Question

The following graph shows the production possibilities frontier (PPF) of an economy that produces clothing and steel. The black points symbols) represent three possible output levels in a given month. You can click on the points to see their exact coordinates Graph 1 32 28 24 PF 16 100 200 300 400 500 600 700 800 STEEL (Millions of tons)

Answer 1

Solution:

We are given PPF of an economy producing clothing (on vertical axis, in thousands of garments) and steel (on horizontal axis, in millions of tons). Accordingly, we are given 3 points on the PPF:

Point A: (500, 12)

Point B: (420, 16)

Point C: (300, 20)

Opportunity cost is defined as the quantity of one good given up in order to produce more of another good. In this respect, it is easy to see that an opportunity cost of producing a good is measured in terms of another good. Hence,

As the economy increases the production of clothing from 12,000 garments to 16,000 garments, it's production of steel decreases from 500 million of tons to 420 million of tons (movement from point A to point B). Thus, in order to increase the production of clothing by (16000 - 12000 =) 4,000 garments, it has to decrease steel production by (500 - 420=) 80 million of tons. Thus, in this case opportunity cost is 80 million tons of steel.

Now, as economy further increases it's clothing production by 4,000 garments (from 16,000 to 20,000), it has to decrease it's steel production by (420 - 300 =) 120 million of tons (movement from point B to point C). So, now the opportunity cost is 120 million tons of steel.

Clearly, opportunity cost of 4,000 additional garments of clothing at point B is greater than the opportunity cost of 4,000 additional garments of clothing at point A (120 million > 80 million). This shows that the quantity of production of steel given up, increases as we move more and more towards production of clothing, reflecting law of increasing opportunity costs.