Dr. Mohammed Alwosabi Econ 140 – Ch.

Notes on Chapter 2
PRODUCTION POSSIBILITIES FRONTIER

— This chapter reinforces the central themes of Chapter one by laying out the core
economic model, the PPF, and using it to illustrate the concepts of scarcity,
tradeoff and opportunity cost. It explains, with a model, the concepts of
marginal cost and marginal benefit, introduces efficiency, and explains how we
can expand production by accumulating capital and improving technology.
— The economic problem of allocating resources (making choices) in a situation
of scarcity can be illustrated by explaining the concept of the production
possibilities frontier (PPF).
— Production Possibilities Frontier (PPF) refers to the maximum combinations
of goods and services an economy can produce efficiently using its available
resources and technology within a given period of time.
— It is the boundary between the goods and services that can be produced from
those that cannot.
— The PPF model is a graphical illustration with the following assumptions
1. The society has a fixed amount of available common resources. i.e., the
same limited resources can be used to produce either of the goods.
2. The society has a fixed amount of technology
3. Full employment of resources
4. The choice is between producing two goods: Machines and Food. All
other goods and services are assumed being the same (ceteris paribus).
This assumption is to allow the use of simple graphical analysis.
— Note that these assumptions are realistic for the short run but not for the long
run.

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 Dr. Mohammed Alwosabi Econ 140 – Ch.2

EXAMPLE:
— The following table summarizes hypothetical choices, or production
possibilities that we confront. This is a production possibilities schedule.
Possibility Machines Food (in tons)
(Point) Per day per day
A 5 0
B 4 2
C 3 3
D 2 3.8
E 1 4.5
F 0 5

— The numbers are plotted in the following graph that is called production
possibility frontier (PPF).

PPF FOR MACHINES AND FOOD

F
5 E
Y
D UNATTAINABLE
4
C
FOOD 3
X
2
B
ATTAINABLE

A
0
0 1 2 3 4 5 6
MACHINES

— The PPF curve divides production space into 3 distinct areas, (1) points on the
PPF curve (points like A, B, C, D, E, and F), (2) points on the inside of the
curve (points like X), and (3) points outside the curve (points like Y)
— Points either on or inside the frontier are attainable with the current level of
resources and technology.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

— Points outside the frontier are unattainable with the economy's current level of
resources and technology. We need more than the available resources and
technology to reach there.
— Because scarcity forces the society to give up one choice for another, the slope
of the PPF will always be negative, reflecting the concept of trade off.
— Possibility A shows that all resources are devoted to producing machines and
no resources are available to produce food.
— Possibility B shows that if some of the resources are assigned to produce 2 tons
of food, the production of machines would be reduced to 4 machines. Why?
Because the resources used to produce the 5th machine were transformed to
food production.
— The pattern continues on to the possibility F, where all resources are in the
production of food and no resources available to produce machines. This results
in 5 tons of food and zero machines
— Points on the PPF represent the maximum production (output) we can get when
all resources are fully employed.

Full Employment and Unemployment

— From the assumptions stated earlier, all resources must be fully employed in
order for the economy to be operating on the PPF.
— If all available resources are not used (i.e., unemployment of some of the
resources), country ends up inside its PPF, producing less output than they
could have.
— A reduction in unemployment moves the economy’s point of production closer
to the PPF. When the society is closer to the PPF that means it is closer to full
employment.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

Efficiency and Inefficiency

— All of the choices on PPF are efficient although they are not equally desirable.
— Efficiency means
1. Producing the maximum output from the available resources used in
production.
2. The use of the least-cost methods to produce specific quantity of
output.
3. Using the fewest resources to produce specific quantity of a good or
a service
4. Using factors of production in the most productive way.
5. All points on the PPF are efficient points.
6. We achieve production efficiency if we cannot produce more of one
good without producing less of some other good.
— With inefficient production, we end up on the inside of the PPF
— Inefficiency is a result of some unemployed (unused) resources or
misallocation (waste, under-use) of the resources, or both. Misallocation means
assigning resources not to their best use.
— Point X in the graph above means that the country's resources are not being
used efficiently. At such a point it is possible to produce more of one good
without producing less of the other good.

Tradeoff
— Every choice along the PPF involves a tradeoff. Changes in production from
one point on the PPF to another involve a tradeoff. Some of one good must be
forgone (given up) to gain more of the other good.
— On this PPF, we must give up some machines to get more food or give up some
food to get more food. Thus, PPF has a negative slope
— Thus, a country that must decrease production of one good in order to increase
the production of another must be producing on its PPF

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

— There is no tradeoff when production points are inside the PPF because it is
possible to get more of some goods and services without producing less of
some other goods and services.
— All tradeoffs involve a cost – an opportunity cost.

