Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

Production Possibility Curve PPC model is an economic model that considers

the maximum possible production (output) that a country can generate if it uses all of its factors of
production to produce only two goods/services

• Any two goods/services can be used to demonstrate this model

• Many PPC diagrams show capital goods and consumer goods on the axes
o Capital goods are assets that help a firm or nation to produce output (manufacturing).
For example, a robotic arm in a car manufacturing company is a capital good
o Consumer goods are end products and have no future productive use. For example, a
watch

A PPC for an economy demonstrating the use of its resources to produce capital or consumer goods

Diagram Explanation

• The use of PPC to depict the maximum productive potential of an economy

o The curve demonstrates the possible combinations of the maximum output this
economy can produce using all of its resources (factors of production)
o At A, its resources are used to produce only consumer goods (300)
o At B, its resources are used to produce only capital goods (200)
o Points C & D both represent full (efficient) use of an economy's resources as these
points fall on the curve. At C, 150 capital goods and 120 consumer goods are produced

• The use of PPC to depict opportunity cost using marginal analysis

o To produce one more unit of capital goods, this economy must give up production of
some units of consumer goods (limited resources)
o If this economy moves from point C (120, 150) to D (225, 100), the opportunity cost of
producing an additional 105 units of consumer goods is 50 capital goods
o A movement in the PPC occurs when there is any change in the allocation of existing
resources within an economy such as the movement from point C to D

• The use of PPC to depict efficiency, inefficiency, attainable and unattainable production
Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

o Producing at any point on the curve represents productive efficiency

o Any point inside the curve represents inefficiency (point E)
o Using the current level of resources available, attainable production is any point on or
inside the curve and any point outside the curve is unattainable (point F)

Shifts in the PPC

• As opposed to a movement in the PPC described above, the entire PPC of an economy can
shift inwards or outwards

Outward shifts of a PPC show economic growth & inward shifts show economic decline

Diagram Explanation

• Economic growth occurs when there is an increase in the productive potential of an economy
o This is demonstrated by an outward shift of the entire curve. More consumer
goods and more capital goods can now be produced using all of the available
resources
o This shift is caused by an increase in the quality or quantity of the available factors of
production
▪ One example of how the quality of a factor of production can be improved is
through the impact of training and education on labour. An educated
workforce is a more productive workforce and the production possibilities
increase
▪ One example of how the quantity of a factor of production can be increased is
through a change in migration policies. If an economy allows more foreign
workers to work productively in the economy, then the production possibilities
increase

• Economic decline occurs when there is any impact on an economy that reduces the quantity or
quality of the available factors of production
Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

o One example of how this may happen is to consider how the Japanese tsunami of 2011
devastated the production possibilities of Japan for many years. It shifted their PPC
inwards and resulted in economic decline

Uses of PPC Limitations of PPC

1. Resource Allocation: It helps in efficient resource allocation

by showing all possible combinations of goods an economy
can produce, allowing decision-makers to make informed
choices about resource allocation
1. Simplification: PPC assumes a simplified two-good, fixed-
2. Opportunity Cost: It highlights the concept of opportunity
resources model, which doesn't reflect the complexity of real-
cost. The slope of the PPC represents the opportunity cost of
world economies
producing one good in terms of the other, aiding in rational
decision-making 2. Ceteris Paribus: It assumes that all other factors affecting
production remain constant, which rarely happens in reality.
3. Comparative Advantage: It assists in identifying
comparative advantage. An economy should specialize in 3. Assumption of Full Employment: It presupposes that
producing goods where it has a lower opportunity cost, leading resources are fully employed, which is not the case during
to international trade benefits economic downturns or recessions.

4. Economic Growth: It shows the potential for economic 4. Static Model: It doesn't account for changes over time or
growth by illustrating that the curve can shift outward with dynamic shifts in resource availability and technology.
technological advancements or increased resource availability
5. Doesn't Address Distribution: It doesn't address issues of
5. Policy Analysis: Governments and policymakers use PPCs to income distribution or equity, focusing solely on production
analyze the impact of policies on resource allocation, inflation, efficiency.
and production efficiency.
6. Inflation, BOP, Consumption of type of goods, externalities
6. Productive and Allocative efficiencies can be determined or competition nothing is considered in the model.
from the model.

