2.2 Production Possibilities Frontier

• How much can an economy produce with the resources available?

• What are the economy’s production capabilities?

Simplifying Assumptions

• 1. To reduce the analysis to manageable proportions, the model the output to two broad classes of production: Consumer goods, such as pizzas and haircuts, and Capital goods, such as pizza ovens and hair clippers.

• 2. The focus is on production during a given period- (ex. A year)

• 3. The resources available in the economy are fixed in both quantity and quality during the period.

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• 4. Society’s knowledge about how best to combine these resource to produce output-that is, the available technology-does not change during the year.

• Point of theses assumptions is to freeze the economy’s resources and technology for a period of time to focus on what possibly can be produced during that time.

Production possibilities frontier

• Shows the possible combinations of the two types of goods that can be produced when available resources are employed fully and efficiently.

• Efficiency means producing the maximum possible output from available resources.

Inefficient and unattainable production

• Inefficient production-

• Look on the board for the PPF Curve

• Law of increasing opportunity cost- states that each additional increment of one good requires the economy to give up successively large increments of the other good.

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• The laws of increasing opportunity cost also applies when moving from the production of capital goods to the production of consumer goods.

• When all resources in the economy are making capital goods, certain resources such as cows & farmland are of little use in making capital goods.

Con’t

• When resources shift from making capital goods to making consumer goods, few capital goods need be given up initially.

• As more consumer goods are produced, resources that are more productive in making capital goods must be used for making consumer goods reflecting the law of increasing opportunity cost.

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• If resources were perfectly adaptable to the production of both types of goods, the amount of consumer goods sacrificed to make more capital goods would remain constant.

• The PPF would be a straight line, reflecting the constant opportunity cost along the PPF

Shifts of the PPF

• Economic growth- an expansion in the economy’s production possibilities or stability to produce.

• Changes in Resources availability

• Work longer hours, retire later, or if the labor is more skilled the PPF shift outward (right)

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• Increase in other available resources, such as new oil discoveries the shift of the PPF outward (right)

• Decrease in availability of quality of resources shifts the PPF inward (left)

Increase in Stock of Capital Goods

• An economy’s PPF depends in part on its supply of the stock of capital goods.

• The more capital goods an economy produces during one period, the more output it can produce in the next period.

• Producing capital goods this period shifts the economy’s PPF outward (right) the next period.

• The choice b/w consumers goods and capital goods is really b/w present consumption and future production.

Technological Changes

• Shifts the economy’s PPF outward is a technological discovery that employs available resources more efficiently.

• Ex. Internet, telephone, fax, email.• Efficiency, the PPF describes the efficient

combinations of outputs that are possible, given the economy’s resources and technology.

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• The second is scarcity.• Given the stock of resources and technology, the

economy can produce only so much.• The PPF slopes downward, indicating that,as the

economy produces more of one good, it must produce less of the other good.

• Trade-off demonstrates opportunity cost.• Bowed-out shape of the PPF reflects the law of

increasing opportunity cost.

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• Shift outward reflects economic growth.

• The PPF need choice.

• That choice will determine not only current consumption but also the capital stock available next.