The production possibilities boundary shows possible combinations of guns and butter that can be produced by a country. The lower diagram shows demand and supply for butter.
FIGURE 12-2
Refer to Figure 12-2. Suppose this economy is allocatively efficient at Q1 units of butter. Now suppose there is an increase in demand for butter from D to D1. After this shift in demand,
◦ the increase in the price of butter (relative to the price of guns) will cause the demand curve to shift back down to D and allocative efficiency will be maintained.
◦ the price of guns (relative to the price of butter) rises and the economy moves to point (a) on the PPB.
◦ the supply curve will shift up to S
1 and allocative efficiency will be maintained.
◦ the marginal value to consumers of butter is less than the marginal cost to producers; the price of butter (relative to the price of guns) rises; the economy moves to output Q
2 of butter and point (c) on the PPB.
◦ the marginal value to consumers of butter is greater than the marginal cost to producers; the price of butter (relative to the price of guns) rises; the economy moves to output Q
2 of butter and point (c) on the PPB.
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