LESSON THREE

RELATIONSHIP BETWEEN SCARCITY, CHOICE AND OPPORTUNITY COST

Due to scarcity of resources, one has to make a choice out of the many alternatives, leaving some needs unsatisfied, hence opportunity cost.

4. THE PRODUCTION POSSIBILITY FRONTIER/ CURVE (PPF/PPC) / TRANSFORMATION CURVE/ OPPORTUNITY COST CURVE

The PPF/C refers to a locus of points showing various combinations of two commodities that can maximumly be produced when all the country’s available resources are fully and efficiently utilized.

ASSUMPTIONS OF THE PPF/C

  • Assumes only two commodities being produced e.g. capital goods and consumer goods.
  • Assumes a closed economy.
  • Assumes full employment of resources.
  • Assumes constant technology.
  • Assumes perfect mobility of factors of production.
  • Producers are assumed to be rational in their production decisions.

ILLUSTRATION OF THE PPF/C

Points along the PPF/C show the maximum amount of both capital goods and consumer goods that can be produced using all the available resources i.e. efficient utilization of resources.

If all resources are devoted to the production of capital goods, the economy/ country will have a maximum of Ko and no consumer goods.

If all resources are devoted to the production of consumer goods, the economy will have a maximum of Co  and no capital goods.

However, both commodities are needed in the society thus the society or producer would decide on how much of each commodity is to be produced. The society can either produce at point A (more capital goods and less consumer goods) or at point C (more consumer goods and less capital goods) or at point B (same amount of capital goods and consumer goods).

Along the PPF/C, society can produce more of one good but only by reducing the amounts produced of the other good. For example moving from point A to C, more consumer goods are produced but the amount produced of capital goods is reduced. A movement from one point to another along the PPF creates opportunity cost.

A point inside the PPF/C (Point D) represents under utilization of resources (excess capacity).

A point outside the PPF/C (point E) is desirable but unattainable because of scarcity of resources.

NOTE

Movement of the PPF/C outwards illustrates economic growth and better utilization of resources.

USE OF THE PPF/C TO EXPLAIN THE BASIC ECONOMIC PRONCIPLES

The PPF/C can be used to explain the concepts of scarcity, choice and opportunity cost.

  • Scarcity

Since resources are scarce, man is forced to produce along the PPF/C. man cannot produce beyond the PPF/C using the available resources and at constant technology.

  • Choice

A choice has to be made concerning how much of each commodity is to be produced. The society can decide to produce only capital goods or only consumer goods or a combination of the two.

  • Opportunity cost

Along the PPF/C, if society chooses to produce at point A rather than point B, then the value of the combination at point B becomes the opportunity cost.

NOTE

For uses of the PPF/C, refer to the uses of the opportunity cost concept.

A SHIFT IN THE PPF/C

The PPF/C can either shift to the left (inwardly) or to the right (outwardly).

ILLUSTRATION

Such a shift is caused by a change in factors that favour/disfavour production of both capital goods and consumer goods.

CAUSES OF THE PPF TO SHIFT OUTWARDS (Part a))

  • Discovery of new natural resources e.g. oil deposits.
  • Improvement in technology.
  • Improvement in entrepreneurship skills.
  • The economy becoming open leading to capital inflow.
  • An increase in the size of the labour force.
  • Improvement in the skills of workers/ increase in the efficiency of workers
  • Increase in the level of capital stock.
  • Political climate becoming favourable
  • Improvement in the existing infrastructures.

CAUSES OF THE PPF TO SHIFT INWARDS (Part b))

  • Depletion/ exhaustion of natural resources
  • Decline in the level of technology.
  • Reduced entrepreneurship ability
  • Increased capital outflow.
  • Decrease in the size of the labour force.
  • Decrease in the skills of workers/decrease in workers efficiency
  • Decrease in the level of capital stock.
  • Political climate becoming unfavourable.
  • Destruction of the existing infrastructures.

NOTE

For factors that cause a shift in the PPF, begin with the word “change” in all your points.

Assignment

Outline any four factors that make the PPF to shift.

ROTATION OF THE PPF

This is caused by a change in factors that favour production of only one commodity. For example if the above mention factors such as technology, natural resource, etc change in favour of capital goods , the PPF will rotate as shown in the diagram below

On the other hand if the factors change in favour of consumer goods, the PPF will rotate as shown in the diagram below.