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Notes on Chapter 2
PRODUCTION POSSIBILITIES FRONTIER
This chapter reinforces the central themes of Chapter one by laying out the core
economic model, the PPF, and using it to illustrate the concepts of scarcity,
tradeoff and opportunity cost. It explains, with a model, the concepts of
marginal cost and marginal benefit, introduces efficiency, and explains how we
can expand production by accumulating capital and improving technology.
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 and services an economy can produce efficiently using its available
resources and technology within a given period of time.
It 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 common resources. i.e., the
same limited resources can be used to produce either of the goods.
2. The society has a fixed amount of technology
3. Full employment of resources
4. The choice is between producing two goods: Machines and Food. All
other goods and services are assumed being the same (ceteris paribus).
This assumption is to allow the use of simple graphical analysis.
Note that these assumptions are realistic for the short run but not for the long
run.
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
EXAMPLE:
The following table summarizes hypothetical choices, or production
possibilities that we confront. This is a production possibilities schedule.
Possibility Machines Food (in tons)
(Point) Per day per day
A 5 0
B 4 2
C 3 3
D 2 3.8
E 1 4.5
F 0 5
The numbers are plotted in the following graph that is called production
possibility frontier (PPF).
F
5 E
Y
D UNATTAINABLE
4
C
FOOD 3
X
2
B
ATTAINABLE
A
0
0 1 2 3 4 5 6
MACHINES
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.
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
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.
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?
Because the resources used to produce the 5th machine were transformed to
food production.
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) we can get when
all resources are fully employed.
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
Tradeoff
Every choice along the PPF involves a tradeoff. Changes in production from
one point on the PPF to another involve a tradeoff. Some of one good must be
forgone (given up) to gain more of the other good.
On this PPF, we must give up some machines to get more food or give up some
food to get more food. Thus, PPF has a negative slope
Thus, a country that must decrease production of one good in order to increase
the production of another must be producing on its PPF
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
There is no tradeoff when production points are inside the PPF because it is
possible to get more of some goods and services without producing less of
some other goods and services.
All tradeoffs involve a cost – an opportunity cost.
Opportunity Cost:
We have defined the opportunity cost of any action or choice as the highest-
valued alternative forgone. The concept of opportunity cost could be made
more precise using the PPF. Since there are only 2 goods, there is no difficulty
in working out the best alternative foregone.
At point A when we use all the resources to produce machines, foregone food
would become the opportunity cost of using all resources to produce machines.
At B, we produce 2 tons of food at the expense of not producing one machine.
Therefore, the opportunity cost of producing 2 tons of food is not producing –
giving up- one machine.
At C, the opportunity cost of producing the 3rd machine is to give up 0.8 ton of
food.
Each additional ton of food produced implies the loss (opportunity cost) of
machines. Likewise, every machine produced implies the loss of some food.
∆ Food
Opportunity cost of producing one more unit of machines =
∆ Machines
∆ Machines
Opportunity cost of producing one more ton of food =
∆ Food
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
Re-writing the PPF schedule and adding the opportunity cost of one more unit
(Marginal Cost)
Machines Food Possibilities OC of OC of
Possibility Per day (in (Points) producing producing
(Point) tons) one unit of One unit of
per day Machines Food
(MC of (MC of Food)
Machines)
A 5 0 ----- ------- -------
B 4 2 A and B 2 0.5
C 3 3 B and C 1 1
D 2 3.8 C and D 0.8 1.25
E 1 4.5 D and E 0.7 1.43
F 0 5 E and F 0.5 2
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
MC
MB
Food Food
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
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.
Allocative efficiency exists when the society has the right quantities of both
goods we prefer this point above all other points on the PPF.
Allocative efficiency exists where marginal benefit is equal to marginal cost or
where marginal benefit curve intersects marginal cost curve. At this point
resources are used efficiently.
MC
MB
Machines
A B C
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
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
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 capable of producing. To attain these
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
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 allocation of resources and the country now
has more of its goods and services. This is what is called economic growth (or
an increase in production capacity).
Economic growth is the increase of the output (or income) of the country. It is
the expansion of production possibilities.
Economic growth increases the well-being (standard of living) of the people,
but it does not overcome the scarcity and cannot avoid the opportunity cost.
Without economic growth, living standards will decline as the population
grows.
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
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
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
EXERCISES
1. Suppose that the PPF for two goods are
Possibility Food Machines
(point) (tons) (Numbers)
A 0 14
B 1 12
C 2 9
D 3 5
E 4 0
a. How many points are there in the PPF?
b. Draw the PPF for this society.
c. Is it possible to produce 3 units of food and 9 units of machines? Why? Is it
a good choice?
d. Is it possible to produce 2 units of food and 5 units of machines? Why? Is it
a good choice?
e. Is producing one ton of food and 5 machines attainable? is it efficient?
f. Calculate the opportunity costs of producing food from A to B, B to C, C to
D and D to E.
g. What is the opportunity cost of one machine if the economy moves its
production from points D to C?
h. What is the marginal cost if the economy moves its production from points
D to C?
i. What is the opportunity cost of 4 tons of food?
j. 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.
k. How does the PPF illustrate scarcity?
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
2. We can summarize the major PPF concepts through the points on the
following graph:
F
C G
D
B E
PPF1 PPF2
A
0 X
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Dr. Mohammed Alwosabi Econ 140 – Ch.2
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