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Course: Microeconomics > Unit 1
Lesson 3: Production possibilities frontier- Production possibilities curve
- Opportunity cost
- Increasing opportunity cost
- The Production Possibilities Frontier
- PPCs for increasing, decreasing and constant opportunity cost
- Lesson summary: the production possibilities frontier
- Interpreting graphs of the production possibilities curve (PPC)
- Calculating opportunity costs from a production possibilities curve (PPC)
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The Production Possibilities Frontier
Key Points
- The Production Possibilities Frontier (PPF) is a graph that shows all the different combinations of output of two goods that can be produced using available resources and technology. The PPF captures the concepts of scarcity, choice, and tradeoffs.
- The shape of the PPF depends on whether there are increasing, decreasing, or constant costs.
- Points that lie on the PPF illustrate combinations of output that are productively efficient. We cannot determine which points are allocatively efficient without knowing preferences.
- The slope of the PPF indicates the opportunity cost of producing one good versus the other good, and the opportunity cost can be compared to the opportunity costs of another producer to determine comparative advantage.
The Production Possibilities Frontier and Social Choices
Just as individuals cannot have everything they want and must instead make choices, society as a whole cannot have everything it might want, either. This section of the chapter will explain the constraints faced by society, using a model called the production possibilities frontier (PPF). There are more similarities than differences between individual choice and social choice. As you read this section, focus on the similarities.
Because society has limited resources (e.g., labor, land, capital, raw materials) at any point in time, there is a limit to the quantities of goods and services it can produce. Suppose a society desires two products, healthcare and education. This situation is illustrated by the production possibilities frontier in this graph.
In the graph, healthcare is shown on the vertical axis and education is shown on the horizontal axis. If the society were to allocate all of its resources to healthcare, it could produce at point A. But it would not have any resources to produce education. If it were to allocate all of its resources to education, it could produce at point F. Alternatively, the society could choose to produce any combination of healthcare and education shown on the production possibilities frontier. In effect, the production possibilities frontier plays the same role for society as the budget constraint plays for Alphonso. Society can choose any combination of the two goods on or inside the PPF. But it does not have enough resources to produce outside the PPF.
Most important, the production possibilities frontier clearly shows the tradeoff between healthcare and education. Suppose society has chosen to operate at point B, and it is considering producing more education. Because the PPF is downward sloping from left to right, the only way society can obtain more education is by giving up some healthcare. That is the tradeoff society faces. Suppose it considers moving from point B to point C. What would the opportunity cost be for the additional education? The opportunity cost would be the healthcare society has to give up. Just as with Alphonso’s budget constraint, the opportunity cost is shown by the slope of the production possibilities frontier. By now you might be saying, “Hey, this PPF is sounding like the budget constraint.” If so, read the following Clear It Up feature.
The Shape of the PPF and the Law of Diminishing Returns
The budget constraints presented earlier in this chapter, showing individual choices about what quantities of goods to consume, were all straight lines. The reason for these straight lines was that the slope of the budget constraint was determined by the relative prices of the two goods in the consumption budget constraint. However, the production possibilities frontier for healthcare and education was drawn as a curved line. Why does the PPF have a different shape?
To understand why the PPF is curved, start by considering point A at the top left-hand side of the PPF. At point A, all available resources are devoted to healthcare and no resources are left for education. This situation would be extreme and even ridiculous. For example, children are seeing a doctor every day, whether they are sick or not, but not attending school. People are having cosmetic surgery on every part of their bodies, but no high school or college education exists. Now imagine that some of these resources are diverted from healthcare to education, so that the economy is at point B instead of point A. Diverting some resources away from A to B causes relatively little reduction in health because the last few marginal dollars going into healthcare services are not producing much additional gain in health. However, putting those marginal dollars into education, which is completely without resources at point A, can produce relatively large gains. For this reason, the shape of the PPF from A to B is relatively flat, representing a relatively small drop-off in health and a relatively large gain in education.
Now consider the other end, at the lower right, of the production possibilities frontier. Imagine that society starts at choice D, which is devoting nearly all resources to education and very few to healthcare, and moves to point F, which is devoting all spending to education and none to healthcare. For the sake of concreteness, you can imagine that in the movement from D to F, the last few doctors must become high school science teachers, the last few nurses must become school librarians rather than dispensers of vaccinations, and the last few emergency rooms are turned into kindergartens. The gains to education from adding these last few resources to education are very small. However, the opportunity cost lost to health will be fairly large, and thus the slope of the PPF between D and F is steep, showing a large drop in health for only a small gain in education.
