production possibility diagrams
TRANSCRIPT
Production Possibility Diagrams
EdExcel 1.1.4
Production Possibility Frontiers (PPF)
• We normally draw a PPF as concave to the origin i.e. when we move down along the PPF, as more resources are allocated towards Good Y the extra output gets smaller
• This is explained by the law of diminishing marginal returns, it occurs because not all factor inputs are equally suited to producing items leading to lower productivity
• Land, labour and capital are imperfect substitutes
A PPF shows alternative combinations of two goods or services attainable when all resources are fully and efficiently employed
A
B
C
Output of
Good X
Output of Good Y
X1
X2
X3
Y1 Y2 Y3
Remember to express output in a given time period
Production Possibility Frontier (PPF)
Output of Pizza
Output of Sugar
A
B
A, B and C are all efficient output combinations as they lie on the existing PPF
C
D
E
F
D and E are inefficient combinations – i.e. not all resources fully utilized
F is an output combination that is not yet attainable as it lies beyond the PPF
Understanding the PPF and Economic Efficiency
• Combinations of the output of consumer and capital goods lying inside the PPF happen when there are unemployed resources or when resources are used inefficiently. We could increase total output of goods and services by moving towards the PPF
• Combinations of goods and services that lie beyond the PPF are unattainable at the moment
• A country would require an increase in factor resources, an increase in productivity and/or an improvement in technology to achieve an outward shift of the PPF
• Trade between countries also allows nations to consume beyond their own PPF potentially leading to gains in economic welfare
• Producing more of both goods with the same resources represents an improvement in welfare and a gain in allocative efficiency
The PPF and Opportunity Cost
Output of Wheat
Output of Cotton
200
160
300 400
A
B
The opportunity cost of employing more resources into cotton production is expressed in terms of the output of wheat given up
One hundred extra tonnes of cotton involves sacrificing 40 tonnes of wheat – the opportunity cost is 4/10ths of a tonne of wheat for each extra tonne of cotton
Examiners are keen that you understand the concept of opportunity cost in relation to the PPF!
PPF, Diminishing Returns and Opportunity Cost
Output of Wheat
Output of Cotton
200
160
300 400
A
B
With diminishing returns, the marginal (extra) output of cotton diminishes as more factor resources are allocated to it.
C80
480
The result is that the opportunity cost measured in lost wheat output increases
To be productively efficient, an economy must be on its production possibility frontier
Drawing a Linear Production Possibility Frontier
Output of consumer
goods
Output of capital goods
PPF1
A straight line PPF is an indication of perfect factor substitutability of resources
90
60
30
10 25 40
If the production possibility frontier is a straight line, then the marginal opportunity cost of switching resources between consumer and capital goods is constant.
For example, the marginal opportunity cost of producing an extra 15 capital goods is 30 consumer goods i.e. the opportunity cost is 2 consumer goods per extra capital good
An Outward Shift in the Production Possibility Frontier
Output of consumer
goods
Output of capital goods
PPF1 PPF2
Changes in production technology or more factor inputs can cause the PPF to shift outwards – this leads to an increase in a country’s potential output
60
25 42
An improvement in the technology available to produce capital goods (other factors held constant) will lead to an outward shift in the production possibility frontier.
After the shift in the PPF more capital goods can be produced for each level of output of consumer goods
Causes of Shifts in the Production Possibility Frontier
Cause of an outward shift in the Production Possibility Frontier
Brief comment on the cause of the shift in the PPF
• Higher productivity / efficiency of factor inputs
This increases the output per unit of input used in production
• Better management of factor inputs
Improved management reduces waste and improves quality
• Increase in the stock of capital and labour supply
e.g. from inward labour migration / capital investment
• Innovation and invention of new products and resources
Improved production processes helps to boost efficiency
• Discovery / extraction of new natural resources (land)
Discovery of commercially viable land inputs drives extraction
Can the Production Possibility Frontier shift inwards?
Yes – productive potential can contract – here are some causes
Damaging effects of natural disasters such as drought, a tsunami, an earthquake and
severe floods
Destruction / loss of factor inputs caused by civil war and
other forms of conflict that last for many years
Large scale net outward labour migration e.g. due to an
economic depression that leads to a brain drain of skilled
workers
A trend decline in the productivity of inputs perhaps
caused by a persistent recession which causes net investment to
be negative
Causes of an inward shift of the
a nation’s PPF
Resource Depreciation and Resource Depletion
Resource Depreciation
Human Capital Flight
Capital Scrapping
Natural Disasters
Deforestation
Machinery Skills Atrophy
Buildings Basic Infrastructure
Resource Depletion
Economic Recovery and the PPF Diagram
During an economic recovery, aggregate demand will be rising. This
leads to an increase in real national
output and a fall in the amount of
spare capacity i.e. we move closer to the PPF boundary
from E to F
Capital goods
Consumer goods
PPF
A
B
C D
E
F
Economic Growth using PPF Diagrams
Economic GrowthA rise in a country’s
productive capacity causes the PPF to shift
out from PPF1 to PPF2 and this then allows
increased supply both of consumer and capital goods.
Capital goods
Consumer goods
PPF1
PPF2
A
B
C D
Successful supply-side policies can help to bring about an outward shift of the a country’s PPF
E
F
Production Possibility Diagrams
EdExcel 1.1.4