Learning Tips
The production possibility frontier (PPF) provides a simple model to illustrate scarcity, opportunity cost, tradeoffs, economic growth, and the distinction between efficient and inefficient output levels.
o
o
A PPF for a person or an economy illustrates the maximum amount of two goods that can be produced in a given
amount of time given a fixed level of resources and technology.
The PPF is a boundary between points that are feasible but inefficient (points inside the PPF) and points are infeasible
(points outside the PPF). All points on the PPF are both feasible and efficient. In the diagram below, point A is feasible
but inefficient. Point C is infeasible. Point B is feasible and efficient.
200
198
192
182
C
168
B
Consumer goods (C)
150
128
A
102
72
38
0
0
1
2
3
4
5
6
7
8
9
10
11
Capital goods (K)
o
Along the PPF, we can produce more of one good only by producing less of the other good. The opportunity cost of
producing more of one good is measured as the number of units of the other good that must be forgone or given up.
In the diagram below a movement from A to B shows that we are increasing the output of capital goods. The
opportunity cost of increasing capital goods by unit from 6 to 7 is giving up or reducing consumer goods by 26 units
from 128 to 102.
200
198
192
182
168
150
Consumer goods (C)

A
128
B
102
72
38
0
0
1
2
3
4
5
6
7
8
9
10
11
Capital goods (K)
o
Economic growth occurs when the PPF shifts out from the origin: an increase in resources or an improvement to
technology will shift the PPF out, indicating an expansion in productive capacity of the economy. In the diagram below
is shown by the right-upward shift in the PPF, indicating that more of both capital and consumer goods can be
produced because of the expansion of productive capacity of the economy.
240
Consumer goods (C)
200
E
142
128
A
0
1
2
3
4
5
6
7
8
9
10
11
12
Capital goods (K)
Exercises
1) Baharestan is a isolated country producing rice and goat cheese. The following table shows different combinations of rice and
coconuts that Baharestan can produce in a year.
Maximum annual
output options
A
B
C
D
E
F
a)
Bushels of rice
2,000
1,600
1,200
800
400
0
Pounds of goat cheese
0
250
450
600
700
800
Graph combinations A-F on the following graph and then connect these combinations to create Baharestan’s PPF.
Bushels 2,200
of rice 2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
0
100
200
300
400
500
600
700
800
900
Pounds of goat cheese
b) Consider the following production combinations for Baharestan. For each combination determine which of the following
classifications best describes the combination:
I.
The combination is feasible and efficient.
II.
The combination is feasible but inefficient.
III.
The combination is not feasible.
i) 300 pounds of goat cheese, 1,200 bushels of rice. _______
ii) 450 pounds of goat cheese, 1,400 bushels of rice. _______
iii) 500 pounds of goat cheese, 600 bushels of rice. _______
iv) 725 pounds of goat cheese, 600 bushels of rice. _______
v) 250 pounds of goat cheese, 1,600 bushels of rice. _______
c)
What is the opportunity cost of producing:
i) 600 pounds of goat cheese instead of zero pounds of goat cheese? _______
ii) 1,600 bushels of rice instead of 800 bushels of rice? _______
iii) 700 pounds of goat cheese instead of 250 pounds of goat cheese? _______
2) Suppose an economy produces only two goods, cheese and wine. The production possibility of this economy is given in the
following diagram.
Wine
per year
A
F
B
C
G
D
E
Cheese per year
a) Which point on the diagram will this economy produce at if it devotes all of its resources to wine production? ______
b) Which point on the diagram represents a feasible but inefficient point for this economy? ______. Explain your answer.
c) Which point on the diagram may become feasible if this economy experiences economic growth? ______. Explain your
answer.
d) Explain how you would measure the opportunity cost of moving from point C to point B.

The model of comparative advantage illustrates why specialization and trade is advantageous to people and
countries even if a person or a country does not have the absolute advantage in producing any good.
