A production possibility frontier (PPF) shows the maximum potential level of output for two goods or services that an economy can achieve when all its resources are fully and efficiently employed, given the level of technology available.
Therefore, the assumptions when drawing a PPF are:
- only two goods or services can be produced
- all resources are fully and efficiently employed
- at a given state of technology
- Resources are interchangeable between the two goods/services
The diagram above shows the production possibility frontier of an economy with capital and consumer goods. It shows the different combinations of goods (consumer goods or capital goods) which can be produced if all resources are fully and efficiently utilized.
The economy therefore could be :
- at point A, utilizing all its resources to the production of 100 units of capital goods and 0 units of consumer goods
- at point B, producing 60 units of capital goods and 60 units of consumer goods
- at point C, producing 30 units of capital goods and 75 units of consumer goods
- at point D, utilizing all its resources to the production of 80 units of consumer goods, or at anywhere else along the PPF, when all available resources are fully and efficiently utilized.
- Point F illustrates unemployment of resources.
- Point G cannot be achieved with the available resources.
PPF AND THE CONCEPT OF EFFICIENCY
If the economy is at any point on the production possibility frontier, such as point A, B, C or D, there is full and efficient allocation of resources since all factors of production are being used to their maximum potential. However, if the economy is located within its production possibility frontier, such as at point F, then there is an inefficient allocation of resources as not all resources are being used.
Any point outside the PPF, such as point E, cannot be achieved with the given level of resources and technology, and can only be achieved through economic growth.
PPF DEMONSTRATES THE CONCEPT OF OPPORTUNITY COST
In the above diagram, when the economy moves from point B to point C, there is an increase in consumer goods from 60 to 75 units, and a fall in capital goods from 60 to 30. So it could be said that, to increase the production of consumer goods by 15 units, there is an opportunity cost of 30 units of capital goods, i.e. We have to give up capital goods to produce more consumer goods.
A typical PPF is concave to the origin (i.e. bowed outwards) and shows that, as more of one good is produced, the opportunity cost rises, because not all resources are as efficient as other resources in the production of both goods. i.e. as we move down the PPF, as more resources are allocated to produce consumer goods, the extra output gets small – and the more of capital goods have to be given up in order to produce the extra output of consumer goods.
However, if the economy moves from point F to point B, then there would be no opportunity cost as more is produced of each type of good. i.e. at point F resources were unemployed and by moving to point B the available resources will be utilized fully and efficiently.
PPF does not always have to be drawn as a curve. If the opportunity cost for producing two products are constant then we draw the PPF as a straight line. The gradient of that line is a way of measuring the opportunity cost between the two goods.
A point, such as point G, that is outside an economy’s current PPF (X1 Y1) is unattainable at a given moment. However, point E can be achieved through an outwards shift in the PPF to X2 Y2, i.e. economic growth.
SHIFTS OF THE PPF
An outward shift in the PPF shows that there has been either an improvement in productivity or an increase in the total stock of resources available to produce different goods and services. The outward shift represents an improvement in economic efficiency.
Therefore, the reasons for an outward shift in the PPF could be listed as:
- an increase in factor resources
- an increase in the efficiency (or productivity) of factor resources
- an improvement in technology
Reasons for an inward shift in the PPF:
- Investment spending is insufficient to replace worn out capital goods
- Natural disaster (hurricanes, tsunami, floods etc.)
- Civil war
CONSUMER GOODS AND CAPITAL GOODS : HOW CURRENT CONSUMPTIONS AFFECTS FUTURE STANDARD OF LIVING
- Consumer Goods are goods that are used by consumers, and it adds to the standard of living in an economy.
- Capital Goods are goods that are used to produce consumer goods
If more consumer good and less of capital goods are produced today, the current standard of living would improve as there are more consumer goods available, however, in the long-run, there will be less capital goods available to produce consumer goods, therefore the standard of living in the future may decline
If less consumer good and more of capital goods are produced today, the current standard of living would decline as there are less consumer goods available, however, in the long-run, there will be more consumer goods produced, therefore the standard of living in the future may improve.