The Production Possibility
Frontier
• A model used to highlight and clarify
scarcity, and issues such as
efficiency, tradeoffs,
opportunity cost and growth,
which are associated with scarcity
1
PPF: Efficiency (Micro Focus Def’n)
• resources must be allocated to the production
of goods & services that people want the most
“getting the best mix”
allocative efficiency
production must be carried on in the
least costly way

productive efficiency
2
P.P.F. Assumptions
• All resources (land, labour, capital,
other) are used
• Productive efficiency is achieved
• Given point in time
– Resources are fixed in quantity but can be
shifted around
– Technology doesn’t change
• Only 2 goods are produced in this
economy
3
Production possibilities of pizza & robots
with full employment, yr. 2009
Production alternatives
TYPE OF PRODUCT
A
B
C
D
E
Pizza (in hundred thousands)
0
1
2
3
4
Robots (in thousands)
10
9
7
4
0
4
Industrial Robots (1000’s)
10
9
PPF Diagram
A
B
8
7
6
5
Any point on the frontier is
Productively Efficient.
It may or may not be
Allocatively Efficient
C
D
4
3
2
I
Any point within the frontier is
productively inefficient
E
1
1
2
3
4
5
6
7
8
Pizzas (100, 000’s)
5
PPF Highlights
– The PPF is “bowed out”:
• the opportunity cost (how much of one
good is sacrificed to produce one of
the other good) depends on how much
of each the economy is producing
• as more pizzas are produced the
opportunity cost of pizzas in terms of
robots
increases
6
Production possibilities of pizza & robots
with full employment, yr. 2006
Production alternatives
TYPE OF PRODUCT
A
B
C
D
E
Pizza (in hundred thousands)
0
1
2
3
4
Robots (in thousands)
10
9
7
4
0
7
Industrial Robots (1000s)
PPF Diagram
10
9
A
B
8
7
6
5
The opportunity cost of increasing
Pizza production from 2 to 3 is
3,000 robots
C
The opportunity cost of increasing
Pizza production from 3 to 4
4,000 robots
D
4
3
2
E
1
1
2
3
4
5
6
7
8
Pizzas (100, 000s)
8
• This is the
PPF Highlights
–Law of increasing relative cost
• not all resources are equally productive
in producing all things - resources are
not perfect substitutes for each other;
• that is, some resources have
comparative advantage over other
resources
• Therefore opportunity costs increase
for each additional good produced
9
Industrial Robots (1000’s)
10
9
PPF Diagram
A
Any point on the frontier is
Productively Efficient.
It may or may not be
Allocatively Efficient
B
8
7
6
5
C
The more specialized the inputs,
the more bowed out the frontier
D
4
3
2
I
Any point within the frontier is
productively inefficient
E
1
1
2
3
4
5
6
7
8
Pizzas (100, 000’s)
10
Change Assumptions
– increase quantity &/or quality of
resources  growth
» PPF shifts to the right
– improve technology  growth
» PPF shifts to the right
– decrease quantity &/or quality of
resources  negative growth
» PPF shifts to the left
– technology decrease  negative
growth
» PPF shifts to the left
11
Industrial Robots (1000s)
Growth
10
9
Growth occurs when the
Production Possibility
Curve shifts to the right
8
7
6
5
Old PPF
4
3
2
New PPF
1
1
2
3
4
5
6
7
8
Pizzas (100, 000s)
12
Growth – Capital and
Consumption Goods
Consumption Goods
-good produced primarily for
consumption
-bread, Xbox 360’s, TV shows
-do not cause growth
Capital Goods
-goods that can be used to produce more
goods
-factories, universities, robots
13
PPF Highlights
– Economic Growth results from
• 1.) technological change and
• 2.) capital accumulation (resource
base)
– The opportunity cost of faster
economic growth is a decrease in
current consumption

NOTICE the affect of present
choices on future growth.
14
Growth depends
on the choices
made today, a
sacrifice of current
consumption
results in more
capital today and
“growth” in the
future
Industrial Robots (1000s)
Growth
10
9
8
7
6
5
PPF, yr. 1998
4
3
2
PPF, yr. 2009
1
1
2
3
4
5
6
7
8
Pizzas (100, 000s)
15
Comparative Advantage:
Specialization and Trade
• Specialization and trade, and therefore
markets that facilitate trade, make
society better off by increasing the
productivity of scarce resources
• Comparative Advantage is the basis for
the gains from specialization and trade
16
Theory of Comparative Advantage:
• Production Possibilities :
– Carl and Mike: retired neighbours:
hobbies are making wine and beer
PPF’s for 1 month using same equipment and time..
Mike’s Production
Possibilities
Carl’s Production
Possibilities
A
B
C
A
B
C
Wine (btls)
0
30
100
0
40
80
Beer (btls.)
1,000
700
0
80
40
0
17
Absolute Advantage
• When a producer with of set of inputs
can produce more output than another
with the same inputs, the first producer
has an absolute advantage in production
of the output.
• Carl has an absolute advantage in the
production of both wine and beer.
18
Carl’s Proposition
• “Since we are both being pressured to
produce more, lets each of us do what
we do best and trade. This will give
each of us more than we now have
without either of us working any
harder.”
• Notice that voluntary trade does not
take place unless both parties benefit.
