated toward market capitalism. Second, market economies are more likely than other systems to allocate resources on the basis of comparative advantage. They thus tend to generate higher levels of production and income than do other economic systems. Third, market capitalist-type systems appear to be the most conducive to entrepreneurial activity.

Suppose Christie Ryder had the same three plants we considered earlier in this chapter but was operating in a mixed economic system with extensive government regulation. In such a system, she might be prohibited from transferring resources from one use to another to achieve the gains possible from comparative advantage. If she were operating under a command socialist system, she would not be the owner of the plants and thus would be unlikely to profit from their efficient use. If that were the case, there is no reason to believe she would make any effort to assure the efficient use of the three plants. Generally speaking, it is economies toward the market capitalist end of the spectrum that offer the greatest inducement to allocate resources on the basis of comparative advantage. They tend to be more productive and to deliver higher material standards of living than do economies that operate at or near the command socialist end of the spectrum.

Market capitalist economies rely on economic freedom. Indeed, one way we can assess the degree to which a country can be considered market capitalist is by the degree of economic freedom it permits. Several organizations have attempted to compare economic freedom in various countries. One of the most extensive comparisons is a joint annual effort by the Heritage Foundation and The Wall Street Journal. The 2008 rating was based on policies in effect in 162 nations early that year. The report ranks these nations on the basis of such things as the degree of regulation of firms, tax levels, and restrictions on international trade. Hong Kong ranked as the freest economy in the world. North Korea received the dubious distinction of being the least free.

It seems reasonable to expect that the greater the degree of economic freedom a country permits, the greater the amount of income per person it will generate. This proposition is illustrated in Figure 2.15 “Economic Freedom and Income”. The group of countries categorized as “free” generated the highest incomes in the Heritage Foundation/Wall Street Journal study; those rated as “repressed” had the lowest. The study also found that countries that over the last decade have done the most to improve their positions in the economic freedom rankings have also had the highest rates of growth. We must be wary of slipping into the fallacy of false cause by concluding from this evidence that economic freedom generates higher incomes. It could be that higher incomes lead nations to opt for greater economic freedom. But in this case, it seems reasonable to conclude that, in general, economic freedom does lead to higher incomes.

Government in a Market Economy

The production possibilities model provides a menu of choices among alternative combinations of goods and services. Given those choices, which combinations will be produced?

In a market economy, this question is answered in large part through the interaction of individual buyers and sellers. As we have already seen, government plays a role as well. It may seek to encourage greater consumption of some goods and discourage consumption of others. In the United States, for example, taxes imposed on cigarettes discourage smoking, while special treatment of property taxes and mortgage interest in the federal income tax encourages home ownership. Government may try to stop the production and consumption of some goods altogether, as many governments do with drugs such as heroin and cocaine. Government may supplement the private consumption of some goods by producing more of them itself, as many U.S. cities do with golf courses and tennis courts. In other cases, there may be no private market for a good or service at all. In the choice between security and defense versus all other goods and services outlined at the beginning of this chapter, government agencies are virtually the sole providers of security and national defense.

All nations also rely on government to provide defense, enforce laws, and redistribute income. Even market economies rely on government to regulate the activities of private firms, to protect the environment, to provide education, and to produce a wide range of other goods and services. Government’s role may be limited in a market economy, but it remains fundamentally important.

Benefits of Practicing MCQs

Practicing MCQs offers numerous benefits to students. It aids in knowledge retention by reinforcing key concepts and principles. Furthermore, MCQ practice enhances critical thinking skills as students analyze and evaluate various options to identify the correct answer. Moreover, it helps in familiarizing students with the exam format, reducing test anxiety and improving performance.

Strategies for Effective MCQ Practice

To make the most out of MCQ practice, students can employ several strategies:

Understanding the Format: Familiarize yourself with the structure of MCQs, including the types of questions commonly asked.

Time Management: Allocate time wisely during practice sessions to ensure coverage of all topics.