The lesson is not that society is likely to make an extreme choice like devoting no resources to education at point A or no resources to health at point F. Instead, the lesson is that the gains from committing additional marginal resources to education depend on how much is already being spent. If on the one hand, very few resources are currently committed to education, then an increase in resources used can bring relatively large gains. On the other hand, if a large number of resources are already committed to education, then committing additional resources will bring relatively smaller gains.
This pattern is common enough that it has been given a name: the law of diminishing returns, which holds that as additional increments of resources are added to a certain purpose, the marginal benefit from those additional increments will decline. When government spends a certain amount more on reducing crime, for example, the original gains in reducing crime could be relatively large. But additional increases typically cause relatively smaller reductions in crime, and paying for enough police and security to reduce crime to nothing at all would be tremendously expensive.
The curvature of the production possibilities frontier shows that as additional resources are added to education, moving from left to right along the horizontal axis, the original gains are fairly large, but gradually diminish. Similarly, as additional resources are added to healthcare, moving from bottom to top on the vertical axis, the original gains are fairly large, but again gradually diminish. In this way, the law of diminishing returns produces the outward-bending shape of the production possibilities frontier.
Productive Efficiency and Allocative Efficiency
The study of economics does not presume to tell a society what choice it should make along its production possibilities frontier. In a market-oriented economy, the choice will involve a mixture of decisions by individuals, firms, and government. However, economics can point out that some choices are unambiguously better than others. This observation is based on the concept of efficiency. In everyday usage, efficiency refers to lack of waste. An inefficient machine operates at high cost, while an efficient machine operates at lower cost, because it is not wasting energy or materials. An inefficient organization operates with long delays and high costs, while an efficient organization meets schedules, is focused, and performs within budget.
The production possibilities frontier can illustrate two kinds of efficiency: productive efficiency and allocative efficiency. The following graph illustrates these ideas using a production possibilities frontier between healthcare and education.
Productive efficiency means that, given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good. All choices on the PPF in this graph, including A, B, C, D, and F, display productive efficiency. As a firm moves from any one of these choices to any other, either healthcare increases and education decreases or vice versa. However, any choice inside the production possibilities frontier is productively inefficient and wasteful because it is possible to produce more of one good, the other good, or some combination of both goods.
For example, point R is productively inefficient because it is possible at choice C to have more of both goods: education on the horizontal axis is higher at point C than point R (E2 is greater than E1), and healthcare on the vertical axis is also higher at point C than point R (H2 is great than H1).
The particular mix of goods and services being produced—that is, the specific combination of healthcare and education chosen along the production possibilities frontier—can be shown as a ray (line) from the origin to a specific point on the PPF. Output mixes that had more healthcare (and less education) would have a steeper ray, while those with more education (and less healthcare) would have a flatter ray.
Allocative efficiency means that the particular mix of goods a society produces represents the combination that society most desires. How to determine what a society desires can be a controversial question, and is usually discussed in political science, sociology, and philosophy classes as well as in economics. At its most basic, allocative efficiency means producers supply the quantity of each product that consumers demand. Only one of the productively efficient choices will be the allocatively efficient choice for society as a whole.
Why Society Must Choose
Every economy faces two situations in which it may be able to expand consumption of all goods. In the first case, a society may discover that it has been using its resources inefficiently, in which case by improving efficiency and producing on the production possibilities frontier, it can have more of all goods (or at least more of some and less of none). In the second case, as resources grow over a period of years (e.g., more labor and more capital), the economy grows. As it does, the production possibilities frontier for a society will shift outward and society will be able to afford more of all goods.
But improvements in productive efficiency take time to discover and implement, and economic growth happens only gradually. So, a society must choose between tradeoffs in the present. For government, this process often involves trying to identify where additional spending could do the most good and where reductions in spending would do the least harm. At the individual and firm level, the market economy coordinates a process in which firms seek to produce goods and services in the quantity, quality, and price that people want. But for both the government and the market economy in the short term, increases in production of one good typically mean offsetting decreases somewhere else in the economy.
The PPF and Comparative Advantage
While every society must choose how much of each good it should produce, it does not need to produce every single good it consumes. Often how much of a good a country decides to produce depends on how expensive it is to produce it versus buying it from a different country. As we saw earlier, the curvature of a country’s PPF gives us information about the tradeoff between devoting resources to producing one good versus another. In particular, its slope gives the opportunity cost of producing one more unit of the good in the x-axis in terms of the other good (in the y-axis). Countries tend to have different opportunity costs of producing a specific good, either because of different climates, geography, technology or skills.
