Circular Flow Diagram
Shows how the economy is organized and how firms and households interact with each other.
Production Possibilities Frontier
The various combinations of two outputs an economy can produce given its fixed factors of production and technology. Demonstrates scarcity, choice, and opportunity cost.
Assumptions:
- The economy produces only 2 products.
- Given resources remain constant.
- Technology and other factors remain constant during the period.
- Resources are fully utilized with maximum efficiency.
- Resources can transfer from one product to the other.
Positions:
- On the boundary
Resources fully and efficiently employed. - Inside the boundary
Resources unemployed or inefficiently employed. - Outside the boundary
Not attainable with current resources.
The curve has a negative slope: more of one good requires producing less of the other.
Shapes:
- Concave
Increasing opportunity cost. Resources are non-homogeneous and not equally efficient across industries. - Straight line
Constant opportunity cost. Homogeneous resources, equally efficient in both industries. - Convex
Decreasing opportunity cost.
Shifts and pivots:
- More available resources or economic growth shift the curve outwards.
- Technological improvement in one product pivots the curve from the relevant axis; improvement in both shifts it outwards.
- Production can increase without opportunity cost by using unemployed resources or raising resource efficiency.