It is possible for individuals, countries, or regions with a country, to be better off if they specialize according to their comparative
advantage and then trade with one another. A country has a comparative advantage in producing a good if it can produce the good
at lower opportunity cost than can another country. For example, if state of Nebraska’s opportunity cost of producing one more unit
of bread is two units of cheese, while state Wisconsin’s opportunity cost of producing one more units of bread is three units of
cheese, then Nebraska has a comparative advantage in producing bread and should produce bread. Conversely, Nebraska’s
opportunity cost of producing one more unit of cheese is ½ unit of bread, while Wisconsin’s opportunity cost of producing one more
unit of cheese is ⅓. Then Wisconsin has comparative advantage in cheese (⅓ < ½) and it should produce cheese.
In the table below, if Nebraska produced no bread and all cheese, total cheese output would be 100. Given Wisconsin’s resources
the total cheese output, with no bread, would be 90. No-cheese-all-bread output for Nebraska is 50 and for Wisconsin is 30.
Nebraska has absolute advantage in both cheese and bread.
Nebraska
Wisconsin
Cheese
100
90
Bread
50
30
The linear production possibility equations and graphs for the two states are shown below:
Nebraska:
Wisconsin:
C = 100 – 2B
C = 90 – 3B
Cheese
100
90
Nebraska
Wisconsin
30
50 Bread
The Wisconsin PPF’s slope is −3, while that of Nebraska is −2. The costs more for Wisconsin to produce bread because it gives up 3
units of cheese for each additional unit of bread. It costs less for Nebraska to produce bread because it gives up 2 units of cheese for
each extra unit of bread.
Exercise
3) Andy and Sandy both produce bread and milk. The table below provides information about some of the combinations of bread
and milk Andy and Sandy can produce from their given resources.
Andy
Bread
100
80
60
40
20
0
a)
Sandy
Milk
0
30
60
90
120
150
Bread
120
90
60
30
0
Milk
0
40
80
120
160
Draw Andy and Sandy’s production possibility frontier on the following graphs.
Andy
Sandy
180
180
Gallons
of milk 160
Gallons
of milk 160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
0
0
0
20
40
60
80
100
120
0
20
Pounds of bread
b)
c)
d)
e)
f)
g)
Which person has the absolute advantage in the production of butter? _______
Which person has the absolute advantage in the production milk? _______
What is the opportunity cost of producing one pound of bread for Andy? _______
What is the opportunity cost of producing one pound of bread for Sandy? _______
What is the opportunity cost of producing one gallon of milk for Andy? _______
What is the opportunity cost of producing one gallon of milk for Sandy? _______
40
60
80
100
120
Pounds of bread
h) Who has the comparative advantage in the production of bread? _______
i) Who has the comparative advantage in the production of milk? _______

The circular flow diagram of the market economy illustrates the relationship between households and firms as
they interact in both the product and factor markets.
Households provide factors of production, while firms produce goods and services using those factors. Households use the income
they earn from selling their factors of production to purchase the goods and services produced by the firms. In the circular-flow
diagram income equals expenditures. The circular-flow diagram depicts two flow: the flows of factors of production and goods and
service (physical flow) in one direction, and the flow of income and expenditure (monetary flow) in the opposite direction.
Households
$
Demand for
goods and
services
Household
expenditures
$
Supply of
factors
Market for
goods and
services
Factor markets
Supply of
goods and
services
Firm
revenues
Factor
income
$
Demand for
factors
Firms
Payments
to factors
$
ANSWERS TO EXERCISES
1) Baharestan is a isolated country producing rise and goat cheese. The following table shows different combinations of rice and
coconuts that Pacifica can produce in a year.
Maximum annual
output options
A
B
C
D
E
F
a)
Bushels of rice
2,000
1,600
1,200
800
400
0
Pounds of goat cheese
0
250
450
600
700
800
Graph combinations A-F on the following graph and then connect these combinations to create Baharestan’s PPF.
Bushels 2,200
of rice 2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
0
100
200
300
400
500
600
700
800
900
Pounds of goat cheese
b) Consider the following production combinations for Baharestan. For each combination determine which of the following
classifications best describes the combination:
I.
The combination is feasible and efficient.
II.
The combination is feasible but inefficient.
