Production Possibility
Frontier
Chapter 2
What is Economics?
Economics is a social science. It examines the problems that
societies face because individuals desire to consume more
goods and services than are available, creating a condition of
relative scarcity.
“Economics is a science which studies human behaviour as a
relationship between ends and scarce means which have
alternative uses.”
- Lionel Robbins
(1932)
Of course, given we want to treat economics as a science, we
want to derive theoretical propositions that allows us to make
predictions that are verifiable using experimental and non-
experimental data.
What is Economics?
Scarcity has three important effects:
The need to make choice
The need for a rationing device – price in a market (an alternate is
first come first service)
Competition – people compete to have more of the rationing device to
avail more goods and services.
Microeconomics deal with questions of choice, allocation and distribution
of resources for individuals, firms and etc. and builds up to an analysis of
society.
It deals with three fundamental questions:
[Link] goods and services are produced?
[Link] to produce such goods and services?
[Link] gets what?
We will see that ‘price mechanism’ ultimately solves all these 3
three questions simultaneously.
Introduction
Every decision or choice has an
opportunity cost – the cost in
foregone opportunities.
Introduction
A production possibility curve is used
to illustrate opportunity cost.
The Production Possibilities
Model
The production possibilities curve
shows the trade-offs among choices
we make.
The Production Possibility
Table
A production possibility table lists
a choice's opportunity costs by
summarizing what alternative outputs
you can achieve with your inputs.
The Production Possibility
Table
Output – an output is simply a result
of an activity.
Input – an input is what you what
you put into a production process to
achieve an output.
The Production Possibility
Curve for an Individual
A production possibility curve
measures the maximum combination
of outputs that can be achieved from
a given number of inputs.
It slopes downward from left to right.
The Production Possibility
Curve for an Individual
The production possibility curve not
only represents the opportunity cost
concept, it also measures the
opportunity cost.
The Production Possibility
Curve for an Individual
The production possibility curve
demonstrates that:
There is a limit to what you can achieve,
given the existing institutions,
resources, and technology.
Every choice made has an opportunity
cost—you can get more of something
only by giving up something else.
A Production Possibility
Curve for a Society
The production possibility curve is
generally bowed outward.
Some resources are better suited for the
production of some goods than others.
A Production Possibility
Curve for a Society
Y
10
9 If the slope of the production
8 curve is -2 at A, the
A
7 2Y opportunity cost
.
6 of 1X is 2Y.
5 1X
4
3
2
1
0
1 2 3 4 5 6 7 8 9 X
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
A Production Possibility
Curve for a Society
Comparative advantage explains
why opportunity costs increase as the
consumption of a good increases.
Some resources are better suited for the
production of some goods than to the
production of other goods.
Increasing Opportunity Cost
A Production Possibilities
Table and Curve
% of resources % of resources
devoted to devoted to
production Number production Pounds
of guns of guns of butter of butter Row
0 0 100 15 A
20 4 80 14 B
40 7 60 12 C
60 9 40 9 D
80 11 20 5 E
100 12 0 0 F
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
A Production Possibilities
Table and Curve
1 pound 15 A
of butter B
14
2 pounds C
of butter 12
D
Butter
5 E
5 pounds
of butter
F
0 4 7 9 11 12 Guns
4 guns 3 guns 1 gun
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Question
Why is the production possibility
curve is not a straight line?
Butter
Gun
Increasing Marginal
Opportunity Cost
The principle of increasing
marginal opportunity cost states
that opportunity costs increase the
more you concentrate on an activity.
In order to get more of something,
one must give up ever-increasing
quantities of something else.
Efficiency
In production, we’d like to have
productive efficiency – achieving as
much output as possible from a given
amount of inputs or resources.
Efficiency
Efficiency involves achieving a goal as
cheaply as possible.
Efficiency has meaning only in
relation to a specified goal.
Efficiency
Any point within the production
possibility curve represents
inefficiency.
Inefficiency – getting less output
from inputs which, if devoted to
some other activity, would produce
more output.
Efficiency
Any point outside the production
possibility curve represents
something unattainable, given
present resources and technology.
Efficiency and Inefficiency
Unattainable point,
10 given available technology,
resources and labor force
8
Efficient C D
Guns
6
points
B
4
A
Inefficient
2 point
0
2 4 6 8 10
Butter
Production Possibility
Frontier
Two Types of Efficiency
Productive Efficiency-
• Products are being produced in the least costly
way.
• This is any point ON the Production Possibilities
Curve
Allocative Efficiency-
• The products being produced are the ones most
desired by society.
• This optimal point on the PPC depends on the
desires of society.
26
Productive and Allocative Efficiency
Productively Efficient
A
14 combinations are A through D
B G
12
Allocative Efficient
10 combinations depend on the
Bikes
wants of society
8
C
6 E (What if this represents a
4
country with low electricity?)
F
2
D
0
0 2 4 6 8 10
Computers 27
Can we produce outside the
production possibility curve?
Can we have more?
Shifts in the Production
Possibility Curve
Society can produce more output if:
Technology is improved.
More resources are discovered.
Economic institutions get better at
fulfilling our wants.
Economic Growth
Economic
Production
The economygrowth
can results
is initially
now in
at point
A outward
an(20
produce shift
fishmore
and of
25of
everything.
coconuts),
the PPF
because
move to point E (25
it can production
possibilities
fish and 30 coconuts).
are expanded.
Shifts in the Production
Possibility Curve
More output is represented by an
outward shift in the production
possibility curve.
Shifts in the Production
Possibility Curve
Neutral Technological Change
Butter
C
A
0 B D Guns
Shifts in the Production
Possibility Curve
Biased Technological Change
Butter
C
B
0
A Guns
What happens if there is an
increase in population?
Butter
Robot
What if there is a technology
improvement in pizza ovens ?
Gun
Pizza
Decrease in the demand for pizza
Q The curve doesn’t shift!
A change in demand
doesn’t shift the curve
Robots
Q
Pizzas 36
BP Oil Spill in the Gulf
Q
Capital Goods (Guns)
Decrease in resources
decrease production
possibilities for both
Q
Consumer Goods (Butter) 37
Distribution and Production
Efficiency
The production possibilities curve
focuses on productive efficiency and
ignores distribution.
Distribution and Production
Efficiency
In our society, more is generally
preferred to less and many policies
have relatively small distributional
effects.
Examples of Shifts in the
Production Possibility Curve
Test your understanding:
A meteor hits the world and destroys half
the earth’s natural resources.
Nanotechnology is perfected that lowers
the cost of manufactured goods.
Examples of Shifts in the
Production Possibility Curve
Test your understanding:
A new technology is discovered that
doubles the speed at which all goods can
be produced.
Global warming increases the cost of
producing agricultural goods.