7. Distinction between Potential and Actual growth of an

economy.

Micro-economics Macro-economics

1. Static Efficiencies
2. Scarcity, Choice/ trade off faced
3. Opportunity cost
4. Social preferences that determined
1. Economic growth – Potential and Actual
by the allocatively efficient point on
2. Relative position of the output gaps.
the PPC
3. Tells you about the unemployment in the economy
5. Pareto efficiency
4. Inward shifts indicate Recession
6. Prediction of the future of an
5. Indication of Future Aggregate Supply in the economy
economy for the choices made
today.
Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

The Use of Ceteris Paribus

• Due to the large number of variables that can influence any particular economic interaction in
society, economists create models using the principle of ceteris paribus

o Translated from Latin, ceteris paribus means 'all other variables remain constant'

o It allows economists to simplify and explain causes and effects, even if the explanation is
somewhat limited by the assumptions

o For example, there are many factors that affect the level of unemployment in an economy
(interest rates, consumer confidence, firm’s investment, government policies
etc.). However, using ceteris paribus, economists can simplify the economic model to
analyse just two variables (unemployment and interest rates). The analysis is conducted
ceteris paribus. The analysis is conducted ceteris paribus. All the other variables remain
constant, even when they are highly likely to have changed

Specialisation & the Division of Labour

• Scotsman Adam Smith is often referred to as the 'father of Economics'

• He published 'The Wealth of Nations' in March 1776 and explained many fundamental economic principles
that we still use today

o The premise of the book was to discuss how to increase productivity and wealth

• Based on observations made during a visit to a pin factory, he developed the ideas of specialisation and
the division of labour

o He noted that a single worker could not make more than 20 pins a day as it involved around 18
different processes, such as cutting the wire, sharpening the end, stamping the head etc.

o However, if the labour was divided up into different tasks and workers specialised in just that
one task, Adam Smith estimated that just 10 workers could produce 48,000 pins per day

• The division of labour is when a task is broken up into several component tasks

• This allows workers to specialise by focusing on one (or a few) of the components that make up the
production process and thereby gain significant skill in doing it

o This results in higher output per worker and so increases productivity

• Specialisation occurs on several different levels

o On an individual level

o On a business level. For example, one firm may only specialise in manufacturing drill bits for
concrete work

o On a regional level. For example, Silicon Valley has specialised in the tech industry

o On a global level as countries seek to trade. For example, Bangladesh specialises in textiles and
exports them to the world
Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

Pros & Cons of the Division of Labour & Specialisation in Production

Pros Cons

Task repetition often leads to boredom and a decrease in

Higher labour productivity lowers cost/unit for firms worker motivation

A decrease in motivation may lead to less

Lower costs can be passed on to consumers in the form productivity and/or poorer manufacturing quality
of lower prices
It may increase worker turnover rates as workers look to
Lower costs can mean higher profits for the firms. This may move on to a role that is more stimulating
lead to higher wages for workers

Increased productivity allows some firms to sell beyond their Mass produced products often lack variety and do not take
local market into international markets different consumer preferences into account

It creates many low skilled jobs If workers lose their jobs, then it may be hard for them to
find work as they are only trained in one skill

Pros & Cons of the Division of Labour & Specialisation in Trade

Pros Cons

International trade is beneficial for the firms that can

Higher labour productivity lowers cost / unit for firms, which compete globally. However, some industries will be unable
makes their goods more competitive internationally to compete and will go out of business
(exports)
Many firms in an entire industry may close leading
Increased exports can result in economic growth for the to structural unemployment
nation
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Specialisation may create over-dependency on other

Economic growth usually leads to higher income and a better countries' resources. This may cause problems if conflict
standard of living arises (For example, Europe's reliance on Russian natural gas
during the Ukraine crisis)

