Learning Objectives
Students will understand:
- The use of production possibility frontiers to depict:
- The maximum productive potential of an economy.
- Opportunity cost (through marginal analysis).
- Economic growth or decline.
- Efficient or inefficient allocation of resources.
- Possible and unobtainable production.
- The distinction between movements along and shifts in production. possibility curves, considering the possible causes for such changes.
- The distinction between capital and consumer goods.
Content
Intro to the PPF
PPF: A curve showing the maximum potential output level of one good for a given level of production of another, for the current state of technology
It could be any two goods which compete for resources.
When all resources are being used, you have to take some away from producing one good in order to produce more of the other.
Often concaved in shape, but can be straight (explained later).
Role: The PPF shows all the combinations of goods that can be produced if an economy’s factors of production are fully employed and used at their maximum efficiency.
General case: When we consider a whole economy we can split all production into two types in order to show it on a PPF:
- Consumption goods – G&S used by people to satisfy their needs and wants.
- Capital goods – G&S used in the production of other goods.
Points on a PPF
- A shows an economy where fishing is the only output.
- B shows an economy where farming is the only output.
- C shows an economy where 90 units of fishing and 50 units of farming are produced.
- D shows an economy where 50 units of fishing and 90 units of farming are produced.
- E is inefficient.
- More of both fishing and farming can be produced, without cutting down on the other.
- Resources are not being fully employed.
- I.e. some FoP may be unemployed.
- F is impossible!
- Any point outside the curve is impossible to achieve with the current level of resources and technology.
- But, may be attainable if some FoP are increased or if technology improves.
The Production Possibility Frontier & Opportunity Cost
Question: Why does the PPF have a negative slope?
When all resources are employed and employed at their most efficient, increasing the production of one good requires resources to be freed from producing another good.
Opportunity Cost (recap): The benefit lost from the next best alternative forgone.
In terms of production, the OC of increasing output of one good by one unit, is the units of the other good that must be foregone.
Showing OC on the PPF: If we move from one point on the PPF to the other we can see how much output we forego of one good to make more of the other.
E.g. going from D to C, the OC of 40 more units of fishing, is 40 less units of farming.
OC ratio: Loss of output of one good : Gain of output in the other good
Examples
- Going from D to C, the OC ratio is 1 unit fall in farming output : 1 unit increase in fishing output.
- B to D the OC ratio is 1 : 5
- C to A the OC ratio is 1 : 0.2
Varying OC along the PPF (Why is the PPF often Concave?)
Resources are not equally efficient at producing both types of g/s
I.e. factor inputs are not perfectly substitutable.
Going from B to D is cheap (only 10 units of farming are forgone for only 50 additional units of fish), we move the specialised resources to fishing (e.g. fishermen, fishing nets, etc) which were not productive on farms. Therefore we gain lots of fish from foregoing very little farming.
From D to C, we start moving resources that are roughly as productive either fishing or farming (e.g. young unexperienced workers, unspecialised capital).
From C to A though is very costly (50 farming forgone, 10 fishing gained) as specialised farming resources are transferred, which are less productive working on a boat than they are on a farm.
there are diminishing marginal returns.
Straight Line PPF
Straight line PPF: Indicates perfect factor substitutability of resources between the two goods. OC is constant.
Any unit of a given resource is as productive as any other unit when used to produce a given good.
E.g. When switching a robotic arm between the two uses, the change in output to cars/trucks is constant.
OC ratio for a straight line PPF: the OC ratio of switching resources between the two goods is constant at all levels of output.
- OC ratio of A→B = 3 cars lost : 2 trucks made
- OC ratio of B→C = 3:2;
- OC ratio of C→D = 3:2
Shifts of The PPF
Economic Growth
Potential Econ Growth: An increase in an economy’s productive potential. (PPF1 to PPF2).
Production of both goods can be increased, without having to cut production of the other.
Causes: an increase in either the quality or quantity of FoP.
Possibly through ideas such as education, immigration or investment.
Actual Econ Growth: An increase in the actual (value of) output of the economy (A to B).
Causes: Utilising more FoPs, or using them more productively.
Negative Economic Growth
Negative Actual Econ Growth: A decrease in the actual (value of) output of the economy (A to B).
Causes: Utilising fewer resources for production, or using them less productively.
Negative Potential Econ Growth AKA Hysteresis: A reduction in an economy’s productive potential (PPF1 to PPF2).
Max. production of both goods is decreased.
Causes: a decrease in either the quality or quantity of FoP.
Possibly through being idle in an economic downturn.
Shifts of the PPF in one good
Shift of the PPF in one good: A horizontal or vertical stretching of the PPF; an outward shift on one axis in the production possibility frontier.
Causes: Changes in production technology or increases in factor inputs that can be used on only one of the two goods.
E.g. an improvement in farming equipment.
Results: After the shift in the PPF more units of farming output can be produced for each level of output of fishing, change in opportunity cost.
Efficiency and The PPF
Productive Efficiency
Productive efficiency: When each unit of output uses the fewest number of resources possible for that unit.
I.e. As efficiently as possible with no extraneous wastage. This occurs at every point on the PPF curve.
Pareto Efficiency
Pareto efficiency: Where it is impossible to make one person better off without making another worse off.
I.e. In order to satisfy some people’s want for extra units of one good, you have to take away units of the other good that would have been consumed by others. Every point on the PPF is pareto efficient.
Allocative Efficiency
Allocative efficiency: Production of those goods and services that are most desired by society in the quantity that they desire.
I.e. Allocatively efficient production implies total welfare is maximised. This occurs at 1 point on the PPF, depending on the consumption preferences of the population.
Inefficient
Inefficient: Combinations of output inside the PPF happen when there are unemployed resources or when resources are not used to their full potential.
We could increase total output of goods and services by moving towards the PPF. Producing more of both goods with the same resources represents an improvement in welfare and a gain in allocative efficiency.
Unattainable
Unattainable: Combinations that require increased resources/increased productivity to achieve.
These exist outside the PPF.
