1.4 How Do We Make Choices?
Learning Objectives
By the end of this section, you will be able to:
- Interpret production possibilities frontier graphs
- Explain the relationship between a production possibilities frontier and opportunity costs
Just as individuals cannot have everything they want and must instead make choices, society as a whole cannot have everything it might want, either. This section will explain the constraints society faces, using a model called the production possibilities frontier (PPF). There are more similarities than differences between individual choice and social choice. As you read this section, focus on the similarities.
Because society has limited resources (e.g., labor, land, capital, raw materials) at any point in time, there is a limit to the quantities of goods and services it can produce. Suppose a society desires two products, healthcare and education. The production possibilities frontier in Figure 1.7 illustrates this situation.
Figure 1.7 shows healthcare on the vertical axis and education on the horizontal axis. If the society were to allocate all of its resources to healthcare, it could produce at point (A). However, it would not have any resources to produce education. If it were to allocate all of its resources to education, it could produce at point (F). Alternatively, the society could choose to produce any combination of healthcare and education on the production possibilities frontier.
The PPF and the Law of Increasing Opportunity Cost
Why is the PPF curved outward? To understand why the PPF is curved, start by considering point (A) at the top left-hand side of the PPF. At point (A), all available resources are devoted to healthcare and none are left for education. People are having cosmetic surgery on every part of their bodies, but no high school or college education exists. Now imagine that some of these resources are diverted from healthcare to education, so that the economy is at point (B) instead of point (A). Diverting some resources away from A to B causes relatively little reduction in health because the last few marginal dollars going into healthcare services are not producing much additional gain in health. However, putting those marginal dollars into education, which is completely without resources at point (A), can produce relatively large gains. For this reason, the shape of the PPF from A to B is relatively flat, representing a relatively small drop-off in health and a relatively large gain in education.
Now consider the other end, at the lower right, of the production possibilities frontier. Imagine that society starts at choice (D), which devotes nearly all resources to education and very few to healthcare, and moves to point (F), which devotes all spending to education and none to healthcare. For the sake of concreteness, you can imagine that in the movement from D to F, the last few doctors must become high school science teachers, the last few nurses must become school librarians