Production Possibility Frontiers

Production Possibility Frontiers
The Production Possibility Frontier

• A production possibility frontier (PPF)
represents all possible combinations of goods an
economy or a firm can produce when all
production factors are fully employed and used
efficiently
• A PPF is normally drawn as concave to the origin
because the extra output resulting from
allocating more resources to one particular good
may fall
Explaining the shape of a concave PPF
▫ As we move down the PPF, as more resources are
allocated towards Good Y, the extra output gets
smaller – and more of Good X has to be given up
in order to produce the extra output of Good Y
▫ This is known as the law of diminishing returns
▫ Resources are not perfectly mobile between
different uses / different industries
▫ Re-allocating resources may require re-training,
the time and cost of moving resources to their new
use
The PPF Illustrated
Output of
DVD
Players
(million
per year)
A
80
B
50
C
20
80 100 110 Output of MP3

Players
(million per year)
The PPF Illustrated Combinations of the two
Output of
DVD goods that lie within the PPF
Players are feasible but show an output
(million that under-utilises existing
per year) resources or where resources
A are being used inefficiently
80
B
50
D C
20

Players
(million per year)
The PPF Illustrated
Output of Combinations of the two
DVD goods that lie on the PPF are
Players feasible and can be produced
(million using all available factor
per year) inputs efficiently
A
80
B
50
D C
20

Players
(million per year)
The PPF Illustrated
Combination E is unattainable
Output of given current resources and the
DVD productivity of the available
Players
factor inputs
(million
per year)
A E
80
B
50
D C
20

Players
(million per year)
Opportunity Cost
• Opportunity cost measures the cost of a choice in terms of
the next best alternative forgone (given up)
• Choices are inevitable because human wants and needs are
unlimited but the resources available to meet them are
finite
• Reallocating scarce resources creates an opportunity cost.
If we increase our output of Good X then fewer resources
become available to produce good Y
• Because of the shape of the PPF as drawn previously, the
opportunity cost of switching resources increases – i.e. we
have to give up more DVD players to increase output of
MP3 players
The PPF and Opportunity Cost
Output of
Reallocating resources from A
DVD
to B to C leads to an increased
Players
output of MP3 players
(million
But the opportunity cost
per year)
measured by the output of DVD
A players given up is increasing
80
This is because of the law of
B diminishing returns
50
Some of the resources used in
producing DVD players are less
C efficient when allocated to MP3
20
players)

Players
(million per year)
Shifts in the PPF
• The PPF can shift outwards when
• (1) There is an increase in the stock of factor inputs
available for production
• (2) An industry or economy achieves a rise in efficiency
(productivity) meaning that more output can be produced
from given resources
• (3) Advances in the state of technology and the
beneficial impact of innovation in improving production
processes
• An outward shift in the PPF signifies an expansion of a
country’s productive potential – in other words – long
term economic growth
Capital-labour substitution
Replacing labour with capital can increase

productivity – but does it cause unemployment to
rise?
Shifting out the PPF
United Kingdom, Potential output of total economy
Source: OECD World Economic Outlook
Potential output for the UK economy

1.2
1.1
1.0
GBP (thousand billions)
0.9
0.8
0.7
0.6
0.5
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: Reuters EcoWin

An Increase in Factor Resources
An increase in the stock of
Output of
DVD land, labour and capital
Players available in both industries
makes combination F feasible
(million
per year)
A
80 F
B
50
C
20

Players
(million per year)
Technological Advances in the Production of MP3
Players A change in the state of technology in supplying
Output of MP3 players causes an outward shift in the PPF.
DVD With the same resources allocated to DVD
Players players, a greater output of MP3 players is
possible
(million The real cost of MP3 players will fall – there
per year) has been a change in the opportunity cost
80 A
B G
50
C
20

Players
(million per year)
Can a Country’s PPF Shift Inwards?
• The assumption that a PPF will always shift outwards can be
questioned:
• Impact of a deep economic recession (slump):
▫ Closure of businesses and scrapping of capital equipment and a level
of investment insufficient to compensate for capital depreciation
▫ Unemployed workers who leave the labour market permanently
• Trend towards early retirement and delayed entry into the labour
market by students
• Over-exploitation of scarce renewable resources:
▫ Collapse in fish stocks from the North Sea
▫ Environmental degradation caused by global warming
• External shocks which destroy factor resources:
▫ Earthquakes and other climatic disasters

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Production Possibility Frontiers

The Production Possibility Frontier

80 100 110 Output of MP3

80 100 110 Output of MP3

80 100 110 Output of MP3

80 100 110 Output of MP3

80 100 110 Output of MP3

Replacing labour with capital can increase

Potential output for the UK economy

Source: Reuters EcoWin

80 100 110 Output of MP3

80 100 110 Output of MP3

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