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PPF notes

The Production Possibility Frontier (PPF) illustrates the most efficient allocation of resources in an economy, showing the trade-offs between different goods. It emphasizes the importance of comparative advantage and specialization for optimal resource use and international trade. Growth is represented by an outward shift of the PPF, while inward shifts indicate resource depletion or inefficiencies.

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PPF notes

The Production Possibility Frontier (PPF) illustrates the most efficient allocation of resources in an economy, showing the trade-offs between different goods. It emphasizes the importance of comparative advantage and specialization for optimal resource use and international trade. Growth is represented by an outward shift of the PPF, while inward shifts indicate resource depletion or inefficiencies.

Uploaded by

nashwa.tariq24
Copyright
© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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PPF also plays a crucial role in economics.

It can be used to demonstrate


the point that any nation's economy reaches its greatest level of efficiency
when it produces only what it is best qualified to produce and trades with
other nations for the rest of what it needs.

The PPF is also referred to as the production possibility curve or the


transformation curve.

In macroeconomics, the PPF is the set of points at which a country’s


economy is most efficiently allocating its resources to produce as many
goods as possible. If production is on the PPF, the country can only
produce more of one good if it produces less of some other good.

If the economy is producing less than the quantities indicated by the PPF,
this is a sign that resources are not being used to their full potential. In this
case, it is possible to increase the production of some goods without
cutting production in other areas.

The production possibility frontier demonstrates that there are, or should


be, limits on production. Each economy must decide what combination of
goods and services should be produced in order to attain maximum
resource efficiency.

Comparative Advantage and Absolute Advantage


An economy may be able to produce for itself all of the goods and services
it needs to function using the PPF as a guide. However, this may actually
lead to an overall inefficient allocation of resources and hinder future
growth when the benefits of trade are considered.

Through specialization, a country can concentrate on the production of just


a few things that it can do best, rather than trying to do everything on its
own.

Comparative Advantage

Each country in our example can produce one of these products more
efficiently (at a lower cost) than the other. We can say that Country A has
a comparative advantage over Country B in the production of cars, and
Country B has a comparative advantage over Country A in the production
of cotton.

Or, both countries could decide to specialize in producing the goods for
which they have a comparative advantage. Each can trade its specialized
product to the other and both countries will be able to enjoy both products
at a lower cost. Quality will improve, too, since each country is making
what it makes best.

Determining how countries exchange goods produced by comparative


advantage ("the best for the best") is the backbone of international trade
theory. This method of exchange via trade is considered an optimal
allocation of resources. It means that national economies, in theory, will no
longer be lacking anything that they need.

Like opportunity cost, specialization and comparative advantage also apply


to the way in which individuals interact within an economy. At least in
modern times, few people try to produce everything they consume.

Absolute Advantage

Sometimes a country or an individual can produce more than another


country, even though countries both have the same amount of inputs. For
example, Country A may have a technological advantage that, with the
same amount of inputs (good land, steel, labor), enables the country to
easily manufacture more of both cars and cotton than Country B.

A country that can produce more of both goods is said to have an absolute
advantage. Better access to natural resources can give a country an
absolute advantage, as can higher levels of education, skilled labor, and
overall technological advancement.

It is not possible, however, for a country to have an absolute advantage in


everything that must be produced. it will always need trade.

Why Is the PPF Often Curved Instead of Straight?


The curved shape reflects the law of diminishing returns. This law states
that there comes a point where an added production factor has less of an
impact. For example, adding additional resources toward the production
process may initially result in fairly large gains. However, these gains
gradually lessen, thus producing the PPF's outward curved shape.

What Does It Mean When the PPF Is a Straight Line?


A straight line occurs if the opportunity cost remains constant. In this
scenario, the opportunity cost of producing two goods is projected as being
equal regardless of where you are along the line. In reality, this scenario is
uncommon and the PPF is more often shown as an outward bending
curve.
What creates growth?
When using a PPF, growth is defined as an increase in potential output
over time, and illustrated by an outward shift in the curve. An outward
shift of a PPF means that an economy has increased its capacity to
produce all goods. This can occur when the economy undertakes some or
all of the following:

Employs new technology


Investment in new technology increases potential output for all goods and
services because new technology is inevitably more efficient than old
technology. Widespread ‘mechanisation’ in the 18th and 19th centuries
enabled the UK to generate vast quantities of output from relatively few
resources, and become the world’s first fully industrialised economy. In
recent times, China’s rapid growth rate owes much to the application of
new technology to the manufacturing process.

An economy will not be able to grow if an insufficient amount of resources


are allocated to capital goods. In fact, because capital depreciates some
resources must be allocated to capital goods for an economy to remain at
its current size, let alone for it to grow.

Employs a division of labour, allowing specialisation


A division of labour refers to how production can be broken down into
separate tasks, enabling machines to be developed to help production,
and allowing labour to specialise on a small range of activities. A division
of labour, and specialisation, can considerably improve productive
capacity, and shift the PPF outwards.
Employs new production methods
New methods of production can increase potential output. For example,
the introduction of team working to the production of motor vehicles in
the 1980s reduced wastage and led to considerable efficiency
improvements. The widespread use of computer controlled production
methods, such as robotics, has dramatically improved the productive
potential of many manufacturing firms.

Increases its labour force


Growth in the size of the working population enables an economy to
increase its potential output. This can be achieved through natural
growth, when the birth rate exceeds the death rate, or through net
immigration, when immigration is greater than emigration.

Discovers new raw materials


Discoveries of key resources, such as oil, increase an economy’s capacity
to produce.

An inward shift of a PPF


A PPF will shift inwards when an economy has suffered a loss or
exhaustion of some of its scarce resources. This reduces an economy’s
productive potential.

A PPF will shift inwards if:


Resources run out
If key non-renewable resources, like oil, are exhausted the productive
capacity of an economy may be reduced. This happens more quickly as a
result of the application of ultra-efficient production methods, and when
countries over-specialise in producing goods from non-renewable
resources.

Sustainable growth means that the current rate of growth is not so fast
that future generations are denied the benefit of scarce resources, such
as non-renewable resources, and a clean environment.

Failure to invest
A failure to invest in human and real capital to compensate for
depreciation will reduce an economy’s capacity. Real capital, such as
machinery and equipment, wears out with use and its productivity falls
over time. As the output from real capital falls, the productivity of labour
will also fall. The quality and productivity of labour also depends on the
acquisition of new skills. Therefore, if an economy does not invest in
people and technology its PPF will slowly move inwards.

Erosion of infrastructure
A military conflict is likely to destroy factories, people, communications,
and infrastructure.

Natural disaster
If there is a natural disaster, such as the 2005 boxing-day tsunami, or the
Haiti earthquake of 2010, an economy’s PPF will shift inwards.

Asymmetric growth
An economy can grow because of an increase in productivity in one sector
of the economy – this is called asymmetric growth.

For example, an improvement in technology applied to industry Y, such as


motor vehicles, but not to X, such as food production, would be illustrated
by a shift of the PPF from the Y-axis only.
Factor mobility
If workers, or other resources, are moved from one sector to another, then
the position of the PPF will change, with an increase in the maximum
output in the industry receiving the resources, and a fall in the maximum
output of the industry losing resources.

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