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PRINCIPLES OF

MICROECONOMICS

The Production Possibility Frontier

CASE  FAIR  OSTER

The Production Possibility Frontier

PPF: illustrates the principles of constrained choice, opportunity cost, and scarcity.
Production Possibility Frontier (PPF) A graph that shows all the combinations of goods
and services that can be produced if all of society’s resources are used efficiently.

 On the Y -axis, we measure the quantity of capital goods produced. On the X -axis, we
measure the quantity of consumer goods.

 All points below and to the left of the

curve (the shaded area) represent
combinations of capital and consumer
goods that are possible for the society
given the resources available and existing
technology.
 Points above and to the right of the curve,
such as point G, represent combinations
that cannot be reached.
 If an economy were to end up at point A
on the graph, it would be producing no
consumer goods at all; all resources
would be used for the production of
capital.
 If an economy were to end up at point B,
it would produce only consumer goods.

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 Although an economy may be

operating with full employment
of its land, labor, and capital
resources, it may still be
operating inside its PPF, at a
point such as D. The economy
could be using those resources
inefficiently.
 Periods of unemployment
correspond to points inside the
PPF, such as point D.
 An economy producing at point
D can produce more capital
goods and more consumer
goods, for example, by moving
to point E.
 This is possible because
resources are not fully
employed at point D or are not
being used efficiently.

 FIGURE 2.4 Production Possibility Frontier

 The PPF illustrates a number

of economic concepts.
 One of the most important is
opportunity cost.
 The opportunity cost of
producing more capital goods
is fewer consumer goods.
 Moving from E to F, the
number of capital goods
increases from 550 to 800,
 but the number of consumer
goods decreases from 1,300
to 1,100.

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Negative Slope and Opportunity Cost

 Society can produce more capital goods only by reducing production of
consumer goods.
 The reason is that: a society’s choices are constrained by available
resources and existing technology, and we assume that the resources
are fully and efficiently employed,
 The opportunity cost of the additional capital is the forgone production of
consumer goods.
 The fact that scarcity exists is illustrated by the negative slope of the PPF
 In moving from point E to point F in Figure 2.4 , capital production increases by
800 - 550 = 250 units (a positive change), but that increase in capital can be
achieved only by shifting resources out of the production of consumer goods.
 Thus, in moving from point E to point F in Figure 2.4 , consumer goods
production decreases by 1300 - 1100 = 200 units (a negative change).
 The slope of the curve, the ratio of the change in capital goods to the change in
consumer goods, is negative.

Marginal Rate of Transformation (MRT): The slope of the production possibility

frontier (PPF).

The Law of Increasing Opportunity Cost

 FIGURE 2.5 Corn and Wheat Production in Ohio and Kansas

 The PPF illustrates that the opportunity cost of corn production increases as we shift
resources from wheat production to corn production. Moving from point E to D, we get
an additional 100 million bushels of corn at a cost of 50 million bushels of wheat.
 Moving from point B to A, we get only 50 million bushels of corn at a cost of 100
million bushels of wheat. The cost per bushel of corn—measured in lost wheat—has
increased.
TABLE 2.1 Production Possibility Schedule for
Total Corn and Wheat Production in
Ohio and Kansas

Total Total
Corn Production Wheat Production
Point (Millions of (Millions of Bushels
on ppf Bushels per Year) per Year)

A 700 100

B 650 200

C 510 380

D 400 500

E 300 550

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Unemployment
 During economic downturns or recessions, industrial plants run at less
than their total capacity. When there is unemployment of labor and
capital, we are not producing all that we can.

Inefficiency
 Waste and mismanagement are the results of a firm operating below
its potential.

 Sometimes inefficiency results from mismanagement of the economy

instead of mismanagement of individual private firms.

 FIGURE 2.6 Inefficiency from Misallocation of Land in Farming

 Society can end up inside its PPF

at a point such as A by using its
resources inefficiently.
 If, for example, Ohio’s climate
and soil were best-suited for corn
production and those of Kansas
were best suited for wheat
production, a law forcing Kansas
farmers to produce corn and Ohio
farmers to produce wheat would
result in less of both. In such a
case, society might be at point A
instead of point B.