Opportunity Cost:
— We have defined the opportunity cost of any action or choice as the highest-
valued alternative forgone. The concept of opportunity cost could be made
more precise using the PPF. Since there are only 2 goods, there is no difficulty
in working out the best alternative foregone.
— At point A when we use all the resources to produce machines, foregone food
would become the opportunity cost of using all resources to produce machines.
— At B, we produce 2 tons of food at the expense of not producing one machine.
Therefore, the opportunity cost of producing 2 tons of food is not producing –
giving up- one machine.
— At C, the opportunity cost of producing the 3rd machine is to give up 0.8 ton of
food.
— Each additional ton of food produced implies the loss (opportunity cost) of
machines. Likewise, every machine produced implies the loss of some food.

Opportunity cost of producing one additional unit

— The opportunity cost of producing one more unit of a good is the marginal cost
of that good. It is calculated as the following
quantities of the good you must give up
— Opportunity cost of producing one more unit =
quantities of the good you will get

∆ Food
Opportunity cost of producing one more unit of machines =
∆ Machines
∆ Machines
Opportunity cost of producing one more ton of food =
∆ Food

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

— Re-writing the PPF schedule and adding the opportunity cost of one more unit
(Marginal Cost)
Machines Food Possibilities OC of OC of
Possibility Per day (in (Points) producing producing
(Point) tons) one unit of One unit of
per day Machines Food
(MC of (MC of Food)
Machines)
A 5 0 ----- ------- -------
B 4 2 A and B 2 0.5
C 3 3 B and C 1 1
D 2 3.8 C and D 0.8 1.25
E 1 4.5 D and E 0.7 1.43
F 0 5 E and F 0.5 2

Increasing Opportunity Costs

— It is difficult to move resources from one industry to another because they are
not all equally productive in all activities. People have different skills and
abilities, land is better suited to some uses rather than others, and the equipment
used to make one good may not be suitable for making another good.
— Because resources are not all equally productive in all activities, the PPF bows
outward (PPF is concave).
— The outward bow of the PPF means that as the quantity produced of each good
increase, its opportunity cost increases.
— The difficulties in transferring factors of production from one industry to
another are so common that we often speak of the law of increasing
opportunity cost. This law says that we must give up increasing quantities of
other goods and services in order to get more of a particular good. The law is
not based solely on the limited use of resources in areas other than what they
are specialized in, but also the mix of factors of production makes a difference
as well.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

PRODUCTION EFFICIENCY AND ALLOCATIVE EFFICIENCY

— All points on the PPF represent production efficiency. Production efficiency
occurs when we cannot produce more of one good without giving up some of
the other good.
— But which point on the PPF gives the society the best allocation of resources on
both goods (i.e., which point has allocative efficiency)?
— To determine the optimal (efficient) quantities of each good the society should
produce, we should compare marginal costs and marginal benefits.

The PPF and Marginal Cost

— The limits to production, which are summarized by the PPF, determine the
marginal cost of each good and service.
— Marginal cost is the opportunity cost of producing one more unit of a good.
Since marginal cost of producing one more unit of a good equals its opportunity
cost, marginal cost increases as we produce more of that good.

Marginal Cot Marginal Benefit

MC

MB

Food Food

Preferences and Marginal Benefit

— People have different preferences. Preferences are description of person's likes
and dislikes. To describe preferences economists use the concepts of marginal
benefit.
— Marginal benefit of a good is the benefit received from producing (or
consuming) one more unit of the good.
— We measure the marginal benefit of a good or service by how much a person is
willing to pay for an additional unit of it.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

— The marginal benefit curve shows the relationship between the marginal benefit
of a good or a service and the quantity produced (or consumed) of that good or
service. The more we have of any good or service, the smaller is its marginal
benefit and the less we are willing to pay for an additional unit of it. The curve
slopes downward to reflect the principle of decreasing marginal benefit.

Allocative Efficiency
— When we cannot produce more of any good without giving up some of the other
good that we value more highly we have achieved Allocative efficiency.
— Allocative efficiency exists when the society has the right quantities of both
goods we prefer this point above all other points on the PPF.
— Allocative efficiency exists where marginal benefit is equal to marginal cost or
where marginal benefit curve intersects marginal cost curve. At this point
resources are used efficiently.

More food than necessary and fewer

machines than needed
Food
A The most favorite point with
Production and allocative efficiency
B
More machines than necessary and
C less food than needed
PPF
Machines

MC

MB
Machines
A B C

— At point A in the graph below we can see the marginal benefit of the machines
is greater than the marginal cost. This means the society wants more machines.
Thus the society will transfer some of the resources to produce more machines
and less food

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

— At point C the marginal cost of machine production exceeds the marginal

benefit. This means the society has more machines than necessary. Therefore,
resources will be taken from machine production to produce more food.
— Point B is the optimal point. It is the only point on the PPF that has both
production efficiency and allocative efficiency where marginal benefit of
producing the two goods is equal to the marginal cost. At point B the society
produce the right (the optimal) amount of both goods.

