1.5 Production Possibility Frontier

PRODUCTION POSSIBILITY FRONTIER
SLIDE 2
Another economic model that is used to help illustrate how an

economic system works is the Production Possibility Frontier,
known as the PPF. Like the circular flow model, the PPF is a
visual representation. It is a graph that shows all the various
combinations of goods and services (or outputs) that can be
produced and not produced, given the factors of production
available (the inputs) and the technology available to use those
factors of production.
SLIDE 3
To help illustrate the PPF, we will focus on two goods, while

holding all other goods and services in the economy constant.
The PPF is the boundary between all combination of goods and
services that can and cannot be produced. Let’s look at guns and
butter. If we produce zero butter, we can produce six hundred
guns. If we produce two hundred butter, we can produce five
hundred guns. If we produce four hundred butter, we can
produce three hundred fifty guns. And if we produce six
hundred butter, we produce no guns.
SLIDE 4
Points beyond the PPF are simply not attainable. Why? Because
we have scarcity of resources. Points on the PPF, such as A, B,
C, or D are attainable. Production is efficient, but only on the
frontier. On the frontier, we achieve production efficiency,
production efficiency meaning that we produce goods and
services at the lowest possible cost. Points inside the PPF, such
as G, are inefficient. Why? Because we are not fully using all
our available resources. Resources could be better employed to
increase the production of both butter and guns. Resources are
unused or misallocated or both.
SLIDE 5
The PPF model also helps illustrate key economic concepts

learned earlier in this module. Notice, as we move along the
PPF, there is always some form of tradeoff involved in diverting
resources from production of one item to another. We gain one
item, but at the opportunity cost of losing another item.
Remember that opportunity cost of an action is the cost of the
highest valued alternative forgone. The bowed out shape of the
PPF actually illustrates the concept of increasing opportunity
cost. Not all resources are considered equal. Some individuals
are better at making guns, while some individuals are better at
churning butter. As such, if we move along the frontier and
produce more butter than guns, more gun makers are now
churning butter. As more resources are diverted away from
making guns, the smaller the additional increase in butter
production will be and the larger the decrease in production of
guns will be. This is an illustration of an increasing opportunity
cost. Resources are not homogeneous, we are not all the same,
we do not all have the same aptitude for producing butter and
guns. If we had homogenous resources, we would actually have
a linear PPF because we would have a constant opportunity cost.
But such is not the case in reality. In reality, resources are
heterogeneous. We are different. That is why we have a bowed
out PPF.
SLIDE 6
From a mathematical standpoint, the opportunity cost when

looking at a PPF is the ratio of what we give up to what we get.
If we move down the PPF, as we move from B to C, what is the
opportunity cost of an additional butter? To obtain this value,
the economy must give up a hundred and fifty guns to get two
hundred butter. So the opportunity cost is a hundred and fifty
guns divided by two hundred butter, which equates to 0.75 guns
per butter.
We gave up a hundred and fifty guns to get two hundred butter.

In actual fact, the opportunity cost is really the slope of the PPF
as we move between these two points. You will also note that
the PPF slope is actually a negative term, as the slope of the PPF
is downward. It is negative sloping, but economists always
document the term as positive.
Now, what point on the PPF is the best point to produce at?
Which point best serves the public interest? To answer this
question, we need to introduce the concepts of marginal cost,
marginal benefits, and allocative efficiency. We will use a
different example to help illustrate these costs.
SLIDE 7
Let’s look at the production of pizza and cola. We are going to

compare the marginal costs and marginal benefits of producing
at different points on the PPF. Marginal cost is defined as the
opportunity cost of producing one more unit of a good or
service. Marginal cost is increasing as we move along the
marginal cost curve. Marginal cost is calculated by the slope of
the PPF at various points. As more pizza is being produced, the
marginal cost of cola is increasing. Note that the marginal cost is
increasing as we move along the curve.
SLIDE 8
Marginal benefit is defined as the benefits received from

consuming one more unit of a good or service. Marginal benefit
is decreasing as we move along the marginal benefit curve.
Individuals purchase goods and services in line with their
preferences, that is, their likes and dislikes. We measure the
benefits from a good or service from the most people are willing
to pay for that good or service. Economists illustrate preferences
using a marginal benefit curve, which simply shows the
relationship between marginal benefit from a good or service.
Note that the marginal benefit is decreasing as we move along
the curve.
SLIDE 9/10
Now back to our question. That is, which point on the PPF is the
best to produce at? What point on the PPF best serves the public
interest? We determine this point by bringing the PPF, marginal
benefit, and marginal cost curve together to determine the point
of allocative efficiency. Allocative efficiency occurs at the point
on the PPF where the marginal benefit curve equals the marginal
cost curve. This is the point which best serves the public
interest. If we produce at point A, we’re producing too much
cola. At this point, the marginal benefits are greater than the
marginal costs. So, we will start producing more pizza and
naturally gravitate to point B, where marginal benefit equals
marginal cost. If we produce at point C, we are producing too
much pizza. At this point, marginal costs are greater than
marginal benefits, so we will start producing more cola and
again naturally gravitate to point B. Point B is considered the
point of allocative efficiency, where marginal benefits equals
marginal costs.
SLIDE 11
Now how do we actually move the PPF out further? That is,
how does a nation’s production possibilities grow? We will
discuss this question further on in the course, but we can denote
at this stage that there are two key factors involved in moving
the PPF out, those being technology change and capital
accumulation.
SLIDE 12
What is the cost of economic growth?
To use resources in research and development and to produce

new capital, we must decrease our production of consumption
goods and services. So economic growth is not free.
The opportunity cost of economic growth is less current
consumption.
We can produce cookies (consumption goods) or ovens (capital

goods) along PPF0.
By using some resources to produce capital goods today, we will

have more productive capital to make goods in the future…so
the PPF shifts outward in the future.
Growth comes at the expense of current consumption…fewer

cookies today for more cookies tomorrow!
SLIDE 13
This figure illustrates this model in action.
In 1963, Hong Kong trailed Canada in their productive

capabilities per capita.
By investing a greater proportion of their productive capacity in

capital goods (accumulating capital at a greater rate), Hong
Kong has been able to outpace Canadian growth and has now
surpassed Canadian per capita production possibilities.
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PRODUCTION POSSIBILITY FRONTIER

Another economic model that is used to help illustrate how an

To help illustrate the PPF, we will focus on two goods, while

The PPF model also helps illustrate key economic concepts

From a mathematical standpoint, the opportunity cost when

We gave up a hundred and fifty guns to get two hundred butter.

Let’s look at the production of pizza and cola. We are going to

Marginal benefit is defined as the benefits received from

What is the cost of economic growth?

To use resources in research and development and to produce

We can produce cookies (consumption goods) or ovens (capital

By using some resources to produce capital goods today, we will

Growth comes at the expense of current consumption…fewer

This figure illustrates this model in action.

In 1963, Hong Kong trailed Canada in their productive

By investing a greater proportion of their productive capacity in

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