Suppose two countries, the US and Brazil, need to decide how much they will produce of two crops: sugar cane and wheat. Due to its climatic conditions, Brazil can produce a lot of sugar cane per acre but not much wheat. Conversely, the U.S. can produce a lot of wheat per acre, but not much sugar cane. Clearly, Brazil has a lower opportunity cost of producing sugar cane (in terms of wheat) than the U.S. The reverse is also true; the U.S. has a lower opportunity cost of producing wheat than Brazil. This can be illustrated by the PPFs of the two countries in the following graphs.
When a country can produce a good at a lower opportunity cost than another country, we say that this country has a comparative advantage in that good. In our example, Brazil has a comparative advantage in sugar cane and the U.S. has a comparative advantage in wheat. One can easily see this with a simple observation of the extreme production points in the PPFs of the two countries. If Brazil devoted all of its resources to producing wheat, it would be producing at point A. However, if it had devoted all of its resources to producing sugar cane instead, it would be producing a much larger amount, at point B. By moving from point A to point B Brazil would give up a relatively small quantity in wheat production to obtain a large production in sugar cane. The opposite is true for the U.S. If the U.S. moved from point A to B and produced only sugar cane, this would result in a large opportunity cost in terms of foregone wheat production.
The slope of the PPF gives the opportunity cost of producing an additional unit of wheat. While the slope is not constant throughout the PPFs, it is quite apparent that the PPF in Brazil is much steeper than in the U.S., and therefore the opportunity cost of wheat is generally higher in Brazil. Countries’ differences in comparative advantage determine which goods they will choose to produce and trade. When countries engage in trade, they specialize in the production of the goods that they have a comparative advantage in, and trade part of that production for goods they do not have a comparative advantage in. With trade, goods are produced where the opportunity cost is lowest, so total production increases, benefiting both trading parties.
Key Concepts and Summary
A production possibilities frontier defines the set of choices society faces for the combinations of goods and services it can produce given the resources available. The shape of the PPF is typically curved outward, rather than straight. Choices outside the PPF are unattainable and choices inside the PPF are wasteful. Over time, a growing economy will tend to shift the PPF outwards.
The law of diminishing returns holds that as increments of additional resources are devoted to producing something, the marginal increase in output will become smaller and smaller. All choices along a production possibilities frontier display productive efficiency; that is, it is impossible to use society’s resources to produce more of one good without decreasing production of the other good. The specific choice along a production possibilities frontier that reflects the mix of goods society prefers is the choice with allocative efficiency. The curvature of the PPF is likely to differ by country, which results in different countries having comparative advantage in different goods. Total production can increase if countries specialize in the goods they have comparative advantage in and trade some of their production for the remaining goods.
Self-Check Questions
Refer to this graph:
Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education?
Could a nation be producing in a way that is allocatively efficient, but productively inefficient?
What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?
Review Questions
What is comparative advantage?
What does a production possibilities frontier illustrate?
Why is a production possibilities frontier typically drawn as a curve, rather than a straight line?
Explain why societies cannot make a choice above their production possibilities frontier and should not make a choice below it.
What are diminishing marginal returns?
What is productive efficiency? What is allocative efficiency?
Critical Thinking Questions
During the Second World War, Germany’s factories were decimated. It also suffered many human casualties, both soldiers and civilians. How did the war affect Germany’s production possibilities curve?
It is clear that productive inefficiency is a waste since resources are being used in a way that produces less goods and services than a nation is capable of. Why is allocative inefficiency also wasteful?
Glossary
allocative efficiency: when the mix of goods being produced represents the mix that society most desires.
comparative advantage: when a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production
law of diminishing returns: as additional increments of resources are added to producing a good or service, the marginal benefit from those additional increments will decline
production possibilities frontier (PPF): a diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available.
productive efficiency: when it is impossible to produce more of one good (or service) without decreasing the quantity produced of another good (or service)
Want to join the conversation?
I dont know if i'm missing something but
"The budget constraints presented earlier in this chapter, showing individual choices about what quantities of goods to consume, were all straight lines"
presented earlier in this chapter where? in the videos he only talks about the PPC and opportunity costs(41 votes)
In the book 'Principles of Microeconomics' where this article is taken from, budget constraints are discussed first then PPF. Hence the sudden mention of Alphonso.(6 votes)
- I don't get the answer to this question:
"Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education?"
The answer states:
"Because of the improvement in technology, the vertical intercept of the PPF would be at a higher level of healthcare. "
I don't see why this would be the case. To me, a higher vertical intercept would mean that you could spend more money to get a higher level of healthcare, but the question says more healthcare can be provided "with the same amount of resources". I would think that the PPF would move in the direction of education, as it's suddenly cheaper in comparison to healthcare. Is this right?(8 votes)
Note the word improvement. It means you don't have buy a medicine which cost you let's say $10 instead you can buy the same medicine for $5 due to medical technology improvement. So you spend less and get more. Now the vertical intercept goes higher. In this case opportunity cost of education is going higher because you have to loose more healthcare(improved) to get more education.(7 votes)
What is a budget constraint? I'm pretty sure it wasn't mentioned in previous videos in this section.