III.
The combination is not feasible.
i) 300 pounds of goat cheese, 1,200 bushels of rice. II
ii) 450 pounds of goat cheese, 1,400 bushels of rice. III
iii) 500 pounds of goat cheese, 600 bushels of rice. II
iv) 725 pounds of goat cheese, 600 bushels of rice. III
v) 250 pounds of goat cheese, 1,600 bushels of rice. I
c)
What is the opportunity cost of producing:
i) 600 pounds of goat cheese instead of zero pounds of goat cheese? 1,200 bushels of rice forgone.
ii) 1,600 bushels of rice instead of 800 bushels of rice? 350 pounds of goat cheese forgone.
iii) 700 pounds of goat cheese instead of 250 pounds of goat cheese? 1,200 bushels of rice.
2) Suppose an economy produces only two goods, cheese and wine. The production possibility of this economy is given in the
following diagram.
Wine
per year
A
F
B
C
G
D
E
Cheese per year
a) Which point on the diagram will this economy produce at if it devotes all of its resources to wine production? A
b) Which point on the diagram represents a feasible but inefficient point for this economy? G. Explain your answer. Point B is
feasible since it is a combination that is inside the PPF, but is inefficient because it would be possible to increase the
production of both wine and cheese.
c)
Which point on the diagram may become feasible if this economy experiences economic growth? F. Explain your answer.
Point F currently is not a feasible point since it lies outside the PPF. However, if there is economic growth the PPF will shift
out, resulting in the ability to produce more of both goods.
d) Explain how you would measure the opportunity cost of moving from point C to point B. The opportunity cost of moving
from point C to B is measured by the units of cheese per year that must be given up in order to increase wine production.
3) Andy and Sandy both produce bread and milk. The table below provides information about some of the combinations of bread
and milk Andy and Sandy can produce from their given resources.
Andy
Bread
100
80
60
40
20
0
a)
Sandy
Milk
0
30
60
90
120
150
Bread
120
90
60
30
0
Milk
0
40
80
120
160
Draw Andy and Sandy’s production possibility frontier on the following graphs.
Andy
Sandy
180
180
Gallons
of milk 160
Gallons
of milk 160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
0
0
0
20
40
60
80
100
120
Pounds of bread
0
20
40
60
80
100
120
Pounds of bread
b) Which person has the absolute advantage in the production of bread? Sandy. Sandy has absolute advantage in production
bread over Andy because she can produce 120 pounds against Andy’s 100 pounds.
c) Which person has the absolute advantage in the production milk? Sandy. Sandy has absolute advantage in production of
milk over Andy because she can produce 160 gallons of milk against Andy’s 150 gallons.
d) What is the opportunity cost of producing one pound of bread for Andy? 1.5. Andy gives up 1.5 gallons of milk for each
extra pound of bread. The opportunity cost is shown as the slope of the PPF: 150 ∕ 100 = 1.5.
e) What is the opportunity cost of producing one pound of bread for Sandy? 1.33. Sandy gives up 1.33 gallons of milk for each
extra pound of bread. The opportunity cost is shown as the slope of the PPF: 160 ∕ 120 = 1.33.
f) What is the opportunity cost of producing one gallon of milk for Andy? The opportunity cost of milk for Andy in terms of
bread given up is the inverse of the opportunity cost of bread: 1 ∕ 1.5 = 0.67.
g) What is the opportunity cost of producing one gallon of milk for Sandy? The opportunity cost of milk for Sandy in terms of
bread given up is the inverse of the opportunity cost of bread: 1 ∕ 1.33 = 0.75.
h) Who has the comparative advantage in the production of bread? The opportunity cost of producing bread, in terms of
gallons of milk given up, is lower for Sandy (1.33 gallons versus Andy’s 1.5 gallons). She has the comparative advantage in
the production of bread.
i) Who has the comparative advantage in the production of milk? The opportunity cost of producing milk, in terms of pounds
of bread give up, is lower for Andy (0.67 pounds versus Sandy’s 0.75). Andy as the comparative advantage in the
production of milk.