PPC and Economic Models

Economists use models to understand and explain real-world

situations.
● A model is a simplified representation of something in the real
world, only representing the important aspects being
investigated while ignoring unnecessary details
Assessment
Objectives:

AO1: Knowledge and

Understanding

AO2: Application and

Analysis

AO3: Synthesis and

Evaluation

AO4: Use and

Application of
Appropriate Skills
Assessment
Objectives:

AO1: Knowledge and

Understanding

AO2: Application and

Analysis

AO3: Synthesis and

Evaluation

AO4: Use and

Application of
Appropriate Skills
Production Possibilities Curve (PPC)
● Also called Production Possibilities Frontier
● Used to model the concepts of scarcity, choice,
opportunity cost, and efficiency.
● PPC - represents the maximum amounts of two
goods that can be produced by an economy in a
given time period, if all the resources are being used
efficiently and the state of technology is fixed.
● We assume that:
○ The economy only produces two goods
○ Resources and state of technology are fixed
○ All resources in the economy are fully employed (and used
efficiently - best way possible to avoid waste)
● Based on what we know so far, what do you think the
points in the diagram represent?
Production Possibilities Curve (PPC)
● Given that resources (factors of production) are
scarce, the country can only produce a limited
amount of the two goods.
● The PPC shows the maximum amount that can be
produced if all resources are used efficiently - the
potential output of the economy.
● Every point on the curve (A - G) are the various
potential combinations that can be produced.
● Any point inside the curve (H) means that not all
resources are being used.
● Any point outside the curve (I) is an impossible
combination given the resources available.
PPC and Scarcity, Choice, and Opportunity Cost
● Because of scarcity, the economy cannot
produce outside of the PPC
● Because of scarcity, the economy must make a
choice about what particular combination of
goods to produce
● Because of scarcity, choices involve opportunity
costs.
● Examine these three points using the diagram
● If an economy is using all of its resources to the
fullest extent possible and operating on the PPC,
there is productive efficiency
Energy or Welfare PPC Activity
The Shape of the PPC
● Why do you think the PPC is curved?
○ Not all factors of production are equally suitable for the two
products
○ Because of this, as you shift your factors of production from
one product to the other, the opportunity cost increases (you
give up more of one product for the other) - think butter and
guns
● The PPC is straight if opportunity cost is constant
○ If factors of production are equally well suited for the
production of both goods
○ Think basketballs and volleyballs which are very similar
Explaining Economic Growth Using PPC
● Economic growth - refers to increases in the quantity of output produced in an
economy over a period of time
● If an economy is not using all of its factors of production or not using them
efficiently, using more factors of production or using them efficiently can lead
to economic growth
● Since the PPC represents the potential output in an economy given a certain
level of resources and technology, if we are at a point on the curve itself,
something would have to cause the curve to shift outward for there to be
economic growth
Explaining Economic Growth Using PPC
● Factors that cause outward shifts of PPC, or growth in production
possibilities:
○ Increases in the quantity of factors of production (resources) in the economy
○ Increases in the quality of factors of production (ex. More educated workforce)
○ Improvements in technology
Production
Possibilities
Curve (PPC)
Additional Practice
The Circular Flow of Income Model
● We will come back to this when we study macroeconomics,
so this is a brief introduction to it
● Circular flow of income model - a simple model that helps
us understand the relationships within the overall economy
● The simplest version is a closed model; no links to other
countries, no government, no financial institutions
● Assumptions of the model:
○ Only decision-makers are households and firms
○ Households own all factors of production and buy all goods and
services
○ Firms hire factors of production from households to produce goods and
services
The Circular Flow of Income Model
● In the closed model it is assumed that all household earnings are spent on
goods and services
● This is of course different from reality
● Consumers do not spend all of their income on domestically produced output.
There are leakages (income that leaves the economy):
○ Taxes
○ Saving
○ Imports
● There are also injections into the circular flow:
○ Government spending
○ Investment
○ Exports
Leakages
● Taxes: a portion of income is paid to the government in the form of taxes and
therefore is not spent on goods and services by consumers
● Saving: people save a portion of their income in financial institutions or
markets (savings accounts in banks, purchase of stocks and bonds, and
pensions) to spend later
● Imports: consumers also may choose to purchase foreign goods which
means the money is sent abroad to foreign producers
Injections
● Government spending: governments at all levels spend money on a variety of
things (education, healthcare, roads, salaries of gov. Workers, etc.). This is
money they have received from taxes that is injected back into the circular
flow.
○ Transfer payments, however, are not injections
● Investment: Financial institutions lend money to firms which then use it to
expand their businesses and buy capital goods (capital goods are also known
as investment goods)
● Exports: Just as domestic consumers purchase foreign goods, foreign
consumers may choose to purchase goods that are then sent abroad,
injecting money into the economy (money coming from abroad)
Leakages and Injections
● Leakages and injections both happen, but they may not be equal to each other
● If there are more leakages than injections, the size of the circular flow will get
smaller
○ Perhaps saving is larger than investment which means fewer goods and services are
purchased, businesses cut back output, people become unemployed, household income
decreases
● If there are more injections than leakages, the size of the circular flow will get
bigger
○ Perhaps revenue from exports is greater than spending on imports so more goods are
demanded by foreign consumers, businesses increase output, hire more workers, and
household income increases
● Again, leakages and injections do not have to be equal
Positive and Normative Economics
● Positive Economics: tries to describe, explain, and predict economic events
based on hypotheses, theories, and models.
○ The unemployment rate is 5%.
○ A higher price in apples results in fewer apples purchased.
○ Unemployment will increase next year.
○ *Notice all of these can be true or false statements/fact checked.*
● Normative Economics: deals with how things in the economy should or ought
to be based on value judgements about what should happen, what is good or
bad, and what is right or wrong.
○ The unemployment rate should be lower.
○ Health care should be provided free of charge to everyone.
○ The government should spend more money on schools.
○ *Notice these are not true or false but are value judgements.*
The Role of Positive Economics
● The ceteris paribus assumption: “other things equal” or “all else equal”
● The use of logic
● The use of hypothesis
● Theory - a general explanation of a set of interrelated events, usually based on
several hypotheses that were tested successfully. It’s a generalization about
the real world to explain why complex events happen.
● The use of empirical evidence
● The use of laws - laws have universal validity, are valid in all times and places
● The use of models
● Refutation is important
The Role of Normative Economics
● Value judgements in policy making
○ Governments take action to try to solve problems
○ These are based on value judgements
○ Based on opinions of individuals or groups of people
○ Governments may choose to reduce unemployment, provide healthcare free of charge, provide
higher education, build a new airport, etc.
● Equity and equality
○ Equal means that everyone has the same amount of something
○ Equitable means fair
○ The two have different meanings, but often equitable is taken to mean equal while inequity is
interpreted to mean inequality
Works Cited
Economics Course Companion, by Jocelyn Blink and Ian Dorton, Oxford
University Press, 2020, pp. 3–25.

Economics for the IB Diploma, by Ellie Tragakes, Third ed., Cambridge University
Press, 2020, pp. 2–39.