EQ: What is the Production Possibilities Frontier?

Transcription

1 EQ: What is the Production Possibilities Frontier? The Production Possibilities Frontier, or PPF, is a useful tool in economics to help understand opportunity costs & trade-offs. It is a graphical representation of trade-offs made in the production of output. It shows the limits of production given the resources available.

2 EQ: What is the Production Possibilities Frontier? The Production Possibilities Frontier is a useful tool in economics for understanding: The limitations on output within a firm or economy. The fact that the reasons for these limitations are that the firm or economy have: A limited number of resources. Limitations on the technology for using resources. How to increase production by: Increasing the number of resources available. Increasing the technology by which those resources are transformed into output. Using existing resources more efficiently.

3 EQ: What is the Production Possibilities Frontier? The textbook defines Production Possibilities Frontier as follows: Represents the maximum combinations of two goods that an economy can produce. Let s make our own definition by defining each word.

4 EQ: What is the Production Possibilities Frontier? Production Possibilities Frontier: Production transforming resources into goods & services for consumption and investment. Possibilities capable of happening without contradicting the circumstances. Frontier in mathematics, a limiting or bounding line.

5 EQ: What is the Production Possibilities Frontier? So, another definition of production possibilities frontier could be: A bounding line that represents the limit of the capability for transforming resources into goods & services without contradicting the circumstances. Note there are two parts: A limit on production. Specific circumstances creating that limitation. We will discuss both parts, but let s first look at what a PPF looks like.

6 EQ: What Does the PPF Look Like? Below is a Production Possibilities Frontier It pretty much always looks something like this That s the vertical axis, i.e., the y-axis One end of the PPF ends at the y-axis That curve right there is the Production Possibilities Frontier (PPF) That s the horizontal axis, i.e., the x-axis The other end of the PPF ends at the x-axis

7 EQ: What Does the PPF Look Like? Because the PPF is a curve on a Coordinate Plane, there are numerous (x,y) points on the graph. The graph that the PPF curve is on compares two goods or services that both demand resources for production. One good/service is represented on the X-axis while the second good/service is represented on the Y-axis. Good A Notice that a PPF curve is negatively sloped. This is because a business must decrease production of Good A in order to increase production of Good B. Resources must be diverted from Good A to produce more of Good B. The PPF curve is actually a series of points on the graph. For example, (7,9), (10,6), & (12,1) are all points on this PPF curve Good B

8 EQ: What Does the PPF Look Like? Why does it bow outward instead of being a straight curve? Because of the Law of Increasing Opportunity Costs If you keep doing the same thing repeatedly, you have to give up more and more stuff to keep doing it. So, if you keep producing more and more of the same product, you have to give up more and more resources to produce one more unit. If you look back to Lesson 1-3, the technical definition of this law is: The more units you produce of a single product, the more you have to give up to produce each additional unit. Let s see what this looks like.

9 EQ: What Does the PPF Look Like? I ve inserted a straight curve to contrast the PPF to a situation without the Law of Incr Opp Costs. Based on this line, when 12 units of Good A are produced, 0 units of Good B are produced. So one end is (0,12). Also, when 12 units of Good B are produced, 0 units of Good A are produced. So the other end is (12,0). Since it is a straight line, it has a constant slope of (0-12) / (12-0) = -1. So, if you want to produce 1 more unit of Good B, you have to produce 1 fewer unit of Good A. Your total production of Good A + Good B will be 12 units. Good A The straight line has a maximum output of 12 for Good A when all resources are used for Good A, while the PPF has a maximum output of 9 units of Good A. The straight line has a maximum output of 12 for Good B when all resources are used for Good B, while the PPF has a maximum output of 8 units of Good B. Notice that the PPF and the straight slope can both produce at (5,7): 5 units of Good B and 7 units of Good A Good B There is NOT a constant slope on the PPF. The only production combination shared by the PPF and the straight curve is 5 units of Good B & 7 units of A. However, the Law of Increasing Opportunity Costs causes a decrease in total production. (5,7) is the only production point where you will produce 12 total units. Increasing production of either Good A or B will decrease overall output. Starting at (5,7), if you want to produce 1 more unit of Good A (8 units), you have to give up 2 units of Good B (3 units). The opportunity cost of producing one more unit of A is 2 units of B. To produce 1 more of Good A (9 units), the opportunity cost increases to 3 (total units of Good B = 0).

