Production possibility diagrams

• Production possibility frontiers (PPFs)


  Depict the maximum productive potential of an economy, using a combination of two goods or services, when resources are fully and efficiently employed
• PPF curves


  • Can show the opportunity cost of using the scarce resources
  • Points A and B are the most efficient combinations of output on the PPF
  • Producing at B incurs an opportunity cost of producing more cheese
• Law of diminishing returns

  The opportunity cost of producing more yoghurt increases, in terms of the lost units of cheese that could have been produced
• Producing at C or D

  • Inefficient, and resources are not used to their full productive potential
  • There is the potential to use these resources more efficiently, which would shift production closer to the curve
• Producing at E


  • Not yet attainable with the current resources
• Producing 100 units of cheese means that only 40 units of yoghurt can be produced instead of the potential of 90, so the opportunity cost is 90 - 40 = 50 units of yoghurt
• Economic growth


  Shown by an outward shift in the PPF
• Economic decline


  Shown by an inward shift in the PPF
• Factors that shift the PPF curve

  • Increase in the quantity or quality of resources
  • Constant state of technology
• Moving along the PPF

  Uses the same number and state of resources, and shifts production from fewer consumer goods to more capital goods, incurring an opportunity cost
• Shifting the PPF curve outwards

  Uses either more resources or resources of a greater quality, reducing the opportunity cost of producing either capital or consumer goods
• Capital goods


  Goods which can be used to produce other goods, such as machinery
• Consumer goods


  Goods which cannot be used to produce other goods, such as clothing
• Productive efficiency


  • All points on the boundary are productively efficient, as resources are being used to their productive potential
• Allocative efficiency


  When no one can be made better off without making someone else worse off (Pareto efficiency)
• If more of both goods could be produced, there would be a gain in allocative efficiency because there is an improvement in welfare
• The PPF only shows potential output, and allocative efficiency is concerned with how goods are distributed in society