Also, who is Alphonso?(9 votes)
Budget constraint is like what a person could afford within his or hers income(2 votes)
What happen if society wants less products than what are on the productive efficiency point? Should the government promote the product or what? And is this the case of allocative inefficiency?(8 votes)
In that case, the government does a marginal analysis and understands its comparative advantage with respect to importing the goods in demand. In any case, the most optimal and efficient way is preferred.(1 vote)
My Review Question Answers
1. A comparative advantage is when a country can produce a good faster and/or cheaper than another country, giving them an advantage over that good.
2. A PPF illustrates the efficient ways an economy can produce two products, with their available resources.
3. Because the curve shows the most efficient ways an economy can produce the products, using all the given resources. Everything inside the curve is inefficient and everything outside is impossible.
4. A society cannot make a choice above (or out) of the PPF because they don't have enough resources to do so. And they shouldn't make a choice in it because it's inefficient and does not use all available resources.
5. Diminishing marginal returns happen when you exceed the optimal limit of producing a product, thus making the marginal returns drop.
6. Productive efficiency is when you can't produce more of a good without decreasing the amount that another good is produced. Allocative efficiency is when the combination of goods produced is exactly what a society needs.
My Critical Thinking Question Answers
7. The war affected Germany's PPF by making it harder to produce goods, because they lost resources. And dramatically changing their needs.
8. Allocative inefficiency is also wasteful because we're producing too much of a good that is not being used, while we're lacking in another. (Ex. Oil>Education)
I think I got most of them right, but if you have any tips please let me know below. Thanks!(7 votes)- Your answers to the review questions and critical thinking questions demonstrate a good understanding of the concepts discussed. Your explanations are clear and concise. Just ensure that you're consistent with your definitions and terminology. For example, in question 5, you might want to clarify that the curve inside the PPF represents inefficient production, rather than saying it's impossible. Otherwise, your responses are well done! Keep up the good work.(1 vote)
- I don't agree with the statement that allocative efficiency must imply productive efficiency. What if on the horizontal axis of the PPF we plotted cigarettes, cocaine, opium and other drugs while on the vertical axis we plotted nuclear bombs or some other undesirable product? Wouldn't allocative efficiency occur at the origin?(4 votes)
- You raise a valid point. Allocative efficiency refers to producing the mix of goods and services that society most desires, but it does not necessarily imply productive efficiency. In the scenario you mentioned, if society desires a mix of harmful or undesirable products like cigarettes, cocaine, and nuclear bombs, allocative efficiency would occur at the origin (where no resources are allocated to production). However, this does not mean that the production process itself is efficient or productive, as producing harmful goods may have negative consequences for society despite fulfilling its desires.(1 vote)
- how does an increasing population affect a PPF(2 votes)
- It depends on what it is going against, For example, If we follow ceteris puribus and take population against employment, the graph will be steep because the number of employable positions is constant and with the rise of the population the only thing that will happen is the decrease in employment. The question thus is incomplete or it undermines the assumption of ceteris puribus.(2 votes)
- How to use clear it up feature??(2 votes)
- 1. hover over link.
2. it should start blinking like crazy.
3. move mouse to the very edge of feature
4. it will then stop blinking
5. sadly you will not be able to read the top.
:((1 vote)
"Output mixes that had more healthcare (and less education) would have a steeper ray, while those with more education (and less healthcare) would have a flatter ray."
According to the graph, there is quite opposite, isn't there?(1 vote)
Incorrect. You are probably thinking of the tangent line of the curve, which describes your claim.
The ray mentioned here refers to "a line from the origin to a specific point on the PPF". So if there is only healthcare (Point A), the ray will be vertical. And if there is only education, the ray will be horizontal.(2 votes)
- In the self-check questions, it is stated in the solution that both in consumer’s budget constraint and society’s production possibilities frontier, the graph shows the opportunity cost graphically as the slope of the constraint (budget or PPF).
I do not quite understand what it means.
I understand that budget constraint is a slope. But according to what I have learned in this lesson PPF is not a slope but a curve.
Or should I include a curve a type of slope as definition?(1 vote)- The term "slope" in this context refers to the rate at which one good can be substituted for another along the PPF. While the PPF is indeed a curve, its slope at any point represents the opportunity cost of producing one good in terms of the other. In the context of the budget constraint, the slope also represents the opportunity cost of consuming one good in terms of another. So, while the PPF is curved, its slope indicates the rate at which resources must be shifted from one good to another, similar to the budget constraint.(1 vote)