ECON 140
Ch.2: PPF
Dr. Mohammed Alowsabi
`
Chapter 2
1.
PRODUCTION POSSIBILITIES
FRONTIER
Dr. Mohammed Alwosabi
2.
3.
4.
This chapter reinforces the central
themes of Chapter one by laying out the
core economic model, the production
Possibilities Frontier (PPF), and using it to
illustrate the concepts of scarcity,
tradeoff and opportunity cost.
explain,
e
p a , with
t a model,
ode , tthe
e co
concepts
cepts o
of
marginal cost and marginal benefit,
introduce efficiency, and
explain how we can expand production
by accumulating capital and improving
technology.
2
1
Thus, the economic problem of allocating
resources (making choices) in a situation
of scarcity can be illustrated by explaining
the concept of the production possibilities
frontier (PPF).
` Production Possibilities Frontier (PPF) refers
to the maximum combinations of goods
g
and services an economy can produce
efficiently using its available resources and
technology within a given period of time.
` PPF is the boundary between the goods
and services that can be produced from
those that cannot.
`
The PPF model is a graphical illustration
with the following assumptions
1. The society has a fixed amount of
available resources and technology
2. Full employment of resources
3. The choice is between producing two
goods: Machines and Food.
` EXAMPLE:
The following table summarizes
hypothetical choices, or production
possibilities that we confront. This is a
production possibilities schedule.
`
3
4
`
Possibility
(Point)
Machines
(Units)
Food
(Tons)
A
B
C
D
E
F
5
4
3
2
1
0
0
2
3
3.8
4.5
5
The numbers are plotted in the following graph
that is called production possibility frontier (PPF).
6
5
F
Y
Unattainable
E
D
4
Food
C
3
2
X
Attainable
B
1
0
5
1
2
3
4
Machines
A
5
6
6
1
ECON 140
Ch.2: PPF
The PPF curve divides production space
into 3 distinct areas, (1) points on the PPF
curve (points like A, B, C, D, E, and F), (2)
points on the inside of the curve (points
like X), and (3) points outside the curve
(points like Y)
` Points either on or inside the frontier are
attainable with the current level of
resources and technology.
Dr. Mohammed Alowsabi
Points outside the frontier are unattainable
with the economy's current level of
resources and technology. We need more
than the available resources and
technology to reach there.
` Because scarcity forces the society to give
up one choice for another, the slope of the
PPF will always be negative, reflecting the
concept of trade off.
`
`
7
Possibility A shows that all resources are
devoted to producing machines and no
resources are available to produce food.
` Possibility B shows that if some of the
resources are assigned to produce 2 tons
of food, the production of machines would
be reduced to 4 machines. Why?
y Because
the resources used to produce the 5th
machine were transformed to food
production.
`
8
The pattern continues on to the possibility
F, where all resources are in the production
of food and no resources available to
produce machines. This results in 5 tons of
food and zero machines
` Points on the PPF represent the maximum
production ((output)
p
p ) we can g
get when all
resources are fully employed.
` Full Employment and Unemployment
` Efficiency and Inefficiency
` Tradeoff
` Opportunity Cost:
`
9
`
Efficiency means
1. Producing the maximum output from the
available resources used in production.
2. The use of the least-cost methods to
produce specific quantity of output.
3. Using the fewest resources to produce
specific quantity of a good or a service
4. We achieve production efficiency if we
cannot produce more of one good
without producing less of some other
good.
10
Opportunity Cost of Producing One
Additional Unit
` The opportunity cost of producing one
more unit of a good is the marginal cost of
that good. It is calculated as the following
Opportunity cost of producing one more unit
=
quantities of the good you must give up
quantities of the good you will get
O pportunity cost of producing one more unit of machines
=
∆ Food
∆ Machines
O pportunity cost of producing one more ton of food
=
11
∆ Machines
∆ Food
12
2
ECON 140
Ch.2: PPF
Increasing Opportunity Costs
` Because resources are not all equally
productive in all activities, the PPF bows
outward (PPF is concave).
` The outward bow of the PPF means that as
the quantity produced of each good
increase,
c ease, its
ts opportunity
oppo tu ty cost increases.
c eases
` The law of increasing opportunity cost says
that we must give up increasing quantities
of other goods and services in order to get
more of a particular good.
