Conversely, the U. Clearly, Brazil has a lower opportunity cost of producing sugar cane in terms of wheat than the U.
The reverse is also true; the U. This can be illustrated by the PPFs of the two countries in Figure 3. When a country can produce a good at a lower opportunity cost than another country, we say that this country has a comparative advantage in that good.
In our example, Brazil has a comparative advantage in sugar cane and the U. One can easily see this with a simple observation of the extreme production points in the PPFs of the two countries.
If Brazil devoted all of its resources to producing wheat, it would be producing at point A. If however it had devoted all of its resources to producing sugar cane instead, it would be producing a much larger amount, at point B.
By moving from point A to point B Brazil would give up a relatively small quantity in wheat production to obtain a large production in sugar cane.
The opposite is true for the U. If the U. The slope of the PPF gives the opportunity cost of producing an additional unit of wheat. When countries engage in trade, they specialize in the production of the goods that they have comparative advantage in, and trade part of that production for goods they do not have comparative advantage in.
With trade, goods are produced where the opportunity cost is lowest, so total production increases, benefiting both trading parties. A production possibilities frontier defines the set of choices society faces for the combinations of goods and services it can produce given the resources available.
The shape of the PPF is typically curved outward, rather than straight. Over time, a growing economy will tend to shift the PPF outwards. The law of diminishing returns holds that as increments of additional resources are devoted to producing something, the marginal increase in output will become smaller and smaller. The specific choice along a production possibilities frontier that reflects the mix of goods society prefers is the choice with allocative efficiency.
The curvature of the PPF is likely to differ by country, which results in different countries having comparative advantage in different goods. Total production can increase if countries specialize in the goods they have comparative advantage in and trade some of their production for the remaining goods. Skip to content Chapter 2. Choice in a World of Scarcity. Learning Objectives By the end of this section, you will be able to: Interpret production possibilities frontier graphs Contrast a budget constraint and a production possibilities frontier Explain the relationship between a production possibilities frontier and the law of diminishing returns Contrast productive efficiency and allocative efficiency Define comparative advantage.
Self-Check Questions Return to the example in Figure 2. Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education? Could a nation be producing in a way that is allocatively efficient, but productively inefficient?
Review Questions What is comparative advantage? What does a production possibilities frontier illustrate? Why is a production possibilities frontier typically drawn as a curve, rather than a straight line? Explain why societies cannot make a choice above their production possibilities frontier and should not make a choice below it. What are diminishing marginal returns? What is productive efficiency?
Allocative efficiency? At point A, all available resources i. Say the doctors are practicing medicine and the teachers are helping out as best they can. This situation would be extreme and even ridiculous. People are having cosmetic surgery on every part of their bodies, but no high school or college education exists! Now imagine that some of these resources are diverted from health care to education, so that the economy is at point B instead of point A.
What type of resources are going to move to producing education? The teachers, though, are good at education, and not very good at healthcare. So it makes sense for teachers to be reallocated from healthcare to education. What this means is that from point A to B, the decrease in healthcare is small, while the gain in education is large. Graphically, the rise is small and the run is large so the slope which is the ratio of rise over run is flat. In other words, the opportunity cost of education in terms of healthcare is low.
Figure 1 shown again. If we started at the other end of the PPF at point F and moved to point D, we would be moving doctors from teaching to healthcare with the result that the gain in healthcare would be large while the loss in education would be small the same logic we used above. In short, the slope of the PPF from point F to D would be steep, and the opportunity cost of education in terms of healthcare would be high.
More generally, as society produces more and more of some good or service, the cost of production grows larger and larger relative to the cost of producing other goods or services. 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.
For example, they might pick butter and missiles, or fighter jets and space missions, or fighter jets and satellites, or magazines and books. Illustration of Scarcity: Scarcity is an economic concept that refers to a relatively permanent dearth or insufficiency of resources available to people, in relation to their wants. Economics considers people to be restless consumers, always consciously wanting to add to their possessions, but having a vague awareness that only some wants can be satisfied.
Some needs are universal and absolutely necessary. Food and water, for example, are paramount. Many wants are individual, they are part of what makes an individual unique in society. The key aspect of this behavioural science, as it relates to economics, is that individuals and societies are forced to make economic choices in two ways. One way is to get more out of their limited resources—"stretching the budget," as we say. If the economy is producing less than the quantities indicated by the PPF, this is a sign that resources are not being used to their full potential.
In this case, it is possible to increase the production of some goods without cutting production in other areas. The production possibility frontier demonstrates that there are, or should be, limits on production. Each economy must decide what combination of goods and services should be produced in order to attain maximum resource efficiency. In business analysis, the PPF operates under the assumption that the production of one commodity can only increase if the production of the other commodity decreases, due to limited available resources.
Thus, PPF measures the efficiency with which two commodities can be produced simultaneously. This data is of importance to managers seeking to determine the precise mix of goods that most benefits a company's bottom line. The PPF assumes that technological infrastructure is constant, and underlines the notion that opportunity costs typically arise when an economic organization with limited resources must decide between two products.
However, the PPF curve does not apply to companies that produce three or more products vying for the same resource. The PPF is graphically depicted as an arc, with one commodity represented on the X-axis and the other represented on the Y-axis. Each point on the arc shows the most efficient number of the two commodities that can be produced with available resources.
Economists use PPFs to demonstrate that an efficient nation produces what it is most capable of producing and trades with other nations for the rest.
For example, if a non-profit agency provides a mix of textbooks and computers, the PPF may show that it can produce either 40 textbooks and seven computers, or 70 textbooks and three computers.
The agency's leadership must determine which item is more urgently needed. In this example, the opportunity cost of producing an additional 30 textbooks equals four computers. For another example, consider the chart below.
Imagine a national economy that can produce only two things: wine and cotton. For instance, producing five units of wine and five units of cotton point B is just as desirable as producing three units of wine and seven units of cotton. Point X represents an inefficient use of resources, while point Y represents a goal that the economy simply cannot attain with its present levels of resources.
As we can see, in order for this economy to produce more wine, it must give up some of the resources it is currently using to produce cotton point A. If the economy starts producing more cotton represented by points B and C , it would need to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A.
Moreover, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output. 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.
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