Chapter 2 Gillespie Powerpoint

The production possibilities
frontier
Chapter 2
Learning outcomes
By the end of this chapter, you should be able to:
• understand what is meant by a production possibilities frontier (PPF),
also known as a production possibility curve (PPC);
• analyse the shape and the position of the PPF;
• understand the concept of productive efficiency; and
• understand the concept of economic growth.
Introduction
One of the key questions in economic thought is to consider what an
economy can produce given its resources.
As consumers, we may want many things, but there is a limit to what our
economy can actually produce to meet these demands.
These issues of scarcity and choice can be analysed using the production
possibilities frontier (PPF).
In this chapter, we examine the factors that determine how much an

economy can produce and the implications of different output decisions.
Scarcity and choice
• As consumers, our needs and wants are unlimited, but there is a limit
to what an economy can produce because of a scarcity of resources.
• A scarcity of resources means that we need to carefully choose the
goods and services to be produced, and what we would forgo.
• What an economy can produce can be shown on a production
possibilities frontier (PPF), also known as a production possibility
curve (PPC).
The production possibilities frontier (PPF)
• The production possibilities frontier (PPF) shows different combinations of
the maximum output that can be produced in an economy at any given
moment, given the available resources and technology.
• If an economy is fully utilising its resources, then it will be producing on the
PPF.
• To have productive efficiency is to be fully utilising the economy’s
resources. This is attractive because it shows that resources are being used
properly and are not wasted.
• At any point where the economy is productively efficient, it can only
produce more of one product by producing less of another; resources have
to be shifted from the production of one product to another (due to the
scarcity of resources).
• The PPF therefore illustrates the concept of opportunity costs.
Reallocation of resources
• The PPF shows all of the combinations of products that an economy
can produce given its present resources and technology.
• Any combination of products on the frontier is productively efficient,

so to have more of one product produced, there will inevitably be a
reduction in the amount of the other produced due to the
reallocation of resources.
Allocating resources in an economy
• In a free market economy, the decisions about what to produce are
determined by market forces of supply and demand. As these market
conditions change, the number of different products produced would
change.
• Market forces, triggered by an increase in demand for the product, would
therefore lead to a reallocation of resources from one industry into another.
• In a planned economy, decisions about what to produce are
determined by government instructions and directives.
• This intervention may happen if the government does not trust market forces
to produce what it regards as the right combinations of products for society.
• Government intervention may lead to surpluses and shortages. The lack of
the profit incentive may also mean that resources are used inefficiently, and
that the economy operates within the PPF.
Market forces, triggered by an increase in
demand for the product, would therefore lead
to a reallocation of resources from one
industry into another. This can be seen as a
movement from B to D.
Figure 2.3 Producing on the production possibilities frontier is productively efficient. (p. 26)
Productive inefficiency
• If an economy is producing a combination of products on the PPF, then it is
productively efficient.
• However, an economy may be operating within the frontier, in which case it
is productively inefficient.
• Example:
An economy may be operating within the frontier → G
If an economy was to produce at point D and not G, then it
would be making more of both cameras and smartphones
Inefficiency may occur if there is a lack of demand in the
economy, so that although it can produce at D, customers can
only afford the combination of products at G
Figure 2.4 Producing within the

production possibilities frontier is
productively inefficient. (p. 28)
Shifting the production possibilities frontier
outward
• Once on the PPF, an economy can only produce more of both products by
shifting the PPF outward – that is, by increasing the amount of both
products that can be produced with the economy’s resources.
• This is what happens over time when the capacity of an economy grows.
The growth in the potential output of the economy enables more goods
and services to become available to consumers. This is known as an
increase in the aggregate supply of the economy.
• An outward shift of the production possibilities frontier might be due to:
• more training and better management of employees, enabling them to be more
productive;
• greater investment in capital goods, such as machines and equipment. In the short
run, this would mean that resources would have to be shifted from consumption
goods toward capital goods
• an increase in the size of the working population
• improvements in technology, providing better ways of doing things
Consumption outside the production
possibilities frontier
The PPF shows what an economy can produce given its
available resources. However, it is possible for an economy
to consume outside the frontier through international
trade. It may well be that another country can produce
some items more efficiently than your economy can, and
that your economy is able to produce some products more
efficiently than your partners abroad. By trading with each
other both countries can benefit.
Figure 2.5 International trade allows Figure 2.6 The benefits of international trade.
consumption outside the production (p. 30)
possibilities frontier. (p. 30)
The shape of the production possibilities
frontier
• So far, we have drawn the PPF as concave to the origin. This is
because of the assumptions that we make about what happens when
resources to output are transferred from one industry to another.
There are different ways of explaining this:
1. Resources are not perfectly substitutable.
2. The returns to a factor of production.
Figure 2.7 The shape of the production Figure 2.8 The shape of a production possibilities
possibilities frontier when there are constant frontier when there are diminishing returns. As
returns. (p. 32) resources are transferred into industry B, there
are diminishing returns: successively less is
produced each time. (p. 32)
Key learning points
• Given the present resources of an economy, there is a maximum
combination of products that can be produced. This is shown by the
PPF.
• The combination of goods and services produced may be determined,
in theory, by the government or by market forces, or, in reality, by a
combination of the two.
• If an economy operates on the PPF it is productively efficient.
• Economic growth can be seen by an outward shift of the PPF.
• By trading abroad, a country can consume outside its PPF.

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Chapter 2 Gillespie Powerpoint

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The production possibilities

In this chapter, we examine the factors that determine how much an

• Any combination of products on the frontier is productively efficient,

Figure 2.4 Producing within the

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