Production Possibilities: Definition, Model & Shifts

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  • 0:01 Opportunity Costs of…
  • 1:57 Graphing Costs
  • 4:08 Moving the Curve
  • 5:06 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Economists talk a lot about opportunity costs, but sometimes it's most helpful just to visualize it all. The production possibility curve allows us to do just that, and this lesson explains how.

Opportunity Costs of Production

At its core, economics is the study of scarcity. For all of economics to work, we have to recognize that nothing exists in infinite supply. We worry about water and air pollution because those resources can't be replicated. True, water and air exist in greater quantity than Babe Ruth rookie cards or designer handbags, but all resources have a limit.

We calculate the cost of something with respect to the inputs, whether time, money, or effort, that has gone in to producing it. However, that's not the only cost. Those same inputs could have been spent doing something else. Therefore, economists give the name opportunity costs to define what a person or company gives up to do another activity.

Right now, you're studying economics, but you could be mindlessly wandering social media. The hour or so you'll spend studying economics today has an opportunity cost of an hour of social media, or an hour with friends, or an hour of studying French. While individuals often manage opportunity costs in terms of time, we can also look at opportunity costs in terms of money. A college education costs tens of thousands of dollars, which you could use instead to buy a brand-new luxury car. Your education has an opportunity cost of a shiny new luxury car.

However, when we are talking about whole economies, the opportunity cost can still be discussed. Instead of measuring in terms of our time or money, we can look at the cost across all resources. In this lesson, we're going to do that while looking at two classic macroeconomic goods: guns and butter. Don't get too caught up on guns and butter as individual goods - they are really just metaphors dating back to a World War II mentality of producing defense goods or producing consumer goods.

Graphing Costs

Pretend that you are trying to measure the economic ability of a country to manufacture guns with respect to its ability to manufacture butter. If it takes as much input to produce one unit of guns as it does to make one unit of butter, chances are your graph would look like this:

Production possibilities chart
production possibilities graph

Now, there are a lot of points on this chart, so let's explain them. Let's start with those on the line. By the way, this line, and indeed the whole graph, is called a production possibilities chart because it shows all the possibilities of combinations of production between two goods.

Let's start with point D. Here, the same amount of guns and butter are produced. At point B, more guns are produced, while at point C, more butter is produced. The curve that these points sit on represents the economy at full efficiency. Note, however, that it is not a straight line. This is because goods can rarely substitute inputs perfectly. At some point, you can shift people to working in gun factories and more money to pay them, but you can't turn milk into guns. Likewise, you can send more people to focus on dairy farming, but steel doesn't make for tasty butter.

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