The sky is blue. — (1)
I like anything that is blue — (2)
Therefore, I like the sky.
(1) is a fact — without going into philosophy (i.e. epistemology), facts are states of nature that are observed. Obama is the US president is a fact; water boils at 100 degrees celsius is a fact; sleep is good for you is not a fact (even though it is probably true); is happiness is important a fact?
(2) is an assertion — specifically it expresses a personal preference and thus its truth cannot be easily challenged.
Words like therefore, thus, hence, because, so, as, if…then…, etc. are known as argument markers. When they appear, it typically means an argument is made. Both (1) and (2) are the premises of an argument; what comes after ‘therefore’ — I like the sky — is the conclusion.
What the heck?
So by now you may be thinking — am I on the right website? How is this even related to economics?
Let’s bring this back to the PPC. The PPC is essentially illustrating the conclusion from an argument.
In economics, arguments that lead to the PPC start with assumptions. Assumptions are statements we take to be true for the sake of the argument. It does not matter if they are actually true. However, if they are shown to be false, then the argument is unsound (but may still be valid). In fact, you’ll see that a lot of arguments in economic fall into this category — they are based on untrue assumptions or premises, and therefore they are unsound but valid.
Assumptions for a specific (two dimensional — only x and y axis) PPC
- It is a snapshot of the economy — taken at a fixed point in time.
- The economy can only choose between two (categories of) goods to produce.
- The total amount of resources in the economy is limited. (more or less a fact)
- Goods and services are produced from resources.
- Resources used in the two production processes are not perfectly substitutable. (seems pretty plausible for most goods)
- Level of technology and resources are fixed. (follows directly from Assumption 1)
Putting them all together
With these — assumptions, facts, and assertions — we can then draw the PPC. Premises (1) and (2) allow us to draw the points on X and Y axis — when all resources are employed to produce just one of the good. Assumption (2) together with Premises (1) and (2) allow us to connect the two points with a line, because by putting resources to different uses we can achieve different combination of the two goods. Premise (3) tells us that the line should be a curve that’s bowed outwards, because opportunity cost is increasing in both directions. Finally, Premise (4) tells us that shifts in PPC can occur when technology, productivity, or resources change.
In summary, arguments are central to economics (and pretty much any science or humanities really). Diagrams are usually used to illustrate conclusions from arguments. It is important to understand what are the assumptions made, so that you can verify their truth and decide on the soundness of the arguments and the plausibility of the conclusion.
Question of the Day
Answers will be given tomorrow.
The production possibilities curve illustrates
a. The concept of opportunity cost.
b. Trade-offs facing a society.
c. When producing on the PPC, more of one good can be produced if only some of the another good is sacrificed.
d. The maximum output that can be produced with a limited amount of resources.
e. All of the above.
- Greed is good. Society should care for the less fortunate. Happiness is important. Oranges are better than apples. More money is better than less. What is common about all of the above statements?
What are some other arguments you can make using the conclusions from the PPC? You are allowed to bring in other premises and definitions.
Premise (2) — I like anything that is blue — is what economists would call a stated preference. Stated preferences are generally regarded as unreliable indicators of actual preferences. To get at actual preferences, economists conduct experiments or studies to find revealed preferences. Actions speak louder than words. Think of a scenario in your everyday life that seems to validate this claim; what have you claimed to prefer that you actually don’t?
We look forward to seeing your responses in the comments section below!
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Till next time, dream economics.
“If you dream of something worth doing then simply go to work for it… if you think of, detail by detail, what you have to do next, it is a wonderful dream even if the end is a long way off, for there are about five thousand steps to be taken before we realise it; and start making the first ten, and stay making twenty after, it is amazing how quickly you get through those five thousand steps.”
— Edwin Land, inventor and founder of the Polaroid.