10 The PPF identifies a specific boundary or limit on any production that can occur. Good A Any point on the PPF curve is a production combination that is possible, although it is at the limit of possibility. Any point inside the PPF curve and both axes is a production combination that is possible. Any point on either the x-axis or the y-axis is a possible production combination, though one of the coordinates is zero [(x,0) or (0,y)] Good B Any point beyond the PPF curve is a production combination that is not possible. There are 4 places on the PPF graph where production can occur. There is a single area where production combinations are not possible.

11 For Example: This business can produce at the point (0,10), which means there are enough resources to produce 10 units of Good A and 0 units of Good B. This business CANNOT produce the production combination at point (10,8), which means there are NOT enough resources to produce both 8 units of Good A and 10 units of Good B. This is not a production possibility. It is beyond the frontier. Good A This business can produce at the point (7,7), which means there are enough resources to produce 7 units of Good A and 7 units of Good B Good B This business can produce at the point (10,6), which means there are enough resources to produce 6 units of Good A and 10 units of Good B. Since it is a point on the PPF curve, it is an efficient production combination. This means that this business cannot produce at either (11,6) or (10,7) because these are beyond the limit of the PPF curve due to insufficient resources. This business can produce at the point (11,0), which means there are enough resources to produce 0 units of Good A and 11 units of Good B.

12 The specific circumstances creating the production limitations on the PPF are the limited resources owned by the economy. In microeconomics, it is the limitation on firm production because of the company s limited resources. In macroeconomics, it is the limitation on national production because of the country s limited resources. So the only way to break past the PPF limitation on production is to change the current resource circumstance. We will discuss this later.

13 Slides 7 and 9 make inferences to limitations and availability of resources. Good A Each point in this area is a production combination of Good A and Good B that is NOT POSSIBLE given the existing resources in the economy or company. Each point in this area, including each point on the PPF curve, is a possible production combination of Good A and Good B given the existing resources in the economy or company Good B

14 Productivity can be increased by increasing: Land Acquire more natural resources for use in production. Acquire real estate (land). Labor Acquire more workers/increase hours. Increase the productivity of workers through training and education. Capital Acquire more capital for use in production. Create/Adopt technological innovations that increase the efficiency of land, labor, and capital.

15 However, some of these strategies for increasing production possibility are limited by the short run. In the short run, a business can: Acquire more labor, natural resources as raw materials, and low-cost capital items. Make small improvements in labor productivity. In the long run, a business can: Acquire more real estate (land) and high-cost capital investments (factories, robotics, trucks, etc.). Adopt technological advances that increase the efficiency of all resources.

16 It is possible for a business or economy to move the PPF curve outward so greater production is possible. Good A The PPF is the Short-Run Limitation Good B Long-Run Possibility In the short run, you can only increase efficiency to increase output. A business can use its resources more efficiently, but not expand the maximum possible production. In the long run, you can add capital stock, buy real estate, and adopt major innovations in production efficiency. When one or more of these occurs, greater output production is possible and business growth occurs.

17 The PPF compares the production of any two goods or services. For example: Military equipment (tanks, soldier training, etc.) Capital infrastructure (highways, sewers, etc.) The U.S. Government must allocate resources to both of these since they are both necessary: Too little infrastructure and the growth capability of our economy is stunted, risking our future economy. Too little military and any infrastructure is in danger of being taken or destroyed by another country in war. The U.S. Government must allocate resources in a balance between the two so that the economy can grow and be protected.

18 Military After looking at the needs for military and infrastructure, Congress finds that there is a need to set infrastructure production at 10 and military production at 10. However, the production combination (10,10) is not possible because the U.S. does not have sufficient resources The government could set production at 5 infrastructure and 10 military (5,10) or 10 infrastructure and 6 military (10,6). This would allow one need to be fulfilled and the other to be partially met. Or, they could compromise and set production at 8 infrastructure and 8 military (8,8). Most likely, even if they choose 10 infrastructure and 6 military (10,6), the resources will be used inefficiently and the actual production achieved will be 8 infrastructure and 4 military (8,4) Infrastructure

19 Frequently, the PPF is used as a tool for understanding the efficient use of resources (efficiency = units of output produced for each unit of input used). Any business that exhibits production on the PPF curve is using all of its resources efficiently. Good A Any business that exhibits production inside the PPF curve is NOT using its resources efficiently. In this case, without acquiring any more resources, more could be produced simply by using the existing resources more efficiently. Many businesses can cut costs, lower prices, and increase profits simply by increasing efficiency of resource use Good B