Production Possibilities Frontier (PPF)

• Scarcity is an issue for every society, requiring decisions on what, how, and for whom to produce

Production Possibilities Frontier (PPF)

• Represents the boundary between combinations of goods and services that can and cannot be produced
• Factors including available resources and technology, affect production boundaries
• The PPF is a tool illustrating effects of scarcity and its consequences

Production Possibilities Assumptions

• Fixed resources are assumed

• There is full employment of resources

• Technology is fixed

• Only two products: capital and consumer goods involved

• Tesla faces trade-offs in deciding which models to produce more or less of

Opportunity Cost

• Defined as the highest-valued alternative that must be given up to do an activity
• Tesla faces a trade-off to build more sedans, and must build fewer SUVs

Production Possibility Frontier Analysis

• Efficient combinations are located on the frontier
• Maximum output is achieved from resources/technology
• PPF separates attainable from unattainable combinations

Combinations

• Attainable combinations on the PPF
• Unattainable combinations are beyond the PPF

Production

• Efficient production is where more of one good/service cannot be produced without reducing another
• Inefficient production is where more could be produced, but resources not used appropriately

Trade-Offs

• Trade-off involves giving up something to get something else

• A "free lunch" is getting something without giving up something else

• Combinations inside the PPF are attainable but inefficient, with more output possible

Production Possibility Frontier

• Curve shows maximum attainable combinations of two products from available resources
• Output combination unattainable due to current resources sits outside the PPF

PPF Implications

• Points along the PPF curve means a trade-off must occur if a company wants to produce more of either an SUV or Sedan
• Movement from a point inside of the PPF to the PPF does not involve a trade-off

Increasing Marginal Opportunity Costs

• Bowed-out shape illustrates concept of increasing marginal opportunity costs
• Production of an additional unit’s (i) cost also incurs increasing marginal opportunity costs
• Demonstrates concept of diminishing returns, where payoff decreases with additional resources

Marginal Opportunity Costs

• As the economy moves along the PPF, increasing production of one good requires larger decreases in another
• To increase wheat production from 0 to 200 units, give up 50 units of wool
• To increase wheat production from 200 to 400 units, give up 150 units of wool

Economic Growth

• Defined as the expansion of society's potential production

• Better technology, improved labour, or increased capital leads to economic growth

• Shifts the PPF outward when an economy’s resources increase.

• With economic growth, the economy can increase production of both wool and wheat

• Shifts in PPF represents economic growth

Gains from Specialisation and Trade

• Production possibility frontier and opportunity cost concept explain economic gains from specialisation and trade

• Example: trade between neighbours producing apples and cherries measured in kilograms

• Trade (i) - The act of buying or selling a good or service in a market

Comparative Advantage, Specialisation and Trade

• Shows how many kgs of apples and cherries each neighbour can pick per month
• Table summarises the changes in production and consumption as resulted from trade with a neighbour

Economic Concepts

• Table 2.2 Summarises production and consumption changes resulting from trade with one's neighbours

Absolute Advantage

• Is the ability to produce more of a good/service than competitors while using the same amount of resources

Comparative Advantage

• Is the ability to produce a good/service at a lower opportunity cost than other producers

• Table 2.3 Summarises opportunity costs for apples and cherries

Basis for Trade

• Based on opportunity costs
• It is more correct to guess that the basis for trade is comparative advantage
• Specialising and trading goods/services where they have a comparative advantage benefits individuals, firms and countries