AP® Macroeconomics review sheet from Aim for Five (aimforfive.com/macro/units/1/1-2)
Unit 1 · Topic 1.2
1.2 Opportunity Cost and the Production Possibilities Curve (PPC)
The production possibilities curve (PPC) is a graph of every combination of two goods an economy can make when it uses all its resources fully and efficiently. It shows scarcity, trade-offs, opportunity cost, efficiency and economic growth in one picture, and it's the first graph you need to draw and read with confidence.
Key terms
- opportunity cost
- production possibilities curve (PPC)
- efficiency
- increasing opportunity cost
- constant opportunity cost
- economic growth
Reading the graph
Put one good on each axis, for example tractors on the horizontal axis and corn on the vertical axis. The PPC is the curve connecting the most corn you can make for each number of tractors. Every point on it is a different way to split the same resources.
The model assumes a fixed amount of resources, fixed technology and a set time period. Change any of those and the curve moves.
- On the curve: efficient. All resources are used, so you can't make more of one good without making less of the other.
- Inside the curve: inefficient. Some resources are unemployed or wasted, as in a recession. You could get more of both goods.
- Outside the curve: unattainable with current resources and technology.
Opportunity cost on a PPC
Moving along the curve shows the opportunity cost of getting more of one good: how much of the other good you give up. To find the cost per unit, divide what you give up by what you gain.
Opportunity cost per unit of X = units of Y given up ÷ units of X gained.
The opportunity cost of one good is the reciprocal of the other. If 1 tractor costs 5 bushels of corn, then 1 bushel of corn costs 1/5 of a tractor.
The shape tells you the cost pattern
- Straight line (constant opportunity cost): resources are equally good at making either good, so each extra unit costs the same. Example: a worker who can sew 12 shirts or 4 hats a day always gives up 3 shirts per hat.
- Bowed outward, away from the origin (increasing opportunity cost): resources are specialized. As you make more tractors, you have to pull in farmland and farmers who are good at corn and bad at tractors, so each extra tractor costs more corn. This is the most common shape on the exam.
- Bowed inward, toward the origin (decreasing opportunity cost): each extra unit costs less than the one before. It's rare, but you should recognize it.
Shifts: growth and contraction
The whole PPC shifts outward (economic growth) when the economy gets more resources or better technology: more workers, more capital, more education (human capital) or a new invention. It shifts inward when resources are lost, such as from a war, a natural disaster or a shrinking population.
If a change helps only one good, only that end of the curve moves. A new corn seed that doubles yields stretches the curve up along the corn axis, while the point where it meets the tractor axis stays put.
Unemployment does not shift the PPC. Laid-off workers are still part of the economy's resources, so the economy moves to a point inside the curve instead.
Choices today affect the curve tomorrow. An economy that makes more capital goods (machines, factories) and fewer consumer goods now will have more capital later, so its PPC shifts out further in the future.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Opportunity cost from a PPC table
An economy's PPC has these points (tractors, corn in thousands of bushels): A (0, 200), B (10, 190), C (20, 160), D (30, 110), E (40, 0). (a) What is the opportunity cost of moving from C to D? (b) What is the cost per tractor between each pair of points, and what does that tell you about the shape? (c) Classify the points (20, 150) and (30, 130).
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- Step 1: (a) Going from C to D, tractors rise from 20 to 30 and corn falls from 160 to 110. You give up 50 thousand bushels to gain 10 tractors. Per tractor: 50 ÷ 10 = 5 thousand bushels.
- Step 2: (b) A to B: 10 ÷ 10 = 1. B to C: 30 ÷ 10 = 3. C to D: 50 ÷ 10 = 5. D to E: 110 ÷ 10 = 11 thousand bushels per tractor.
- Step 3: The cost per tractor keeps rising, so the PPC has increasing opportunity cost and is bowed outward from the origin.
- Step 4: (c) With 20 tractors the economy could make 160 corn, so (20, 150) is inside the curve: inefficient, with some resources unused. With 30 tractors the most corn possible is 110, so (30, 130) is outside the curve: unattainable right now.
Answer: (a) 50 thousand bushels of corn in total, or 5 thousand bushels per tractor. (b) 1, 3, 5, then 11 thousand bushels per tractor, so opportunity cost is increasing and the curve bows outward. (c) (20, 150) is inefficient; (30, 130) is unattainable.
- Example 2
What shifts the PPC, and what doesn't (classic trap)
For each event, say whether the economy moves along its PPC, moves inside it, or the curve shifts (and which way): (1) a recession lays off 5% of workers, (2) a hurricane destroys many factories, (3) a new robot makes car production much faster, (4) the country switches some workers from cars to food.
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- Step 1: (1) The workers still exist; they just aren't working. The economy moves to a point inside the PPC. The curve doesn't shift.
- Step 2: (2) Factories are capital, and capital was destroyed. The economy has fewer resources, so the PPC shifts inward.
- Step 3: (3) Better technology for cars only: the curve shifts out along the car axis, while the food intercept stays the same.
- Step 4: (4) Reallocating fully employed resources is a movement along the curve, with more food and fewer cars.
Answer: (1) Point inside the PPC, no shift. (2) Inward shift. (3) Outward shift of the car end only. (4) Movement along the PPC.
Common mistakes
- Shifting the PPC inward for a recession or unemployment. Unemployment puts the economy at a point inside the curve; only a loss of resources shifts it in.
- Dividing the wrong way. Opportunity cost of X = what you give up of Y ÷ what you gain of X. Check that the units read "bushels per tractor" when you want the cost of a tractor.
- Shifting the whole curve when a new technology affects only one good. Only that good's intercept moves.
- Saying a point inside the curve is unattainable. It's attainable, just inefficient.
On the exam
- Expect multiple-choice questions that give a PPC table or graph and ask for an opportunity cost, the meaning of a point, or what caused a shift.
- When the exam asks about "full employment," think of points on the PPC. This links straight to the vertical LRAS curve in 3.4.
Connected topics
Videos
Check yourself
5 questions on 1.2 Opportunity Cost and the Production Possibilities Curve (PPC). Pick an answer to see if you got it, and why.
| Point | Robots | Wheat (tons) |
|---|---|---|
| V | 0 | 100 |
| W | 10 | 90 |
| X | 20 | 75 |
| Y | 30 | 50 |
| Z | 40 | 0 |
Hypothetical production possibilities for one country
What is the opportunity cost of increasing robot production from 20 to 30?
Based on the table, the economy's PPC (robots on the horizontal axis, wheat on the vertical axis) is
A combination of 20 robots and 60 tons of wheat would be
A combination of 30 robots and 60 tons of wheat would be
What is the opportunity cost of each of the last 10 robots produced (moving from point Y to point Z)?
0 of 5 answered