Production Possibilities Frontier PPF Chapter 1 Section 3

PRODUCTION POSSIBILITIES Production Possibilities Frontier The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology. The PPF is a valuable tool for illustrating the effects of scarcity and its consequences.

PRODUCTION POSSIBILITIES Figure 1.1 shows the PPF for bottled water and CDs. Each point on the graph represents a column of the table. The line through the points is the PPF.

The PPF puts three features of production possibilities in sharp focus: 1. Attainable and unattainable combinations 2. Full employment and unemployment 3. Tradeoffs and free lunches

Attainable/Unattainable Because the PPF shows the limits to production, it separates attainable combinations from unattainable ones. Figure 3.2 on the next slide illustrates the attainable and unattainable combinations.

Points outside the PPF such as point G are unattainable. We can produce at any point inside the PPF or on the frontier. The PPF separates attainable combinations from unattainable combinations.

Full Employment and Unemployment Full employment occurs when all the available factors of production are being used. Unemployment occurs when some factors of production are not used. Figure 1.2 on the next slide illustrates full employment and unemployment.

1. When resources are fully employed, production occurs at points on the PPF such as D and E. 2. When resources are unemployed, production occurs at a point inside the PPF such as point H.

Tradeoffs and Free Lunches A constraint or limit to what is possible that forces an exchange or a substitution of one thing for something else. To emphasize that every choice involves a cost, economists say, “There is no such thing as a free lunch.” But there would be a free lunch—something for nothing—if we were not at a point on the PPF.

1. When production is on the PPF, we face a tradeoff 1. When production is on the PPF, we face a tradeoff. There’s no free lunch. 2. If production were inside the PPF, there would be a free lunch. We could get more of both goods without forgoing either good.

OPPORTUNITY COST CALULATIONS Finding the OC of a trade-off If I make 15 CDs, how many bottles of water can I make? How many bottles of water could I make if I made zero CDs? Thus: If I make 15 CDs, how many bottles of water am I NOT making? In other words, what is the OC of 15 CDs?

OPPORTUNITY COST CALULATIONS Finding the OC of a trade-off If I make 12 CDs, how many bottles of water can I make? How many bottles of water am I NOT making as a result of making 12 CDs? What is the OC of 12 CDs?

I am making 2 bottles of water (point C) I am making 2 bottles of water (point C). I want to make 1 more bottle of water (go to point D). How many CDs am I making when I make 2 bottles of water? How many CDs am I making when I am making 3 bottles of water? How many CDs did I have to give up to make that extra Bottle of Water?

OPPORTUNITY COST PER UNIT The Per Unit Opportunity Cost of a Bottle of Water The opportunity cost of a bottle of water is the decrease in the quantity of CDs divided by the increase in the number of bottles of water as we move along the PPF Figure 3.5 illustrates the calculation of the opportunity cost of a bottle of water.

Moving from A to B, 1 bottle of water costs 1 CD.

Moving from B to C, 1 bottle of water costs 2 CDs.

Calculate the OC of each 1 unit increase of Bottled Water (moving from point A to B, B to C, C to D, etc)