The production possibility frontier (curve): the PPF or PPC
The starting point in our economic analysis is to consider what an economy can produce. As consumers we may want many things, but there is a limit to what our economy can actually produce. This can be analysed using the production possibility frontier (PPF). In this unit we examine the factors that determine how much an economy can produce and the implications of different output decisions. LEARNING OBJECTIVES
By the end of this unit you should be able to: ✔ understand what is meant by a production possibility frontier; ✔ analyse the shape and the position of the production possibility frontier; ✔ understand the concept of productive efﬁciency.
■ Scarcity and choice
In Unit 1 we saw how the study of economics was based around the issue of scarcity and choice. As consumers our wants are unlimited, but there is a limit to what an economy can produce because of a scarcity of resources. As consumers and voters we are, of course, interested in what an economy can produce. What an economy is capable of producing can be shown on a production possibility frontier.
■ The production possibility frontier (PPF)
The production possibility frontier or curve (PPF or PPC) shows the maximum output that can be produced in an economy at any given moment, given the resources available. If an economy is fully utilising its resources then it will be producing on the PPF. To keep
2: The production possibility frontier
Product A (units)
Q0 Q1 X
Product B (units)
Figure 2.1 Transferring resources out of producing product A into producing product B.
our analysis simple we consider an economy that produces only two products, A and B (see Fig. 2.1). Imagine that all of an economy’s resources, such as land, labour and capital, were used in industry A. Then Q0 of A would be produced and none of B would be made. Alternatively, if all resources were transferred to industry B then Q5 of B would be produced and none of A would be made. If resources were divided between the two industries then a range of combinations of products is possible. For example, at point X the economy produces Q1 of product A and Q2 of product B; alternatively, resources could be allocated differently between the two industries and it could produce at point Y, producing Q3 of A and Q4 of B. All of the points on the frontier, such as X and Y, are said to be productively efﬁcient because they are fully utilising the economy’s resources. This is attractive because it shows that resources are being used properly and not wasted. When an economy is productively efﬁcient it can only produce more of one product by producing less of another; resources have to be shifted from one product to another. The PPF therefore illustrates the concept of opportunity costs. As more units of product B are produced this involves shifting resources into industry B and out of industry A: this will involve sacriﬁcing product A. Some units of A will be sacriﬁced to produce more of product B; the amount sacriﬁced is the opportunity cost. For example, the opportunity cost of producing the extra Q4 − Q2 units of B is Q1 − Q3 units of A.
Foundations of economics
Now you try it
Using Fig. 2.2 calculate the opportunity cost of the 5th unit of B in terms of the number of units of A sacriﬁced.
Product A (units)
5 4.5 3.5
0 1 2 3 4 5
Product B (units)
Figure 2.2 A production possibility frontier.
The importance of opportunity cost
The concept of opportunity cost is extremely important in economics and business. It represents the opportunities foregone. Whenever a manager makes a strategic decision he/she is deciding to lead the business in one direction rather than another. Sometimes this works; for example,...