`
Dr. Mohammed Alowsabi
Production Efficiency and Allocative
Efficiency
` All points on the PPF represent production
efficiency.
` Production efficiency occurs when we
cannot produce more of one good without
giving
g
g up some
so e of
o the
t e ot
other
e good
good.
` But which point on the PPF gives the
society the best allocation of resources on
both goods (i.e., which point has allocative
efficiency)?
13
14
To determine the optimal (efficient)
quantities of each good the society should
produce, we should compare marginal
costs and marginal benefits.
The PPF and Marginal Cost
` The limits to production, which are
summarized by the PPF, determine the
marginal cost of each good and service.
` Marginal cost is the opportunity cost of
producing one more unit of a good.
` Since marginal cost of producing one more
unit of a good equals its opportunity cost,
marginal cost increases as we produce
more of that good.
15
16
Marginal Cot
Marginal Benefit
MC
MB
Food
Food
17
Preferences and Marginal Benefit
` People have different preferences.
` Preferences are description of person's
likes and dislikes.
` To describe preferences economists use
the concepts of marginal benefit.
` Marginal benefit of a good is the benefit
received from producing (or consuming)
one more unit of the good.
` We measure the marginal benefit of a good
or service by how much a person is willing
to pay for an additional unit of it.
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3
ECON 140
`
Ch.2: PPF
The marginal benefit curve shows the
relationship between the marginal benefit
of a good or a service and the quantity
produced (or consumed) of that good or
service. The more we have of any good or
service, the smaller is its marginal benefit
and the less we are willing to pay for an
additional unit of it. The curve slopes
downward to reflect the principle of
decreasing marginal benefit.
Allocative Efficiency
` When we cannot produce more of any good
without giving up some of the other good
that we value more highly we have
achieved Allocative efficiency, where the
society has the right quantities of both
goods we prefer
g
p
this point
p
above all other
points on the PPF.
` Allocative efficiency exists where MB=MC
or where MB curve intersects MC. At this
point resources are used efficiently.
19
The most favorite point with
Production and allocative
efficiency
A
B
C
20
At point A in the graph below we can see
the marginal benefit of the machines is
greater than the marginal cost. This means
the society wants more machines. Thus the
society will transfer some of the resources
to produce more machines and less food
` At point C the marginal cost of machine
production exceeds the marginal benefit
benefit.
This means the society has more machines
than necessary. Therefore, resources will
be taken from machine production to
produce more food.
`
More F than necessary
and less M than needed
Food
Dr. Mohammed Alowsabi
More machines than
necessary and less
food than needed
Machines
MC
MB
Machines
A
`
B
C
21
Point B is the optimal point. It is the only
point on the PPF that has both production
efficiency and allocative efficiency where
marginal benefit of producing the two
goods is equal to the marginal cost. At
point B the society produce the right (the
optimal) amount of both goods.
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22
Economic Growth
` All output combinations outside the PPF
are unattainable with the available
resources and technology. At these
combinations, we could get more goods
and services than what we are currently
p
g To attain these
capable
of p
producing.
combinations, the two key factors are
1. Capital accumulation is the growth of
capital resources, which includes human
capital (increasing or improving the
quality of resources
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4
ECON 140
Ch.2: PPF
2. Technological change is the development
of new goods and of better ways of
producing goods and services.
` Any of these changes will shift PPF
outward to reach new points.
` The new PPF would represent the new
efficient
e c e t allocation
a ocat o of
o resources
esou ces and
a d the
t e
country now has more of its goods and
services. This is what is called economic
growth.
Dr. Mohammed Alowsabi
Economic growth is the increase of the
output (or income, or production capacity)
of the country.
` Economic growth is represented by the
expansion of production possibilities.
` Economic growth increases the well-being
(standard
(sta
da d o
of living)
g) of
o the
t e peop
people,
e, but itt
does not overcome the scarcity and cannot
avoid the opportunity cost.
` Without economic growth, living standards
will decline as the population grows.
`
25
The cost of economic growth
` To expand our production possibilities in
the future, we must devote fewer resources
to producing consumption goods and
more resources to accumulating capital
and developing technologies so that we
can produce
p
more consumption
p
goods
g
in
the future. Some consumption must be
given up today so that more capital goods
can be produced.
