1. Economic Models: Production Possibilities Frontier
Illustrating Opportunity Cost, Trade-offs and the cost of idle resources

2. Efficiency / inefficiency and unemployment
Today’s Agenda
Scarcity
A simple two-good model of production
Production possibilities frontiers
Use PPFs to illustrate various concepts
Slope of the PPF
Examples
Efficiency / inefficiency and unemployment
Opportunity cost
Economic Growth
Concave PPF
Linear PPF
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4. Production Possibilities Frontier
Economic Model
Used to show opportunity cost and trade-offs
Production Possibilities Frontier:
Represents all the different combinations of goods and/or services an economy can produce at maximum efficiency.
It’s called the Production possibilities Frontier because the graph charts the POSSIBLE outcomes of PRODUCTS.
When all productive resources are fully employed.

5. Let’s examine guns and butter
Remember, in society the amounts of guns and butter a society has is indirectly proportional.
What does this mean?
Right, as the AMOUNT of one Product goes UP, the AMOUNT of the other Product goes DOWN

7. Identifying Possible Alternatives
Classic example has two goods
Guns (representing military needs)
Butter (representing civilian needs)
Economy produces only two goods, but has many alternatives!
The Economy Could…
Use all of its resources to produce 100 units of butter and 30 units of guns (point A)...
...or it could move resources to more gun production (point B)...
Because the economy has so many options, this is why it is called a “Production Possibilities” frontier!

9. Fully Employed Resources
Points (A, B) represent maximum outputs if all resources are fully employed.
Ex. Suppose the economy wanted to move to point C, which is more guns and more butter.
What happens?
This is why the graph is called a production possibilities “frontier” because it shows the maximum amount of goods and/or services that can be produced.

10. Cost of Idle Resources
If not all resources are being employed, then it is impossible for an economy to reach is full potential (capacity).
Ex.<Strike>
A point inside the curve (such as point D) could also be the result of other unused resources
Undeveloped Land
Factories that are not being used

11. So if the point is on the arch or on the line it tells you what?
If the point is inside the arch that means what?
If the point is outside of the graph that means what?

12. Attainable and Unattainable
All points on or inside the frontier are attainable
Point A is attainable, so is point B. In fact B is better!
Point C is unattainable
Production
Possibilities frontier
3,000 C B
Quantity of
Computers
Produced A
Quantity of
Cars Produced
1,000 15 12
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13. Opportunity Cost
The Production Possibilities Frontier also displays opportunity cost and trade-offs.
Ex. Economy wants to move from point A to point B on graph. The opportunity cost of producing the additional 50 units of guns is...
...the 90 units of butter given up.

15. The slope determines the opportunity cost of producing good X in terms of good Y
Remember Opportunity cost, is the cost of the THING THAT YOUR ARE GIVING UP!!

16. Illustrating Concepts Using a Production Possibility Frontier
Scarcity
Efficiency, Inefficiency and Unemployment
Opportunity Cost
Economic Growth 21 16
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17. Scarcity All points on or inside the frontier are attainable
Points A and B are attainable
At point C more cars and computers are being produced than at A or B
But point C is unattainable. Why?
Scarcity
Production possibilities are bounded
3,000 C B
Quantity of
Computers
Produced A
Quantity of
Cars Produced
1,000 15 17
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18. Opportunity Cost Start at B1—800 cars and 1500 computers
Say we want to increase the number computers to 2000
At point B2 we are producing 2000 computers, but only 600 cars. To increase computer-production by 500, we must give up car-production by 200
The negative slope of the PPF implies that whenever we increase production of one good…
…we must give up some of the other good
3,000
Not Possible! B2 C
2,000 B1
1,500
Quantity of
Computers
Produced
Quantity of
Cars Produced
600
800
1,000 15 18
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19. Economic Growth—Long Run
Over time an economy can grow
More labor and capital
Technological progress
What happens to the PPF?
Shifts outward!
Previously unattainable levels of production…
…now become attainable
4,000
3,000
Quantity of
Computers
Produced
Quantity of
Cars Produced
1,000
1,500 15 19
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20. Why Does the PPF Bow Outward?
PPF does not necessarily have to be concave!
But it is reasonable assumption. Why?
Because not all resources are equally suited at producing the same good
Computer manufacturers make poor car makers and vice versa
If more and more resources were diverted into the production of cars say, then even computer manufacturers would find themselves on the automobile assembly line. But their productivity would be low! 15 20
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21. Illustrating the Point
Suppose we go from A to B. Production of cars is virtually unaffected, but production of computers falls by 750!
Computer manufacturers are lousy at making cars
PPF is steep
Suppose we go from C to D. Production of computers is virtually unaffected, but production of cars decreases by 250!
Car makers are lousy at making computers
PPF is flat
As we move up the PPF its slope decreases D C
3,000
Quantity of
Computers
Produced A
750 B
Quantity of
Cars Produced
250
1,000 15 21
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22. Linear PPFs The slope of the PPF….
…measures the opportunity cost of producing good X (in this case cars) in terms of good Y (in this case computers)
If the PPF is linear, then the opportunity cost of producing X in terms of Y is constant at all levels of production
This is unrealistic, but linear PPFs are easier to deal with
3,000
Slope = DY/DX
Slope at A…
Quantity of
Computers
Produced A DY
equals Slope at B B DX
Quantity of
Cars Produced
1,000 15 22
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23. Measuring the Opportunity Cost
What is the opportunity cost of producing cars?
Pick any two points on the PPF…
As we move from A to B…
DY = and
DX = 600
Slope = -1800/600 = -3
O/C of 1 car is 3 computers
3,000
Slope = DY/DX A
2,400 DY
Quantity of
Computers
Produced B
600 DX
200
800
1,000
Quantity of
Cars Produced 15 23
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24. Summary
A PPF shows all combinations of goods and services that can be produced given available resources and technology
The PPF is used to illustrate concepts such as scarcity and opportunity cost
The slope of the PPF measures the o/c of producing good X in terms of good Y
The curvature of the PPF reflects increasing opportunity cost when substituting one type of production for another 15 24
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