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CHAPTER-3
Production possibility frontiers (PPFs) depict the maximum productive potential of an
economy, using a combination of two goods or services, when resources are fully and
efficiently employed.
Margin- a point of possible change.
Economic efficiency: where scarce resources are used in the most efficient way to produce
maximum output.

The basic concept of economic efficiency stems from this fundamental economic problem.
Economic efficiency is said to exist when it could be judged that all of our scarce resources are
being used in the ‘best’ possible way. This means that the greatest possible level of infinite
wants is being met with those scarce resources. In agriculture, for example, it is where
maximum crop yields result from farming a given area of land, or in manufacturing, where as
much output as possible is produced from a given set of inputs. Economic efficiency is a very
important concept in Economics. It is something that is always judged to be desirable. It
represents the best possible solution to the economic problem.

Allocative efficiency: This occurs when firms produce the combination of goods and services
that are most wanted by consumers. The implication is that there is no waste and both producers
and consumers are satisfied with what is produced.

Productive efficiency: This occurs when firms produce at the lowest possible cost. A firm is
productively efficient when it is making the best use of resources and producing at the lowest
cost possible. For example, it can apply where a car assembly plant is using the most up-to date
technology, minimising the cost of producing each vehicle.

 Points A and B are productively efficient.

 Point D is inefficient because you could produce more goods or services with no
opportunity cost
 Point C is currently impossible.
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The PPF below shows the maximum number of houses (on the horizontal axis) and vehicles
(on the vertical axis) that can be made, using the existing level of resources in an economy.

Points A, B, C and D (and every other point on the PPF) are all achievable without using any
extra resources. However, they are only achievable when all the available resources are used
as efficiently as is actually possible.
• Notice how, as you move along the curve from A to B, you’re building more houses (about
22 500 instead of 1000) but fewer vehicles (80 000 instead of 120 000).
• Moving along the curve from A to B like this corresponds to allocating more resources to the
production of houses, and fewer resources to the production of vehicles.
• In other words, there’s a trade-off between ‘building more houses’ and ‘making more
vehicles’ — to do more of one, you have to do less of the other.

 All points on the PPF are productively efficient because all resources are used as
efficiently as possible to produce the maximum possible output. However, not all points
on the PPF are allocatively efficient because not all points will reflect the production
of goods that people want or need — e.g. if all resources are used to produce vehicles,
this might not match society’s need for houses.
 Point E lies outside the PPF, so it isn’t achievable using the current level of resources
in the economy. To build that many houses and vehicles at the same time, extra (or
better) resources would need to be found.
 Point F lies inside the PPF (rather than on it) — this means making this mix of goods
is productively inefficient. With the current level of resources, you could build more
houses without making fewer vehicles (or more vehicles without making fewer houses).

Economic Growth shifts the PPF

 A PPF shows what’s possible using a particular level of resources (e.g. a particular
number of people, a particular amount of capital and raw materials, and so on).
 If this level of resources is fixed, then movements along the PPF just show a
reallocation of those resources
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 However, if the total amount of resources changes, then the PPF itself moves.

 For example, increased resources (e.g. an increase in the total number of workers)
would mean that the total possible output of that economy would also increase — so
the PPF shifts outward.
 For the economy shown by this PPF, the extra output could be either more houses or
more vehicles or a combination of both.

 Improved technology or improvements to labour (e.g. through training) can also shift
the PPF outwards, because it allows more output to be produced using the same
resources.
 An outward shift of the PPF shows economic growth

 When fewer total resources are available (e.g. after some kind of natural disaster), the
opposite happens — the PPF shifts inwards, showing that the total possible output has
shrunk. This shows negative economic growth.

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 In this example, the possible output has grown because of improved technology.
However, this particular technology can only help with house-building — this means
the PPF has been stretched in only the horizontal direction.

 A further case is where opportunity cost is constant. The production possibility curve
in this case is a straight line as shown in Figure 1.8. This indicates that every additional
unit of agriculture that is produced requires the sacrifice of the same amount of
manufactured goods.

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 In Figure 1.9b, however, only the ability to produce agricultural products has been
improved. This could perhaps be because there has been a technological breakthrough
in producing agricultural products, which does not apply to the production of
manufactured products. Nevertheless, this economy’s production possibilities have
improved and the curve has shifted outwards from the origin.

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