The Production Possibilities Frontier

Introduction The Production Possibilities Frontier (PPF) is a graph that shows all possible combinations of two goods when an economy is producing at full potential. It does not actually show reality, since it assumes only two goods are produced. It is a simplification that shows what sort of trade-offs would be made in reality. It only shows what can be produced – not what would be consumed.

PPF for the Country ALPHA A point on the graph represents how much of each item is being produced. Guns 800 800 Butter

PPF for the Country ALPHA The frontier shows the limit of what can be produced – all possible combinations when all resources are fully utilized. Guns Butter

PPF for the Country ALPHA All resources are being used to produce guns. 1500 Guns Butter

PPF for the Country ALPHA All resources are being used to produce butter. 1500 Guns 2000 Butter

Usually a point is chosen where both items are being produced:

PPF for the Country ALPHA 1100 Guns 1500 Butter

Production may occur anywhere on or within the frontier. It may NOT occur beyond the frontier– there are not enough resources to do so.

PPF for the Country ALPHA At point A (and at any point on the frontier), production is EFFICIENT. A Guns Butter

Efficient production means that all resources are being fully employed to produce the most goods and services possible. Therefore it is impossible to produce more of one item without producing less of the other.

PPF for the Country ALPHA At point B (and at any point inside the frontier), production is INEFFICIENT. B Guns Butter

Inefficient production means not all resources are being fully employed – it is still possible to increase production of both goods. This could occur during a recession or depression, or in a developing country.

The PPF can be used to show tradeoffs. Any two or more points on the frontier represent tradeoffs.

PPF for the Country ALPHA A and B represent tradeoffs. A produces more guns, B produces more butter. A B Guns Butter

The PPF can be used to show the opportunity cost of choosing one alternative over the other.

PPF for the Country ALPHA The opportunity cost of A equals the decrease in butter: 1100 units. A 1400 B Guns 800 600 1700 Butter

PPF for the Country ALPHA The opportunity cost of B equals the decrease in guns: 600 units. A 1400 B Guns 800 600 1700 Butter

The PPF can also show economic growth by moving outward. This may occur due to additional resources, increasing population, or new technology.

PPF for the Country ALPHA Growth Guns Butter

Review Any point on the graph shows how much of both goods is being produced. Efficiency is shown by whether the point is on the curve (efficient) or within the curve (inefficient). Tradeoffs are shown by any two points on the curve. Opportunity cost is shown by the decrease in one good when the other is increased. Growth is shown by the frontier moving outward.

law of diminishing returns: can occur because factor resources are not perfectly mobile between different uses, for example, re-allocating capital and labour resources from one industry to another may require re-training, added to a cost in terms of time and also the financial cost of moving resources to their new use.

Law of increasing cost The production possibility curve bows outward as a result of the law of increasing cost. The law of increasing costs takes place when society uses more resources (which takes those resources always from the production of the other good), to product any specific good. This causes increased opportunity cost with each additional unit produced of that specific good (increasing amounts of the other good have to be given up). The reason is simply that, as a nation, certain resources are better suited for producing some goods then they are for other goods. Some resources would be better adapted for use with investment goods, for instance, than consumption goods. Resources are generally not perfectly adaptable for producing both categories of goods (consumption vs. investment). Therefore, increasing the output of a particular good, must use less efficient resources than those already used. Hence the increasing opportunity cost of producing the additional units and the law of increasing cost. The more specialized the resources, the more bowed out the production possibility curve.