AP Macroeconomics

Scarcity and economic resources

Scarcity is the condition that wants are unlimited while the resources available to satisfy them are limited. Because of it, every individual, business and government has to choose, and choosing one use of a resource means giving up another. Scarcity is not the same as shortage: a shortage is a market condition at a particular price, whereas scarcity exists at every price and in every economy, including rich ones.

Economic resources, also called factors of production, are the inputs used to produce goods and services.

Human capital is the knowledge and skill workers acquire through education, training and experience. It raises the output a worker can produce, so economists treat it as part of the productive capacity of an economy alongside physical capital.

Opportunity cost

The opportunity cost of a choice is the value of the best alternative given up. It is measured in what is sacrificed, not only in money. A student who spends an afternoon at a part-time job gives up the study they would otherwise have done, and an economy that builds more roads has fewer resources left for hospitals.

Because resources are scarce, every choice has an opportunity cost, and rational decision makers compare the extra benefit of an action with its extra cost. The idea underlies everything later in the course: the cost of holding money is the interest forgone, the cost of government borrowing is the private investment displaced, and comparative advantage is defined through opportunity cost.

The production possibilities curve

The production possibilities curve (PPC), also called the production possibilities frontier, shows the maximum combinations of two goods or two categories of goods an economy can produce in a given period, when all resources are fully and efficiently employed and technology is fixed. The usual graph puts one good on each axis. It is a model, so it takes the quantities of resources and the technology as given and shows the trade-off between the two goods.

Points on the curve, inside it and outside it mean different things.

A movement along the curve is a reallocation of resources between the goods, and it shows the opportunity cost directly. A movement from inside the curve to the curve is a recovery from unemployment or inefficiency, which is why a recession is drawn as a point inside the PPC.

Calculating opportunity cost

Opportunity cost along a PPC is the quantity of one good given up divided by the quantity of the other gained. Suppose an economy can produce the following combinations of computers and tractors per year.

Moving from A to B gives 10 thousand more computers and costs 6 thousand tractors, so the opportunity cost of one computer is $\frac{6}{10} = 0.6$ tractors. From B to C the cost is $\frac{54-44}{10} = 1.0$ tractors per computer, from C to D it is $\frac{44-28}{10} = 1.6$, and from D to E it is $\frac{28-0}{10} = 2.8$. The cost of each extra computer rises as more computers are produced.

The shape of the curve

The shape depends on whether opportunity cost is constant, increasing or decreasing.

• With increasing opportunity cost the PPC is bowed outward (concave to the origin), as in the table of computers and tractors. It occurs because resources are not equally suited to both goods. The first resources moved into computers are those best at making computers, and the economy then has to use resources that are better at making tractors, so each extra computer costs more tractors than the one before. This is the usual case.
• With constant opportunity cost the PPC is a straight line, because resources are perfectly adaptable between the two goods. The slope is the same everywhere and equals the opportunity cost.
• With decreasing opportunity cost the PPC is bowed inward. It is unusual and would mean that the more of a good is produced, the less must be given up for each extra unit.

Shifts of the curve and economic growth

The PPC shifts when the economy's capacity changes. It shifts outward when the quantity or quality of the factors of production rises (more labor, more physical capital, more land or natural resources, better-educated workers) or when technology and productivity improve. This is economic growth. It shifts inward if capacity falls, for example through the destruction of capital in a war or a natural disaster, or a fall in the labor force.

A shift can be biased toward one good. A technological advance that applies only to computers moves the intercept on the computer axis outward while leaving the tractor intercept in place, so the curve pivots. An advance that raises productivity in both goods shifts the whole curve outward.

An economy that is on its PPC can only get more of one good by producing less of the other. It can only get more of both by moving from inside the curve to the curve, or by growing so that the PPC itself moves outward. The long-run aggregate supply curve is the macroeconomic counterpart: an outward shift in the PPC corresponds to a rightward shift in long-run aggregate supply.