` The opportunity cost of more future
consumption is the loss of current
consumption.
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Balanced and Imbalanced Growth
` If the capital accumulation and /or the
advancement in the technology result in an
increase in the production in all sectors
there will be a balanced outward shift of
the PPF (balanced economic growth).
` But
ut if there
t e e is
s an
a increase
c ease in tthe
e resources
esou ces
and/or new advancement in the technology
that lead to a development of only one
sector or one good the growth would be
imbalanced.
27
`
For example if a new technology
discovered that makes machine production
more efficient and more productive the PPF
outward shift will affect only machine
sector and will not affect the food sector,
at least in the short run.
28
`
Balanced Economic Growth
F
F
M
29
Imbalanced
Economic Growth
M
30
5
ECON 140
Ch.2: PPF
Inward Shift
` When the PPF shifts out, we know the
economy is growing. Alternatively, when
the PPF shifts inward, it indicates that the
economy is shrinking as a result of a
decline in its most efficient allocation of
resources and optimal
p
production
p
capability.
` A shrinking economy could be a result of
war or natural disaster that results in a
decrease in production or a deficiency in
technology which might move the PPF
inward and to the left.
`
`
Dr. Mohammed Alowsabi
Example:
We can summarize the major PPF concepts through
the points on the following graph:
Y
C
F
G
G D
B
0
A
E PPF1 PPF2 X
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1. At point A: Society is not able to produce either
good because it is so inefficient.
2. At point B: Society is producing inside the PPF1.
Society is employing some of its available
resources but not all of them. Some of resources
are unemployed, operating inefficiently, can
produce more of X without giving up some of Y.
Zero opportunity cost.
3. At points C & D: Society is producing on the PPF1.
It is employing the most output possible with the
available resources and technology. Full
employment of resources. Efficient use of
resources. Producing more of one good implies
producing less of another good.
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4. At points E & F (on PPF2): Society might be able to
produce these combinations if resources
increased or technology improved but cannot
produce it with current resources and technology
(of PPF1).
5. At point G: Society might be able to produce this
combination if resources increased or technology
improved more than what is available in PPF2.
6. An increase in capacity to produce (i.e., economic
growth) can be represented by movement from C
or D to E (or F) [PPF shifts outward] {not from B to
C or D; not from C to D}
7. An increase in unemployment can be represented
by movements from C or D to B.
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8. Decrease in unemployment (increase in
employment) can be represented from B to C or
D.
9. A movement from D to C (or from F to E) is a
reallocation of resources from X to Y.
10. A shift from PPF1 to PPF2 could be caused by: 1)
an increase in quantity of resources, 2) improve
quality of workers and other resources, and 3)
improve or discoveries of new technology.
11. If the opportunity cost producing X was zero at
all levels of production, the PPF would best be
represented by a horizontal straight line.
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34
12. If the opportunity cost producing Y was zero at
all levels of production, the PPF would best be
represented by a vertical straight line.
13. Any economic backwardness because of wars,
natural disasters, a decrease in the available
resources or supply of labor, etc. leads to an
inward shift of PPF (e.g., from PPF2 to PPF1).
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6
ECON 140
Ch.2: PPF
Dr. Mohammed Alowsabi
1. How many points are there in the PPF?
2. Draw the PPF for this society.
3. Is it possible to produce 3 units of food and 9
EXERCISE:
Suppose that the PPF for two goods are
units of machines? Why? Is it a good choice?
Possibility Food Machines
(Tons) (numbers)
A
0
14
B
1
12
C
2
9
D
3
5
E
4
0
4. Is it possible to produce 2 units of food and 5
units of machines? Why? Is it a good choice?
5. Is producing one ton of food and 5 machines
attainable? is it efficient?
6. Calculate the opportunity costs of producing
food from A to B, B to C, C to D and D to E.
7. What is the opportunity cost of one machine if
the economy moves its production from points
D to C?
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38
8. What is the marginal cost if the economy
moves its production from points D to C?
9. What is the opportunity cost of 4 tons of
food?
10.Assume a discovery of new technology that
will reduce the costs of machine production,
what will happen to the PPF of the society?
Draw the new PPF on the same diagram.
g
11.How does the PPF illustrate scarcity?
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7