1.3 OPPORTUNITY COST AND PPC

Question 1

What is the definition of opportunity cost?

Answer 1

Opportunity cost is the next best alternative foregone when making an economic decision (for an economist this is the true cost of an economic decision)

Question 2

What are production possibility curves and what are they used to show?

Answer 2

• PPC’s show the maximum output of 2 goods or services that can be produced when fully utilisng current technology
• PPC’s are used to show the concepts of scarcity, productive efficiency and opportunity cost

Question 3

How do you represent opportunity cost using a PPC?

Answer 3

• Opportunity Cost is shown on the PPC as the loss of the opposing good or service when one good or service when one good or service is increased
• This is because there will be a reallocation of resources from one type of good and service to another in order to produce more of the other
• E.g in the diagram the opportunity cost of increasing the amount of capital goods from K1 to K2 will be the difference in consumer goods between C1 and C2

Question 4

Why does the PPC curve generally curve outwards?

Answer 4

• The PPC curves outwards when there is an increasing opportunity cost moving along the PPC because the most efficient workers and resources will be moved off the production of the good last, so the opportunity cost will increase as you move along the curve
• This is because the least efficient workers and technology used to produce those products are removed first
• Theoretically there can be a linear PPC, which means the opportunity cost will be constant

Question 5

How does the PPC show productive, allocative and economic efficiency?

Answer 5

• output point on the PPC line is productively efficient
• For an economy to achieve allocative efficiency the combination of products must maximise social welfare (greatest social benefit over lowest social cost)
• There is one point on the curve which has both productive and allocative efficiency, which is called economic efficiency (when social welfare is the preference of society)

Question 6

How can the PPC curve shift?

Answer 6

• Over time the PPC can shift inwards or outwards depending on the increase or decrease in the productive capacity of the economy over time
• The productive capacity of the economy is dependent on the quality of factors of production, the quantity of factors of production and the productive efficiency of the economy (technology)

Question 7

How can the PPC be used to show actual and potential economic growth

Answer 7

• Shifts from PPC1 to PPC2 show potential economic growth (an increase in the potential productive capacity of the economy)
• Increases in actual output from A to B (points on the graph) show the actual economic growth (short run economic growth) where there is an actual increase in goods and services outputted