19
Bottles of
beer
1000–
Mike’s Production Possibilities/
Opportunity Costs
In a month Mike can produce either
80 bottles of wine or 80 bottles of beer
900–
Opp cost of 80 wine is 80 beer
Opp cost of 1 wine is 1 beer
825–
800–
Opp cost of 80 beer is 80 wine
Opp cost of 1 beer is…………
700–
600–
500–
400–
300–
200–
175–
80–
40–
•A
0
|
10
|
20
|
30
B Consumption choice before trade
•| | | | | C| | |
40 45 50
60
70
•80
90
100
Bottles of
wine
20
Carl’s Production Possibilities/
Opportunity Costs
Bottles of
beer
Opp cost 100 wine is 1000 beer
Opp Cost 1 wine is 10 beer
•A
1000–
Opp cost of 1000 beer is 100 wine
Opp Cost 1 beer is…………..
900–
800–
B Consumption choice before trade
•
700–
600–
500–
400–
300–
200–
100–
0
C
|
10
|
20
| | |
30 35 40
|
50
|
60
|
70
|
80
|
90
|
•100
Bottles of
wine
21
Comparative Advantage
• When producer A has a lower opportunity
cost of producing good A compared to
another producer, then producer A is said to
have a comparative advantage in the
production of good A.
Opportunity Cost Table
Opportunity
cost of 1 beer
Opportunity
cost of 1 wine
Carl
1/10 wine
10 beer
Mike
1 wine
1 beer
22
Comparative Advantage: Specialization
• Carl has a “comparative advantage” (lowest
opportunity cost producer) in the production of
beer and therefore specializes in beer
production.
• Mike has a “comparative advantage” in the
production of wine and therefore specializes in
wine production
• As long as opportunity costs differ, there is
comparative advantage
23
Comparative Advantage: Specialization
Theory of Comparative Advantage
• if specialization takes place according
to comparative advantage (the lowest
opportunity cost producer) and then
trade takes place…. both parties can
benefit: that is, move outside their
current PPF’s.
24
Carl & Mike Before Specialization & Trade
Carl Produces &
Consumes
Mike Produces &
Consumes
+
=
Total
Consumption
Wine (btls.)
30
40
70
Beer (btls.)
700
40
740
Carl & Mike After Specialization, but Before Trade
Carl Produces &
Can Consume
Wine (btls.)
Beer (btls.)
+
Mike Produces &
Can Consume
=
Total
Production &
Consumption
Total
Gains
0
80
80
+10
1,000
0
1,000
+260
25
Trade: The Benefits of Specialization
• Carl proposes, after specialization, that he
trade Mike 175 beer for 35 wine.
(terms of trade: 5 beer for 1 wine)
Carl gets wine for a reduced sacrifice
–35 wine for 175 beer instead of 350 beer, the
opportunity cost before trade
Mike gets beer for a reduced sacrifice
–175 beer for 35 wine instead of 175 wine, the
opportunity cost before trade
26
Terms of Trade: 1 Wine for 5 Beer
• Since voluntary trade requires that both
parties benefit from the trade.
Carl is better off as he now only
• Before trade:
has to give up 5 beer for a wine
• Carl: 1 wine “trades” for 10 beer
After trade 1 wine “trades” for 5 beer
• Mike: 1 wine trades for 1 beer
Mike is better off as he now only
has to give up 1/5 wine for a beer
•The Terms of Trade are between the personal
ones that exist before trade, thus producing
gains for both parties participating in the trade
27
Trade Between Carl & Mike
175 Bottles of
Beer
Carl
(specializes
in beer)
1 Wine trades for 5 Beer
or
1 Beer trades for 1/5 Wine
Mike
(specializes
in wine)
35 Bottles of
Wine
Before trade Mike gave up 1 wine to get 1 beer, after trade1/5 wine
Before trade Carl gave up 10 beer to get a wine, after trade 5 beer
28
Carl & Mike After Specialization & Trade
Carl
Produces
Wine (btls.)
Beer (btls.)
Trades
For (+)
Away (-)
0
1,000
+35
-175
Produces
Trades
For (+)
Away (-)
Consumes
After
Trade
35
825
Produced &
Consumed
Before Trade
30
700
Gains
from
Trade
+5
+125
Mike
Wine (btls.)
Beer (btls.)
80
0
-35
+175
Consumes
After
Trade
45
175
Produced &
Consumed
Before Trade
40
40
Gains
from
Trade
+5
+135
29
Mike’s Production Possibilities
After Trade
Bottles of
beer
1000–
900–
825–
800–
700–
Mike produces 80 wine and then trades
35 wine for 175 leaving him with 45 wine
and 175 beer, point D
600–
500–
400–
300–
200–
175–
80– A
40–
•
0
B
|
10
|
20
|
30
•
•| |
D Consumption after trade
|
40 45 50
C
|
60
|
70
•80|
|
90
|
100
Bottles of
wine
30
Carl’s Production Possibilities/
Opportunity Costs, After Trade
Bottles of
beer
Carl produces 1000 beer and trades 175 beer
to Mike for 35 wine, leaving him with 825 beer
and 35 beer, point D
•D Consumption after trade
•A
1000–
900–
825–
800–
B
•
700–
600–
500–
400–
300–
200–
100–
0
C
|
10
|
20
| | |
30 35 40
|
50
|
60
|
70
|
80
|
90
|
•100
Bottles of
wine
31
Gains from Specialization
• Specialization produces gains for both
traders, even when one trader enjoys an
absolute advantage in both endeavors.
• Specialization
– Uses differences in individual skills
– Breaks tasks into simple steps which
multiplies the productivity of workers by
deepening skills via practice
32