1. Production Possibility Frontiers and Opportunity Cost Source

2. Production Possibilities Production Possibilities with No Trade The figure in (b) shows all of the combinations of logs and bushels of food that Bill can produce by himself. If he spends all 30 days each month on logs, he produces 120 logs and no food (point D). If he spends all 30 days on food, he produces 240 bushels of food and no logs (point E). If he spends 20 days on logs and 10 days on food, he produces 80 of each (point F).

3. Production Possibilities Capital Goods and Consumer Goods consumer goods Goods produced for present consumption. investment The process of using resources to produce new capital.

4. Production Possibilities The Production Possibility Frontier production possibility frontier (PPF) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

5. Production Possibilities The Production Possibility Frontier All points below and to the left of the curve (the shaded area) represent combinations of capital and consumer goods that are possible for the society given the resources available and existing technology. Points above and to the right of the curve, such as point G, represent combinations that cannot be reached. If an economy were to end up at point A on the graph, it would be producing no consumer goods at all; all resources would be used for the production of capital. If an economy were to end up at point B, it would produce only consumer goods.

6. Scarcity, Choice, And Opportunity Cost The Production Possibility Frontier Although an economy may be operating with full employment of its land, labour, and capital resources, it may still be operating inside its PPF, at point D. The economy could be using those resources inefficiently. Periods of unemployment also correspond to points inside the PPF, such as point D. Moving onto the frontier from point D means achieving full employment of resources.

7. Scarcity, Choice, And Opportunity Cost The Production Possibility Frontier The PPF illustrates a number of economic concepts. One of the most important is opportunity cost. The opportunity cost of producing more capital goods is fewer consumer goods. Moving from E to F, the number of capital goods increases from 550 to 800, but the number of consumer goods decreases from 1,300 to 1,100.

8. Production Possibilities The Production Possibility Frontier Unemployment: During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labour and capital, we are not producing all that we can.

9. Production Possibilities The Production Possibility Frontier Inefficiency: Waste of resources results from a firm operating below its potential. Sometimes, inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms.

10. Production Possibility Frontiers The Production Possibility Frontier Inefficiency: Inefficiency from Misallocation of Land in Farming Society can end up inside its ppf at a point such as A by using its resources inefficiently. If, for example, Salisbury plain’s climate and soil were best suited for corn production and those of Somerset were best suited for wheat production, a law forcing Somerset farmers to produce corn and Salisbury’s farmers to produce wheat would result in less of both. In such a case, society might be at point A instead of point B.

11. Production Possibility Frontiers The Production Possibility Frontier The Efficient Mix of Output To be efficient, an economy must produce what people want. Negative Slope and Opportunity Cost marginal rate of transformation (MRT) The slope of the production possibility frontier (PPF).

12. Production Possibility Frontiers The Production Possibility Frontier The Law of Increasing Opportunity Cost Production Possibility Schedule for Total Corn and Wheat Production Point on ppf Total Corn Production (Millions of Bushels Per Year) Total Wheat Production (Millions of Bushels Per Year) A 700 100 B 650 200 C 510 380 D 400 500 E 300 550 Corn and Wheat Production The PPF illustrates that the opportunity cost of corn production increases as we shift resources from wheat production to corn production. Moving from point E to D, we get an additional 100 million bushels of corn at a cost of 50 million bushels of wheat. Moving from point B to A, we get only 50 million bushels of corn at a cost of 100 million bushels of wheat. The cost per bushel of corn— measured in lost wheat— has increased.

13. Production Possibility Frontiers The Production Possibility Frontier Economic Growth economic growth An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources.

14. Production Possibility Frontiers The Production Possibility Frontier Economic Growth Productivity increases have enhanced the ability of the United Kingdom to produce both corn and wheat. As Table 2.2 shows, productivity increases were more dramatic for corn than for wheat. Thus, the shifts in the ppf were not parallel. Note: The ppf also shifts if the amount of land or labour in corn and wheat production changes. Although we emphasize productivity increases here, the actual shifts between years were due in part to land and labour changes.

15. Production Possibility Frontiers The Production Possibility Frontier and Inequality Sources of Growth and the Dilemma of Poor Countries Capital Goods and Growth in Poor and Rich Countries: Rich countries find it easier than poor countries to devote resources to the production of capital, and the more resources that flow into capital production, the faster the rate of economic growth. Thus, the gap between poor and rich countries has grown over time.

16. Production Possibility Frontiers The Economic Problem The three questions facing all economic systems: (1) What gets produced? (2) How is it produced? (3) Who gets it? Given scarce resources, how do complex societies go about answering the three basic economic questions?

17. Production Possibility Frontiers The Economic Problem Whatever form our economy takes, it must be somewhere on or within the PPF. One fundamental objective is to obtain full employment of resources – to be on the frontier not within it. We can also shift the whole frontier outwards. There are only two ways to do this: 1. To obtain more resources (eg more labour through immigration) 2. To increase the efficiency of resource use. Keep these two ideas in mind as we explore the economic arguments as to how to achieve this.

18. Production Possibility Frontiers An eternal truth In the long run, productivity growth is almost all that matters. Yet UK productivity growth in recent years has been poor. Activity: using a PPF, discuss why productivity growth in the long run is virtually all that matters (that is, productivity of land, labour and capital)

19. Key Terms • consumer goods • capital goods • economic growth • factors of production (or factors) • inputs or resources • marginal rate of transformation (MRT) • market • opportunity cost • production • productivity • production possibility frontier (PPF)