Production Possibilities
and Opportunity Costs
What is a Production
Possibilities Frontier (PPF)?
A graph that shows the
maximum combinations of
goods that can be produced
when resources and
technology are used efficiently
Scarcity & the PPF
Economics involves choice since
limited resources means that there
will be a limited output. A PPC
will show that as tradeoffs are
made, sacrifice or opportunity
costs are incurred.
A Quick Review of
Terminology
Opportunity Cost is defined as the value
of the next best alternative.
So…opportunity cost measures the
sacrifice we make when we are forced
to make choices due to scarcity.
For simplicity, lets take
a world with only 2
products
Lets use cola and pizza
(perhaps the flat pizzas
we serve at lunch)
Cola
A typical PPF has the following shape:
The curve has a
negative slope.
The curve is
concave to the
origin.
Pizza
Cola
All points on the curve correspond
to full use of resources.
A
B
Pizza
Cola
Points outside the PPF are not
feasible with existing resources.
.A
Pizza
Cola
Periods of unemployment or
inefficiency in production correspond
to points under the PPF.
.A
Pizza
Shape of the PPF? Why
Concave?
If PPF has a straight line, we
have constant opportunity
costs
If PPF concave, we have
increasing opportunity costs
Consider a straight line PPF
Cola given up, the
opportunity cost,
remains constant (10
colas forgone for
every additional
pizza produced).
Cola 40
30
20
10
1
2
3
4
Pizza
Concave shape, increasing
opportunity costs.
Cola given up, the
opportunity cost, is
increasing
Cola 40
30
20
10
1
2
3
4
Pizza
What is the Law of
Increasing Costs?
The opportunity cost of
producing a good
increases as more of the
good is produced
Why does the Law of
Increasing Opportunity
costs hold?
Because resources are not
perfectly adaptable to all
products … example next
page.
Say this is a company that can produce colas or pizzas, and let’s say that
they begin by producing all colas and no pizzas. When they decide to
produce their first pizza, they take away some of their resources from
producing colas. In terms of labor, the firm will take away those resources
that can easily produce pizzas as well as colas. But when
we begin to make more pizzas, we start to take
Cola 40
away resources that were REALLY
good at producing colas, and
are not so good at producing
30
pizzas.
20
10
1
2
3
4
Pizza
How do we have
more of everything?
By increasing our
resources, either land,
labor, capital, or
entrepreneurship
Cola
Economic growth indicates an increase
in the total output of an economy.
The PPF shifts
to the right !
Pizza
Causes of rightward
shifts in PPF’s?
Increase in resources
Increased productivity
Improved technology
Can a PPF shift inward
(to the left)?
YES!! For just the
opposite reasons as an
outward shift such as a
loss of resources
19
Capital goods
Economic growth and the Capital
Consumer goods tradeoff:
A
From which point would
an economy grow faster,
A or B?? Answer is A,
with more capital goods
B
Consumer goods
What should a country
specialize in producing?
In those goods and
services that it has a
comparative advantage
What is
Comparative Advantage?
A country’s ability to
produce a good at a lower
opportunity cost than the
country which it trades
What is
Absolute Advantage?
A country’s ability to
produce a good using fewer
resources than the country
with which it trades
Example: 2 people, 2 jobs, time
required
Job A
Job B
Judy
60 min.
75 min
Sam
90 min
150 min
In the table, Judy is absolutely
advantaged at both tasks – she
can work either job faster than
Sam. But what is her
comparative advantage? What
is Sam’s comparative
advantage?
Judy’s comparative advantage is
at job B, and Sam’s
comparative advantage is at job
A
To see why, look at the ratios in
the table- Judy can do job A in
2/3 the time of Sam, but she
can do job B in ½ the time, so
she is relatively more efficient
at job B.
Theory of comparative
advantage
Argues that output is
greater when resources
tend to specialize in their
greatest comparative
advantages
Problem
With the same quantity of resources,
Euphoria can produce 100 barrels of
cola to Extasia’s 50 barrels, and
Euphoria can produce 150 pizzas to
Extasia’s 100. According to
comparative advantage, what product
should Extasia tend to specialize in?
What about Euphoria?
ANSWER:
Extasia should specialize
in pizzas, Euphoria in
cola production
Conclusion
Production-possibility frontiers (and curves) help us
to be able to analyze opportunity costs and tradeoffs.
The analysis of opportunity costs can lead us to be
able to extend our analysis even further into
absolute advantage, comparative advantage, and
specialization.
Be sure to review these fundamental concepts, and
ask questions for clarification in cases where you
are not understanding.