Lecture 2

READING MATERIAL

• Sloman
– Ch.1 pp. 10-14.
THE PRODUCTION POSSIBILITIES FRONTIER
A Simple Model of the economy
(PPF) Frontier (PPF)
- Production Possibility

Assume that we have any economy with:

• a given quantity of productive resources (land, labour & capital)

• a given state of technology

This economy is capable of producing two products,

namely:

• bread
• wine
 THE PPF
Production Possibilities Frontier

26 00 Bread Wine
24 00
22 00
20 00
0 2000
18 00
1000 1800
Wine (Bottles)

16 00
14 00
12 00
10 00
2000 1400
8 00
6 00 3000 800
4 00
2 00 4000 0
0
0 500 1000 150 0 2 000 2 500 300 0 3500 4000 4 500 50 00

Bread (Loaves)

How much wine is this economy capable of producing if all its

resources are dedicated to wine production ?
 THE PPF
Production Possibilities Frontier

2600 Bread Wine

2400
2200
2000
0 2000
1800
1000 1800
Wine (Bottles)

1600
1400
1200
1000
2000 1400
800
600
3000 800
400
200 4000 0
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)

How much bread is this economy capable of producing if all its

resources are dedicated to bread production ?
 THE PPF
Production Possibilities Frontier

2600
2400
2200
2000
1800
Wine (Bottles)

1600 PPF
1400
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 THE PPF
Production Possibilities Frontier

2600
2400 This economy is capable of producing any
2200 combination of bread and wine that is on or
2000
1800 inside its PPF
Wine (Bottles)

1600
1400
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 THE PPF
Production Possibilities Frontier

2600
2400 Points outside the PPF are not obtainable
2200 given current productive resources
2000
1800
Wine (Bottles)

1600
1400
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 THE PPF
Production Possibilities Frontier

2600 For this economy to be at point on its PPF, it must:

2400 • all resources must be fully employed
2200
2000 • all resources are being used in a technically efficient way
1800
Wine (Bottles)

1600
1400
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 THE PPF
Production Possibilities Frontier

2600 If the economy is at a point inside its PPF, means:

2400
2200 • all resources are not being fully employed
2000
1800
and/or
Wine (Bottles)

1600 • production is technically inefficient

1400
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 THE PPF
Production Possibilities Frontier

2600 The major limitation of the PPF is that I t

2400 does not tell us what combination of output
2200
2000 The economy should produce.
1800 This will be determined by consumer
Wine (Bottles)

1600
1400 preferences (DEMAND side) considerations
1200
1000
800
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 OPPORTUNITY COST
Opportunity Cost is the amount of one good or service which must be
Given up (forgone) in order to produce or consume additional units of
another good or service

For example:
students who elect to go clubbing forgo the opportunity to
study Introduction to Economics
 OPPORTUNITY COST
Production Possibilities Frontier

2600
2400
2200
2000
1800 A Assume the economy is initially at point A
Wine (Bottles)

1600
1400
1200
1000
800
600
400 Now assume that due to a change in
200 consumer preference there is an
0
0
increase
500
in demand
1000 1500
for bread.
2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)
 OPPORTUNITY COST
Production Possibilities Frontier

2600
2400
2200 In moving from A to B
2000
1800 A
Wine (Bottles)

1600 Forego
1400
1200 400 bottles B
1000 Of wine
800
+ 1000 Bread Producing +1000 loaves of bread
600
400
200
0
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Bread (Loaves)

Opportunity cost of additional 1000 loves of bread (1000 to 2000)

= 400 bottles of wine (1800 to 1400)
 OPPORTUNITY COST
Production Possibilities Frontier

2600
2400
2200
2000
1800 A
In moving from B to C
Wine (Bottles)

1600
1400
1200
B
1000
800 Forego
600 600 bottles C
400 Of wine
200
0 + 1000 Bread
0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000
Producing +1000 loaves of bread
Bread (Loaves)

Opportunity cost of additional 1000 loves of bread (2000 to 3000)

= 600 bottles of wine (1400 to 800)
LAW OF INCREASING OPPORTUNITY COSTS
Note that as you produce more of one good the opportunity cost of
producing it increases.

This is reflected in the shape (bowed outward) of the PPF.

Opportunity cost of going from A to B was 400 wine

Opportunity cost of going from B to C was 600 wine

The reason we assume that there are increasing costs (and

therefore draw the PPF as being bowed outward from the origin) is
because we assume that some of the economy’s resources are
better suited to producing wine while other are better suited to
producing bread. Therefore as you produce more bread you start
using resources that are better suited to wine production and less
productive (higher cost) at producing bread.
 ECONOMIC GROWTH
Production Possibilities Frontier

2600 Unbiased economic growth is when the PPF

2400
2200 shifts out evenly and may result from
2000 increase in productive resources (eg an
1800
increase in population)
Wine (Bottles)

1600
1400
1200
1000
800
600
400 Economic Growth is
200
0 represented by an outward
0 shift
500 of an economy’s
1000 1500 2000 PPF
2500 3000 3500 4000 4500 5000
Bread (Loaves)
 ECONOMIC GROWTH
Production Possibilities Frontier

2600
2400
2200
2000
1800
Wine (Bottles)

1600
1400
1200
1000
800
600
400 Biased economic growth
200
0 might occur as a result of a
0 technological
500 1000 improvement
1500 2000 2500 3000 3500 4000 4500 5000
in one industry (eg wine)
Bread (Loaves)