MA ECONOMICS: 2018

Wednesday, February 7, 2018

Production Possibility Frontier

A production possibility frontier (PPF) shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed

Opportunity Cost and the PPF

Reallocating scarce resources from one product to another involves an opportunity cost

If we increase our output of consumer goods (i.e. moving along the PPF from point A to point B) then fewer resources are available to produce capital goods

If the law of diminishing returns holds true then the opportunity cost of expanding output of X measured in terms of lost units of Y is increasing.

We normally draw a PPF on a diagram as concave to the origin i.e. as we move down the PPF, as more resources are allocated towards Good Y the extra output gets smaller – so more of Good X has to be given up in order to produce Good Y

This is an explanation of the law of diminishing returns and it occurs because not all factor inputs are equally suited to producing items

PPF and Economic Efficiency

Production Possibilities

A production possibility frontier is used to illustrate the concepts of opportunity cost, trade-offs and also show the effects of economic growth.

Points within the curve show when a country’s resources are not being fully utilised

Combinations of the output of consumer and capital goods lying inside the PPF happen when there are unemployed resources or when resources are used inefficiently. We could increase total output by moving towards the PPF

Combinations that lie beyond the PPF are unattainable at the moment

A country would require an increase in factor resources, an increase in the productivity or an improvement in technology to reach this combination.

Trade between countries allows nations to consume beyond their own PPF.

Producing more of both goods would represent an improvement in welfareand a gain in what is called allocative efficiency.