The Economic Problem, Production

Possibilities Frontier (PPF)

Chapter 2
Outline
• Economic Problem
• Motivation – 2 examples
• Production Possibilities Frontier (PPF)
• Case 1 – linear PPF
• Case 2 – non-linear PPF
• PPF to
• Introduce the concept of opportunity cost and efficiency
• Characterize tradeoffs people face in society
• Characterize economic growth – production capacity

• Ultimately, we want to use the PPF to understand how scarce

resources are allocated
The Economic Problem
• Allocation of scarce resources.

• Satisfy unlimited wants with limited resources!

• What gets produced?
• How it is produced?
• Who gets what is produced?

• And so there are tradeoffs we as a society face:

• Use PPF to characterize these tradeoffs and
understand resource allocation.
Example 1: Growth vs. environment
• Pressing environmental challenges
• CO2 emissions from cars
• Need economic growth to raise incomes, decrease poverty,
etc.
• One policy approach: set stringent environmental standards
e.g., CAFE.
• Standards may raise costs which may undermine growth in the
short-run.
• But in the long-run better technology may increase the
production capacity of the economy.
• Tradeoff: quality of environment vs. economic growth
Example 2: Manufacturing vs agriculture in
South Korea
• South Korea put forward aggressive policies to turn its
economy into a “modern” economy;
• As a result S. Korea’s production shifted from agriculture to
manufacturing;
• Resources were re-allocated: away from agriculture and into
the manufacturing sector.
• Tradeoff: manufacturing vs. agriculture
The PPF: A Summary
• The PPF shows all combinations of two goods that an
economy can possibly produce during a given period
of time, given its resources and technology.

 The PPF illustrates the concepts of

opportunity cost and efficiency (waste,
unemployment), and economic growth.

 A bow-shaped PPF illustrates the concept of

increasing opportunity cost.
PPF: Case 1
• Case 1:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours available for production (limited
resource).
PPF Case 1
• Producing one computer requires 100 hours labor.
• Producing one ton of wheat req. 10 hours labor.
Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000
E 0 50,000 0 5,000
PPF Case 1
Production Wheat
Point
(tons)
on Com- 6,000
graph puters Wheat E
5,000
A 500 0 D
4,000
B 400 1,000
3,000 C
C 250 2,500
2,000
D 100 4,000 B
1,000
E 0 5,000 A
0
0 100 200 300 400 500 600
Computers
The PPF: What We Know So Far
Points on the PPF (like A – E)
• possible
• Production efficiency
Points under the PPF
• possible
• not efficient: some resources are underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF
• not possible
The PPF and Opportunity Cost
• Recall: The opportunity cost of an item
is what must be given up to obtain that item.
 Moving along a PPF involves shifting resources
(e.g., labor) from the production of one good to
the other.
 Society faces a tradeoff: Getting more of one
good requires sacrificing some of the other.
 The slope of the PPF tells you the opportunity
cost of one good in terms of the other.
The PPF and Opportunity Cost
Wheat
The slope of a line
(tons) equals the
–1000 “rise over the run”;
6,000 slope = = –10
100 this is our measure
5,000
of Opp. Cost.
4,000
3,000
2,000
1,000
Here, the
0 opportunity cost of
0 100 200 300 400 500 600 a computer is
Computers 10 tons of wheat.
 Opportunity Cost: More examples

What are some of the potential opportunity

costs of:

1. Going to graduate school?

2. Studying for your next econ test?
3. Playing computer games?
4. Opening a coffee shop?
Economic Growth and the PPF
Wheat
(tons) Economic
With additional growth shifts
6,000
resources or an the PPF
improvement in 5,000 outward.
technology, 4,000
the economy can
produce more 3,000
computers, 2,000
1,000
more wheat, 0
or any 0 100 200 300 400 500 600
combination in Computers
between.
The Shape of the PPF
• The PPF could be a straight line, or bow-shaped
• Depends on what happens to the opportunity cost
as the economy shifts resources from one industry to
the other.
• If opp. cost remains constant,
PPF is a straight line.
(In the previous example, opp. cost of a computer was always 10 tons of
wheat.)
• If opp. cost of a good rises as the economy produces more of the good,
PPF is bow-shaped.
Why the PPF Might Be Bow-Shaped – PPF
example 2
As the economy

Beer
shifts resources
from beer to
mountain bikes:
 PPF becomes
steeper
 opp. cost of
mountain bikes
increases
Mountain
Bikes
Why the PPF Might Be Bow-Shaped
At A, opp. cost of

Beer
At point A, A mtn bikes is low.
most workers are
producing beer,
even those that
are better suited
to building bikes.
So, do not have to
give up much beer
to get more bikes.
Mountain
Bikes
Why the PPF Might Be Bow-Shaped
At B, most workers are

Beer
producing bikes. At B, opp. cost
The few left in beer are of mtn bikes
the best brewers. is high.
Producing more bikes
would require shifting B
some of the best
brewers away from beer
production,
would cause a big drop
in beer output.
Mountain
Bikes
Why the PPF Might Be Bow-Shaped

• So, PPF is bow-shaped when different workers have

different skills, different opportunity costs of
producing one good in terms of the other.
• The PPF would also be bow-shaped when there is
some other resource, or mix of resources with
varying opportunity costs
(E.g., different types of land suited for
different uses).
The PPF: A Summary
• The PPF shows all combinations of two goods that an
economy can possibly produce,
given its resources and technology.
 The PPF illustrates the concepts of
tradeoff and opportunity cost,
efficiency and inefficiency,
unemployment, and economic growth.

 A bow-shaped PPF illustrates the concept of

increasing opportunity cost.