1.4 - Production Possibility Frontiers - notes

The concept of production possibility frontiers

A production possibility frontier (PPF) illustrates the maximum combination of two goods or services that an economy can produce using its available resources efficiently. It highlights the challenge of allocating scarce resources between different options, such as consumer goods and capital goods.

Key features of a production possibility frontier

The diagram below shows a PPF for an economy that can produce two goods: houses and vehicles.

• Shape and axes - The PPF is typically a downward-sloping curve.
• Points on the curve - Points such as A and B represent maximum achievable output when all resources are used fully and efficiently.
• Points inside the curve - A point such as F indicates inefficiency, where resources are not fully utilised.
• Points outside the curve - A point such as E is unattainable with current resources, requiring additional or improved resources to reach.

PPFs can apply to any two products or categories, demonstrating choices in resource allocation.

Trade-offs and opportunity cost

Moving along the PPF involves making choices between producing more of one good and less of another, due to limited resources. This creates a trade-off, where achieving more in one area means compromising in another.

Trade-offs on the PPF

Trade-offs occur because resources are scarce, forcing decisions like allocating more factors to houses and fewer to vehicles. On the PPF above, this is a movement along the curve from A to B: the economy builds more houses, but must give up some vehicles.

Opportunity cost

Opportunity cost refers to the next best alternative forgone when making a choice. In moving from A to B on the PPF, the opportunity cost of the extra houses is the vehicles that can no longer be made. Thinking in terms of opportunity cost helps resources to be allocated more efficiently across various economic agents.

How opportunity cost is applied:

• By consumers - Choosing how to spend limited income.
• By producers - Deciding which product to make.
• By governments - Evaluating policies.

Challenges with using opportunity cost:

• Not all alternatives may be known.
• Information on alternatives and their costs can be incomplete.
• Some resources lack alternative uses.
• Switching certain resources, like land, to new purposes can be difficult.

Productive and allocative efficiency

Efficiency on the PPF relates to how well resources are used to maximise output and meet societal needs.

Productive efficiency

All points on the PPF, such as A and B, achieve productive efficiency, as resources are used to their full potential to produce the maximum output possible. Points inside the curve, such as F, are productively inefficient, as more output could be achieved without reallocating resources.

Allocative efficiency

Not every point on the PPF is allocatively efficient, as it depends on whether the mix of goods matches what society wants or needs. Choosing different points on the PPF reflects decisions on resource use to balance these efficiencies.

Shifts in the production possibility frontier

The PPF can move based on changes in the quantity or quality of resources, affecting the economy's overall capacity.

Outward shifts and economic growth

• An outward shift occurs with more resources or improvements like better technology or training, increasing possible output. The diagram below shows the PPF shifting outward from PPF1 to PPF2.
• This represents economic growth, allowing more of both goods or a focus on one.

• Shifts can be uneven; technology improving only house-building might stretch the PPF horizontally. In the diagram below, the maximum output of houses rises from PPF1 to PPF2 while the maximum output of vehicles is unchanged.

Inward shifts and negative growth

An inward shift happens with fewer resources, such as after a natural disaster, reducing maximum output and showing negative economic growth. The diagram below shows the PPF shifting inwards from PPF1 to PPF2. These shifts demonstrate how changes in resources or technology influence an economy's production potential.