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The Efficient Mix of Output

 To be efficient, an economy must produce what people want.

Economic Growth
 economic growth: An increase in the total output of an economy.
Growth occurs when a society acquires new resources or when it
learns to produce more using existing resources.

TABLE 2.2 Increasing Productivity in Corn and Wheat Production

in the United States, 1935–2009

Corn Wheat

Yield per Acre Labor Hours per 100 Yield per Acre Labor Hours
(Bushels) Bushels (Bushels) per 100 Bushels

1935–1939 26.1 108 13.2 67

1945–1949 36.1 53 16.9 34
1955–1959 48.7 20 22.3 17
1965–1969 78.5 7 27.5 11
1975–1979 95.3 4 31.3 9
1981–1985 107.2 3 36.9 7
1985–1990 112.8 NAa 38.0 NAa
1990–1995 120.6 NAa 38.1 NAa
1998 134.4 NAa 43.2 NAa
2001 138.2 NAa 43.5 NAa
2006 145.6 NAa 42.3 NAa
2007 152.8 NAa 40.6 NAa
2008 153.9 NAa 44.9 NAa
2009 164.9 NAa 44.3 NAa

a Data not available.

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 FIGURE 2.7 Economic Growth Shifts the PPF Up and to the Right
 Productivity increases have
enhanced the ability of the United
States to produce both corn and
wheat.
 As Table 2.2 shows, productivity
increases were more dramatic for
corn than for wheat. Thus, the
shifts in the PPF were not parallel.
 Note: The PPF also shifts if the
amount of land or labor in corn and
wheat production changes.
Although we emphasize
productivity increases here, the
actual shifts between years were
due in part to land and labor
changes.

Sources of Growth and the Dilemma of Poor Countries

 FIGURE 2.8 Capital Goods and Growth in Poor and Rich Countries

 Rich countries find it

easier than poor
countries to devote
resources to the
production of capital,
and the more resources
that flow into capital
production, the faster the
rate of economic growth.
 Thus, the gap between
poor and rich countries
has grown over time.

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The Economic Problem

Recall the three basic questions facing all economic systems:

(1) What gets produced?

(2) How is it produced?

(3) Who gets it?

Given scarce resources, how do large, complex societies go about

answering the three basic economic questions?

The economic problem: asserts that an economy's scarce

resources are insufficient to satisfy all human wants and needs. It
assumes that human wants are unlimited, but the means to satisfy
human wants are limited.

Economic Systems and the Role of Government

Command Economies

 command economy An economy in which a central government either

directly or indirectly sets output targets, incomes, and prices.

Laissez-Faire Economies: The Free Market

 laissez-faire economy Literally from the French: “allow [them] to do.” An

economy in which individual people and firms pursue their own self-interest
without any central direction or regulation.

 market The institution through which buyers and sellers interact and
engage in exchange.

 Some markets are simple and others are complex, but they all involve
buyers and sellers engaging in exchange.
 The behavior of buyers and sellers in a laissez-faire economy determines
what gets produced, how it is produced, and who gets it.

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Consumer Sovereignty

 consumer sovereignty The idea that consumers ultimately dictate

what will be produced (or not produced) by choosing what to
purchase (and what not to purchase).

Individual Production Decisions: Free Enterprise

 free enterprise The freedom of individuals to start and operate
private businesses in search of profits.

Distribution of Output

 The amount that any one household gets depends on its income and
wealth.

 Income is the amount that a household earns each year. It comes in

a number of forms: wages, salaries, interest, and the like.


Wealth is the amount that households have accumulated out of past
income through saving or inheritance.

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Price Theory
 In a free market system, the basic economic questions are answered
without the help of a central government plan or directives.
 This is what the “free” in free market means—the system is left
to operate on its own with no outside interference.
 Individuals pursuing their own self-interest will go into business
and produce the products and services that people want. Other
individuals will decide whether to acquire skills; whether to
work; and whether to buy, sell, invest, or save the income that
they earn.
 The basic coordinating mechanism is price.

Mixed Systems, Markets, and Governments

 The differences between command economies and laissez-faire
economies in their pure forms are enormous. In fact, these pure
forms do not exist in the world; all real systems are in some sense
“mixed.”