Income gained from exports can be used to purchase other Specialisation using a country's own resources will lead to
goods from around the world (imports). This increases resource depletion over time. Specialisation will increase the
the variety of goods available in a country rate of resource depletion

The Functions of Money

• As individuals and firms trade with each other in order to acquire goods or raw materials, they require a
means of exchange that is acceptable and easy to use

• Modern currency fulfils this purpose and money functions as a medium of exchange, a measure of value,
a store of value, and a method of deferred payment

The Four Functions of Money

A Method of Deferred
A Medium of Exchange A Measure of Value A Store of Value
Payment

• Without money, it • Money provides a • Money holds its • Money is an

becomes necessary means of ascribing value over time (of acceptable way
for buyers and sellers value to different course inflation means to arrange terms of
to barter (exchange goods and services that is not always true!) credit (loans) and to
goods) settle any future
• Knowing the price of • This means that
debts
• Bartering is a good in terms of money can be saved
problematic as it money allows both • This allows producers
requires two people consumers and
• It remains valuable in
and consumers to
exchange over long
to want each other's producers to make acquire goods in
periods of time
good (double co- decisions in their the present and pay
incidence of wants) best interests for them in
the future
• Money easily • Without this
facilitates measure it is difficult
the exchange of for buyers and
goods as no double sellers to arrange
co-incidence of an agreeable
wants is necessary exchange

Characteristics of money:
1. Medium of Exchange: Money facilitates the exchange of goods and services by acting as a widely accepted
intermediary. Instead of bartering, people use money to buy and sell goods and services, making
transactions more efficient.
Revision Notes PPC/Division of Labor Nabeel Ismail Economics - 03008578998

2. Unit of Account: Money provides a common measure of value that allows people to compare the prices of
different goods and services. It serves as a unit of measurement, enabling individuals and businesses to set
prices and keep track of financial transactions.

3. Store of Value: Money retains its value over time, allowing individuals to save and store wealth. It should be
durable and not easily perishable, ensuring that people can hold onto it for future use. This characteristic
helps preserve the purchasing power of money.

4. Standard of Deferred Payment: Money enables contracts and financial agreements to specify future
payments. Individuals and businesses can agree to make payments in the future using money as a standard
of value, providing stability and predictability in financial transactions.

5. Portability: Money should be easy to carry and transfer from one person to another. Physical money, like
coins and banknotes, should be convenient to transport. In the modern era, digital and electronic forms of
money, such as bank deposits and cryptocurrencies, also offer high portability.

6. Divisibility: Money should be divisible into smaller units to accommodate transactions of varying sizes. For
example, a single currency unit can be divided into smaller denominations, making it suitable for both large
and small purchases.

7. Uniformity: Money should be relatively uniform in terms of quality and appearance. People should be able
to easily recognize genuine money and distinguish it from counterfeits. Central authorities often regulate the
production and design of money to maintain uniformity.

8. Acceptability: Money is widely accepted as a means of payment in transactions. People have confidence
that others will accept it in exchange for goods and services. Acceptability is often reinforced by legal tender
laws, which mandate that certain forms of money must be accepted for all debts.

9. Durability: Physical forms of money, such as coins and banknotes, need to be durable enough to withstand
normal wear and tear. This ensures that money remains in circulation for an extended period without
deteriorating in quality.

10. Fungibility: Each unit of money should be interchangeable with another unit of the same denomination. In
other words, one unit of money should be identical in value and characteristics to any other unit of the same
denomination, promoting ease of use and trade.

11. Difficult to Forge.

Marginal decisions in economics

What is the importance of the margin when making choices?

Marginal in economics means having a little more or a little less of something. It refers to the effects of consuming
and/or producing one extra unit of a good or service

Marginal benefit – is the change in total private benefit from one extra unit

Marginal cost – is the change in total private cost from one extra unit

Rational consumers and producers are assumed to calculate the marginal cost and benefit of each decision. We are
never making decisions in a vacuum; rather all decisions are made at the margin. This means that they represent
relative trade-offs based on who we are, what we need and what we prefer