Elimination Technique: Eliminate obviously incorrect options to increase the probability of selecting the correct answer.

Guessing Strategies: Develop educated guesses by analyzing the context of the question and eliminating implausible options.

How to Create MCQ Practice Sets?

Creating customized MCQ practice sets tailored to specific learning objectives can enhance the effectiveness of practice sessions. Utilize textbooks, lecture notes, and online resources to compile questions covering various topics.

Tools and Resources for MCQ Practice

Numerous online platforms offer access to extensive question banks and practice tests across a wide range of subjects. Additionally, educational websites, mobile apps, and flashcards are valuable resources for MCQ practice.

Common Mistakes to Avoid

When practicing MCQs, avoid common pitfalls such as:

Overlooking Key Terms: Pay attention to precise wording in questions and answers.

Skipping Directions: Read instructions carefully to avoid misinterpreting questions.

Neglecting to Review: Take time to review incorrect answers and understand the reasoning behind them.

Incorporating MCQs into Study Routine

Integrate MCQ practice sessions into your study routine to reinforce learning and gauge progress regularly. Schedule dedicated time for practice, focusing on specific topics or chapters as needed.

MCQs Practice for Different Subjects

MCQ practice is beneficial across various subjects, including:

Mathematics: Solve numerical problems and equations to strengthen problem-solving skills.

Science: Test comprehension of scientific principles and theories through application-based questions.

History: Recall historical events, dates, and significance through contextual inquiries.

Literature: Analyze literary works, characters, and themes through interpretive questions.

Advantages of Online MCQ Practice Platforms

Online MCQ practice platforms offer several advantages, including accessibility, interactive features, and instant feedback on performance. These platforms often incorporate gamification elements to enhance engagement and motivation.

Challenges Faced in MCQ Practice

Despite its benefits, MCQ practice may present challenges such as question ambiguity, time constraints, and fatigue. Developing effective strategies and maintaining a positive mindset can help overcome these obstacles.

Tips for Retaining Information from MCQ Practice

To retain information effectively from MCQ practice, engage in active learning techniques such as summarizing key points, teaching concepts to others, and self-testing through flashcards or quizzes.

MCQ practice is a valuable educational tool that enhances understanding, critical thinking skills, and exam preparedness across various subjects. By incorporating effective strategies and utilizing available resources, students can optimize their learning experience and achieve academic success.

Frequently Asked Questions (FAQs)

How often should I practice MCQs?

Aim for regular practice sessions, ideally several times a week, to maintain consistency and maximize learning benefits.

Are MCQs suitable for all subjects?

Yes, MCQs can be effectively used to practice and assess knowledge across a wide range of subjects, from mathematics to literature.

How can I improve my guessing strategy for MCQs?

Focus on eliminating obviously incorrect options and making educated guesses based on contextual clues within the question.

Should I prioritize specific topics during MCQ practice?

Prioritize topics based on individual strengths and weaknesses, allocating more time to areas requiring further review.

Are online MCQ practice platforms reliable?

Choose reputable online platforms with a proven track record of accuracy and quality content to ensure reliable practice experiences.

Common Mistakes to Avoid

When practicing MCQs, avoid common pitfalls such as:

Overlooking Key Terms: Pay attention to precise wording in questions and answers.

Skipping Directions: Read instructions carefully to avoid misinterpreting questions.

Neglecting to Review: Take time to review incorrect answers and understand the reasoning behind them.

Incorporating MCQs into Study Routine

Integrate MCQ practice sessions into your study routine to reinforce learning and gauge progress regularly. Schedule dedicated time for practice, focusing on specific topics or chapters as needed.

MCQs Practice for Different Subjects

MCQ practice is beneficial across various subjects, including:

Mathematics: Solve numerical problems and equations to strengthen problem-solving skills.

Science: Test comprehension of scientific principles and theories through application-based questions.

History.

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