Topic 3#: The Production Possibilities Frontier Dr David Penn Associate Professor of Economics and Director of the Business and Economic Research Center

Production Possibilities Frontier As we know, resources are scarce (1 st principle) and consequently the economy must face tradeoffs (2 nd principle). Doing more of one thing means doing less of something else. To think about tradeoffs, economists use a model called the production possibilities frontier (PPF). A production possibility frontier (PPF) for an economy can be used to illustrate: Tradeoffs Efficiency Opportunity cost, and Economic growth.

Production Possibilities  A PPF shows possible production combinations for two goods.  We make three important assumptions when drawing a PPF:  The economy produces just two goods,  Resources (land, labor, capital) are fixed, and  Resources are being used efficiently.

Example 1: Aircraft  The PPF (next slide) shows the tradeoff the economy faces when choosing to produce Dreamliners (787) and small jets.  With a given (fixed) amount of resources, the PPF shows the maximum number of each aircraft that can be produced each year. We can produce:  30 Dreamliners and 0 small jets, or  40 small jets and 0 Dreamliners, or  Of course, many other possible combinations of Dreamliners and small jets exist in between.

Aircraft PPF Dreamliners Small jets A B C 28 9 Points A and B: feasible and efficient Point C: feasible but not efficient Point D: not feasible with current resources D The negative slope of the PPF shows the tradeoff that must occur when the economy is operating efficiently. If we are at point B and want more Dreamliners, we must give up some small jets.

Example 2: Guns and butter  Suppose we have two goods, guns and butter.  The table shows possible production combinations of guns and butter, given our resources.

Production Possibilities

 The negative slope of the PPF shows the tradeoff that exists between producing more guns and producing more butter.  Opportunity cost is how much of one good that has to be sacrificed to produce more of the other.

Production Possibilities  Beginning at Point A, if we wish to move to Point B and produce one more gun, we have to give up 1 butter (opportunity cost).  At Point B, producing one more gun requires us to give up 2 butters.  The opportunity cost of guns in terms of butter rises as we increase gun production.  Increasing opportunity cost gives the PPF its curved shape.

Production Possibilities  Why increasing opportunity costs?  Increasing opportunity cost occurs because resources are not equally productive in all uses.  Some resources are good at producing butter, others are good at producing guns.

Efficiency  Point F is not feasible, given the resources available (PPF on next slide).  Point G inside the PPF is feasible but not efficient, since more of one or both goods could be produced with the available resources.  Points A-E are both feasible and efficient, since they are on the PPF. When the economy is producing efficiently, the only way to produce more of one good is to produce less of another good.

Production Possibilities Frontier F (Not feasible) ☻ ☻ G Feasible, but not efficient Feasible and efficient

Economic Growth  Economic growth is an increase in the ability of the economy to produce goods and services.  Economic growth shifts the PPF to the right, enabling the economy to produce more of both goods.  Thus, economic growth expands the economy’s production possibilities

Economic Growth  Causes of economic growth  Increase in the economy’s factors of production – a factor of production is a resource used to produce goods and services. Resources included are land, labor, physical capital, and human capital.  Technological progress – consists of new ways to produce more with the same amount of resources. Includes new machines, new ideas, and new ways of organizing production.

Economic Growth Growth When growth occurs the economy can produce more of both goods.

Summary  A production possibilities frontier (PPF) is a simplified model of the tradeoffs involved when increasing production of a good or service.  The PPF can be used to illustrate efficiency, inefficiency, tradeoffs, opportunity costs, and economic growth.