4.1.1.5 - Production Possibility Diagrams

Production Possibility Curve (PPC/PPF) =

A curve which shows the maximum combination of two goods that can be produced when all the available resources are fully and efficiently employed. (Max output)

PPC Diagram

Axes either Good A & Good B, or Capital Goods & Consumer Goods

Any point within/inside PPF:

Resources are not being fully or efficiently used/employed. Resources used inefficiently - not maximising goods produced

Any point outside/beyond PPF

Currently unattainable without increasing number of resources or increasing productivity of its current resources or improving technology

Any point on PPF:

Resources are being fully and efficiently used/employed - productively efficient

Why is the PPF curved?

• Economic resources are not completely adaptable to alternative uses - resources may be better at producing one type of good than another

• Law of diminishing returns - The cost of producing successive units will eventually increase as additional inputs are less efficient

• Opportunity cost is not constant along the PPF. Bowed outwards because of increasing opportunity costs of production

A combination of goods containing more of which type of good leads to more economic growth and consumption in the FUTURE?

Capital Goods. Because capital goods can be used to produce more consumer goods in the future

PPF to show Short Run Economic Growth

A movement of a point outwards

PPF to show Long Run Economic Growth

Shift of the curve outwards

Why do shifts in PPF occur?

Improvements of QQE of CELL

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Capital:

• Quantity - Investment in new machinery

• Quality - Technological advances

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Enterprise:

• Quantity - Encouraging more entrepreneurial activity (e.g. by gov. grants)

• Quality - Education, training & development

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Land:

• Quantity - New resources like oil and wind

• Quality & Efficiency - Redevelopment (e.g. improving drainage)

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Labour:

• Quantity - More immigration, higher birth rates

• Quality & Efficiency - Education and training, division of labour / specialisation

Flaws of PPFs

• Unrealistic to only look at 2 goods

• Impossible to know the exact output gained from each resource we have

• Factors of production available are fixed in PPF's, however they are constantly changing in real life

• Full employment of resources is often assumed, whereas this is rarely a reality

Productive Efficiency

When the maximum output is produced from the available factors of production

• and when it is not possible to produce more of one good or service without producing less of another

Allocative Efficiency

When all the available economic resources are used to produce the combination of goods and services that MAXIMISE SOCIETY'S WELFARE

• Requires value judgement, so unable to determine point on PPC

Economic Welfare

Utility gained through the achievement of material goods & services

Opportunity Cost

The cost of forgoing the production of one good to produce more of another

Trade-off

The act of choosing to produce one good over another

How does PPC illustrate different features of the Fundamental Economic Problem?

Resource Allocation:

• Refers to how an economy decides to distribute its limited resources between the production of different g&s

• The PPC shows the maximum potential output combinations of two goods, assuming efficient use of resources.

• Points on the curve represent different choices of resource allocation

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Opportunit Cost & Trade-offs:

• On PPC, moving from one point to another invovles a trade-off - choosing to produce more of Good A instead of Good B.

• This has an opportunity cost, being the amount of Good B sacrificed to increase the production of Good A

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Unemployment of Economic Resources:

• Points inside the PPC represent unemployment of resources - where there is inefficiency and resources are underutilised

• This means the economy is not operating at full potential

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Economic Growth:

• SREG can be shown by a movement of a point outwards

• LREG can be shown by a shift of the PPC outwards, showing an increase in productive capacity

• Shift of PPC occurs due to improvements of QQE of CELL