Microeconomics – Week 1. Production Possibility Frontier (PPF)
1.Production Possibility Frontier (PPF)
Under the field of macroeconomics, the production possibility frontier (PPF) represents the point
at which an economy is most efficiently producing its goods and services and, therefore, allocating
its resources in the best way possible. If the economy is not producing the quantities indicated by the
PPF, resources are being managed inefficiently and the production of society will dwindle. The
production possibility frontier shows there are limits to production, so an economy, to achieve
efficiency, must decide what combination of goods and services can be produced.
Let's turn to the chart below. Imagine an economy that can produce only wine and cotton. According
to the PPF, points A, B and C - all appearing on the curve - represent the most efficient use of
resources by the economy. Point X represents an inefficient use of resources, while point Y
represents the goals that the economy cannot attain with its present levels of resources.
As we can see, in order for this economy to produce more wine, it must give up some of the
resources it uses to produce cotton (point A). If the economy starts producing more cotton
(represented by points B and C), it would have to divert resources from making wine and,
consequently, it will produce less wine than it is producing at point A. As the chart shows, by moving
production from point A to B, the economy must decrease wine production by a small amount in
comparison to the increase in cotton output. However, if the economy moves from point B to C, wine
output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that
A, B, and C all represent the most efficient allocation of resources for the economy; the nation must
decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of
increasing its output is proportional to the cost of decreasing cotton production. Microeconomics – Week 1. Production Possibility Frontier (PPF)
Point X means that the country's resources are not being used efficiently or, more specifically, that
the country is not producing enough cotton or wine given the potential of its resources. Point Y, as
we mentioned above, represents an output level that is currently unreachable by this economy.
However, if there were changes in technology while the level of land, labour and capital remained
the same, the time required to pick cotton and grapes would be reduced. Output would increase, and
the PPF would be pushed outwards. A new curve, on which Y would appear, would represent the
new efficient allocation of resources.
When the PPF shifts outwards, we know there is growth in an economy. Alternatively, when the PPF
shifts inwards it indicates that the economy is shrinking as a result of a decline in its most efficient
allocation of resources and optimal production capability. A shrinking economy could be a result of a
decrease in supplies or a deficiency in technology.
An economy can be producing on the PPF curve only in theory. In reality, economies constantly
struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo
one choice for another, the slope of the PPF will always be negative; if production of product A
increases then production of product B will have to decrease accordingly.
2. Opportunity Cost
Opportunity cost is the value of what is foregone in order to have something else. This value
is unique for each individual. You may, for instance, forgo ice cream in order to have an extra
helping of mashed potatoes. For you, the mashed potatoes have a greater value than dessert. But
you can always change your mind in the future because there may be some instances when the
mashed potatoes are just not as attractive as the ice cream. The opportunity cost of an individual's
decisions, therefore, is determined by his or her needs, wants, time and resources (income).
This is important to the PPF because a country will decide how to best allocate its resources
according to its opportunity cost. Therefore, the previous wine/cotton example shows that if the
country chooses to produce more wine than cotton, the opportunity cost is equivalent to the cost of
giving up the required cotton production.
Let's look at another example to demonstrate how opportunity cost en