Economic Growth
— All output combinations outside the PPF are unattainable with the available
resources and technology. At these combinations, we could get more goods and
services than what we are currently capable of producing. To attain these
combinations, the two key factors are
1. Capital accumulation is the growth of capital resources, which includes
human capital (increasing or improving the quality of resources
2. Technological change is the development of new goods and of better
ways of producing goods and services.
— Any of these changes will shift PPF outward to reach new points. The new PPF
would represent the new efficient allocation of resources and the country now
has more of its goods and services. This is what is called economic growth (or
an increase in production capacity).
— Economic growth is the increase of the output (or income) of the country. It is
the expansion of production possibilities.
— Economic growth increases the well-being (standard of living) of the people,
but it does not overcome the scarcity and cannot avoid the opportunity cost.
— Without economic growth, living standards will decline as the population
grows.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

The cost of economic growth

— To expand our production possibilities in the future, we must devote fewer
resources to producing consumption goods and more resources to accumulating
capital and developing technologies so that we can produce more consumption
goods in the future. Some consumption must be given up today so that more
capital goods can be produced. The opportunity cost of more future
consumption is the loss of current consumption.

Balanced and Imbalanced Growth

— If the capital accumulation and /or the advancement in the technology result in
an increase in the production in all sectors there will be a balanced outward
shift of the PPF (balanced economic growth).
Food Food
B
a
l
B
B
Machines Machines

Balanced Economic Growth Imbalanced Economic Growth

— But if there is an increase in the resources and/or new advancement in the

technology that lead to a development of only one sector or one good the
growth would be imbalanced. For example if a new technology discovered that
makes machine production more efficient and more productive the PPF outward
shift will affect only machine sector and will not affect the food sector, at least
in the short run.

Inward Shift
— When the PPF shifts out, we know the economy is growing. Alternatively,
when the PPF shifts inward, it indicates that the economy is shrinking as a

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

result of a decline in its most efficient allocation of resources and optimal

production capability. A shrinking economy could be a result of war or natural
disaster that results in a decrease in production or a deficiency in technology
which might move the PPF inward and to the left.

EXERCISES
1. Suppose that the PPF for two goods are
Possibility Food Machines
(point) (tons) (Numbers)
A 0 14
B 1 12
C 2 9
D 3 5
E 4 0
a. How many points are there in the PPF?
b. Draw the PPF for this society.
c. Is it possible to produce 3 units of food and 9 units of machines? Why? Is it
a good choice?
d. Is it possible to produce 2 units of food and 5 units of machines? Why? Is it
a good choice?
e. Is producing one ton of food and 5 machines attainable? is it efficient?
f. Calculate the opportunity costs of producing food from A to B, B to C, C to
D and D to E.
g. What is the opportunity cost of one machine if the economy moves its
production from points D to C?
h. What is the marginal cost if the economy moves its production from points
D to C?
i. What is the opportunity cost of 4 tons of food?
j. Assume a discovery of new technology that will reduce the costs of machine
production, what will happen to the PPF of the society? Draw the new PPF
on the same diagram.
k. How does the PPF illustrate scarcity?

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

2. We can summarize the major PPF concepts through the points on the
following graph:

F
C G

D
B E

PPF1 PPF2
A
0 X

1. At point A: Society is not able to produce either good because it is so

inefficient.
2. At point B: Society is producing inside the PPF1. Society is employing
some of its available resources but not all of them. Some of resources are
unemployed, operating inefficiently, can produce more of X without giving
up some of Y. Zero opportunity cost.
3. At points C & D: Society is producing on the PPF1. It is employing the most
output possible with the available resources and technology. Full
employment of resources. Efficient use of resources. Producing more of one
good implies producing less of another good.
4. At points E & F (on PPF2): Society might be able to produce these
combinations if resources increased or technology improved but cannot
produce it with current resources and technology (of PPF1).
5. At point G: Society might be able to produce this combination if resources
increased or technology improved more than what is available in PPF2.
6. An increase in capacity to produce (i.e., economic growth) can be
represented by movement from C or D to E (or F) [PPF shifts outward] {not
from B to C or D; not from C to D}
7. An increase in unemployment can be represented by movements from C or
D to B.

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Dr. Mohammed Alwosabi Econ 140 – Ch.2

8. Decrease in unemployment (increase in employment) can be represented

from B to C or D.
9. A movement from D to C (or from F to E) is a reallocation of resources
from X to Y.
10. A shift from PPF1 to PPF2 could be caused by: 1) an increase in quantity of
resources, 2) improve quality of workers and other resources, and 3)
improve or discoveries of new technology.
11. If the opportunity cost producing X was zero at all levels of production, the
PPF would best be represented by a horizontal straight line.
12. If the opportunity cost producing Y was zero at all levels of production, the
PPF would best be represented by a vertical straight line.
13. Any economic backwardness because of wars, natural disasters, a decrease
in the available resources or supply of labor, etc. leads to an inward shift of
PPF (e.g., from PPF2 to PPF1).

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