An increase in which of the following is consistent with an outward shift of the production possibilities curve?

Question

a. Exports

b. Aggregate demand

c. Income tax rates

d. Long-run aggregate supply

e. Transfer payments

Answer 1

Hi Sophie, here is the answer to your question.

The production possibilities curve (PPC) is a graph that shows the various combinations of output of two goods that a country can possibly produce given the available factors of production (resources) and the available production technology that firms use to turn these factors into output. An outward shift of the Production Possibilities Curve (PPC) happens when there is an increase in the amount of resources that the country has, or there is an improvement in technology which allows the country to produce more of either one or both the goods.

a. Exports - exporting means selling domestically produced goods and services abroad. An increase in exports does not imply an increase in production possibilities. It is thus not consistent with an outward shift of the PPC.

b. Aggregate Demand - aggregate demand shows the total demand for goods and services that comes from households, firms, the government, and the rest of the world. If an economy is currently experiencing unemployment, then it is at a point inside the PPC. An increase in aggregate demand will take the economy in the long run at full employment, which is at a point on the PPC. But it will not cause an outward shift in the PPC.

c. Income Tax Rates - An increase in income tax rates will reduce people's disposable income and thus reduce household consumption and the demand for goods and services. If the economy was initially in long run equilibrium at full employment, output will fall below the full-employment level and we will move to a point inside the PPC. It will not result in any outward shift of the PPC.

d.. Long Run Aggregate Supply (LRAS) - LRAS shows the amount of goods and services produced by a country in the long run. An increase in LRAS implies an increase in the amounts of goods and services produced. This will cause the PPC to shift outward.

e. Transfer payments - An increase in transfer payments will lead to an increase in demand for goods and services. It will not shift the PPC outward.