The Produc+on Possibility Fron+er Applying the PPF concept •  Opportunity cost •  Gains from specialisa8on and trade •  Showing economic growth Some topical issues: 1.  Economic effects of natural disasters 2.  The collapse of fish stocks / deforesta8on 3.  Debate over investment in fracking 4.  Economics of labour migra8on Produc+on Possibility Fron+ers (PPF) A PPF shows the output combina+ons of two goods or services aPainable when all resources are fully and efficiently employed Output •  We normally draw a PPF as of concave to the origin i.e. Good X when we move down along the PPF, as more resources X1 are allocated towards Good Y X2 the extra output gets smaller •  This is explained by the law of X3 diminishing marginal returns, it occurs because not all factor inputs are equally suited to producing items leading to lower produc+vity A B C Y1 Y2 Y3 Output of Good Y Produc+on Possibility Fron+er (PPF) Output of Pizza F is an output combina8on that is not yet aPainable as it lies beyond the PPF F A D D and E are inefficient combina8ons – i.e. not all resources fully u8lized B E C A, B and C are all efficient output combina8ons as they lie on the exis8ng PPF Output of Sugar The PPF and Economic Efficiency •  Combina8ons of the output of consumer and capital goods lying inside the PPF happen when there are unemployed resources or when resources are used inefficiently. We could increase total output of goods and services by moving towards the PPF •  Combina8ons of goods and services that lie beyond the PPF are unaAainable at the moment •  A country would require an increase in factor resources, an increase in produc+vity and/or an improvement in technology to achieve an outward shiW of the PPF •  Trade between countries also allows na8ons to consume beyond their own PPF poten8ally leading to gains in economic welfare •  Producing more of both goods with the same resources represents an improvement in welfare and a gain in alloca+ve efficiency The PPF and Opportunity Cost Output of Wheat A 200 B 160 One hundred extra tonnes of coPon involves sacrificing 40 tonnes of wheat – the opportunity cost is 4/10ths of a tonne of wheat for each extra tonne of coPon The opportunity cost of employing more resources into coPon produc8on is expressed in terms of the output of wheat given up Examiners are keen that you understand the concept of opportunity cost in rela8on to the PPF! 300 400 Output of CoPon PPF, Diminishing Returns and Opportunity Cost With diminishing returns, the marginal (extra) output of coPon diminishes as more factor resources are allocated to it. Output of Wheat A 200 B 160 C 80 The result is that the opportunity cost measured in lost wheat output increases Output of CoPon 300 400 480 To be produc8vely efficient, an economy must be on its produc8on possibility fron8er Drawing a Linear Produc+on Possibility Fron+er Movements along a PPF require a realloca8on of factor resources Output of consumer goods 90 If the produc8on possibility fron8er is a straight line, then the marginal opportunity cost of switching resources between consumer and capital goods is constant. For example, the marginal opportunity cost of producing an extra 15 capital goods is 30 consumer goods i.e. the opportunity cost is 2 consumer goods per extra capital good 60 30 PPF1 10 25 40 Output of capital goods Outward ShiH in the Produc+on Possibility Fron+er Changes in produc+on technology can cause the PPF to shiW outwards – this leads to an increase in a country’s poten+al output Output of consumer goods An improvement in the technology available to produce capital goods (other factors held constant) will lead to an outward shiW in the produc8on possibility fron8er. AWer the shiW in the PPF more capital goods can be produced for each level of output of consumer goods 60 PPF1 25 42 PPF2 Output of capital goods Causes of ShiHs in the Produc+on Possibility Fron+er Cause of an outward shiH in the Produc+on Possibility Fron+er Brief comment on the cause of the shiH in the PPF •  Higher produc8vity / efficiency This increases the output per unit of factor inputs of input used in produc8on •  BePer management of factor inputs Improved management reduces waste and improves quality •  Increase in the stock of capital and labour supply e.g. from inward labour migra8on / capital investment •  Innova8on and inven8on of new products and resources Improved produc8on processes helps to boost efficiency •  Discovery / extrac8on of new natural resources (land) Discovery of commercially viable land inputs drives extrac8on Can the Produc+on Possibility Fron+er shiH inwards? Yes – produc8ve poten8al can contract – here are some causes Damaging effects of natural disasters such as drought, a tsunami, an earthquake and severe floods Destruc8on / loss of factor inputs caused by civil war and other forms of conflict that last for many years Causes of an inward shiW of the a na8on’s PPF Large scale net outward labour migra8on e.g. due to an economic depression that leads to a brain drain of skilled workers A trend decline in the produc8vity of inputs perhaps caused by a persistent recession which causes net investment to be nega8ve A magnitude-­‐7.8 earthquake struck Nepal during April, killing as many as 10,000 people and causing catastrophic damage throughout Nepal, India, China, and Bangladesh. Preliminary economic losses were expected to reach and possibly exceed USD5.0 billion – which would equal to at least 25 percent of Nepal's gross domes+c product (GDP) – with very low insurance penetra8on in the region. Government figures revealed that more than 700,000 homes and other structures were damaged or destroyed by the earthquake, as well as dozens of historical sites Can the Produc+on Possibility Fron+er shiH inwards? Yes – produc8ve poten8al can contract – here are some causes Damaging effects of natural disasters such as drought, a tsunami, an earthquake and severe floods Destruc8on / loss of factor inputs caused by civil war and other forms of conflict that last for many years Causes of an inward shiW of the a na8on’s PPF Large scale net outward labour migra8on e.g. due to an economic depression that leads to a brain drain of skilled workers A trend decline in the produc8vity of inputs perhaps caused by a persistent recession which causes net investment to be nega8ve The Produc+on Possibility Fron+er