PRODUCTION POSSIBILITY DIAGRAMS

The production possibility boundary, also known as a production possibility frontier (PPF) or the production possibility curve (PPC), shows the maximum possible combinations of output of two goods that an economy can produce within a given time period.

It is a very useful diagram as it can be used to demonstrate many economic concepts such as opportunity costs, Pareto efficiency, and economic growth at AS level and the concept of comparative advantage at A2 level.

1. Opportunity Cost

Remember that opportunity cost is the benefit foregone from the next best alternative of a particular choice. In 1936 the German nazi leader Hermann Goering said, “We have no butter…but I ask you, would you rather have butter or guns?…preparedness makes us powerful. Butter merely makes us fat.” The important word of course is or. Goering suggests that Germany has a choice – guns or butter. This choice can be demonstrated on a production possibility frontier. In the presentation below the PPF is draw as a straight line. If the present level of production is 5 million guns, this means no butter is produced. To produce 1 million tons of butter will mean moving down the PPC and only producing 4 million guns i.e. giving up 1 million guns. This means that one gun is equivalent to one unit of butter, or as we prefer to say - the opportunity cost of one gun is one unit of butter. Because the PPF is straight this means the opportunity cost is the same all the way along it’s length. Wherever you measure the opportunity cost on this PPF, one unit of butter always costs one unit of guns - we say that in this case opportunity costs are constant. In this case we made the maths simple, the ratio of guns to butter is 1:1. Take a look at the multiple choice questions at the bottom of the page to examine other instances where the opportunity cost isn’t so simple.

Click on the picture to watch the PPF presentation.



In reality the relationship of one gun to one unit of butter will not always be stable because people have different skills and not everyone is a capable gunsmith. Not only are peoples’ abilities different, land is better suited for some purposes than others, and the equipment used to make butter is not entirely suitable for making guns. If only a few guns were to be produced then we would expect that the land, labour and capital that were best suited for this purpose to be used first. People who are skilled designers, metal workers and those with an interest in weapons would be employed first. However, If we want to to produce even more guns, factors of production that are less well suited to making guns would have to be used. Eventually factors which are the least suited to the task have to be used if production is to rise further.

This principal can be seen in the oil industry. The first oil that mankind discovered was in america and was easy to get at. The costs of production were low, but as that oil ran out we drilled in the deserts of Arabia which were more difficult, then in search of more we began looking in more inaccessible places like Alaska and the North Sea.

What this means is that as production increases the opportunity cost, instead of remaining the same, rises. In the next presentation, we start at the position where there are 6 million units of wheat being produced and no oil. If we wish to produce 1 million barrels of oil this means giving up 0.2 million tonnes of wheat.

Watch the presentation and see why the PPF bows outwards. You can download the text version of this unit by clicking on the link at the bottom of the page.



Another way of using the PPF is as a model of the economy as a whole and this is looked at in the macroeconomics part of the course. Using the PPF to demonstrate the benefits from international trade is dealt with in the A2 microeconomics section.

2. Pareto efficiency

On the diagram below there are three positions shown. At position A it is possible for the economy to produce more guns and more butter by moving to point B. Producing more guns did not involve giving up any butter. All that had to happen is that the existing economic resources had to work harder. So position A shows an economy working at less than full capacity. One or more of the resources, land, labour, capital or enterprise is not being fully employed. The PPF is a useful diagram for illustrating the problem of unemployment.



At position B it is impossible to have more guns without sacrificing some butter, similarly we can have no more butter unless some guns are given up. Vilfredo Pareto was an Italian economist and he realized that when an economy was producing at the maximum, it was necessarily true that it was impossible to make one person better off without making someone else worse off. We can see from the PPF that at point B, if we make butter producers better off, this means we will make gun suppliers worse off. So being at point B on the PPF is sometimes referred to as Pareto efficiency, other textbooks call this allocative efficiency. It must also true that all the firms in the economy must be working efficiently, and this we call productive efficiency. Productive efficiency means producing goods and services at the lowest average total cost and this is explained further in the unit on costs of production.

Pareto efficiency therefore means being at a point on the PPF and at this point the economy is productively efficient. Allocative efficiency means producing where supply and demand are equal - and more about this will be said throughout the course. For the moment you need to understand that an economy could be productively efficient but just making guns and no butter, and this would be allocatively inefficient because people who wanted butter and could afford it would not get any.

Point C is beyond the PPF and is therefore impossible.

Author’s note: I have seen some textbooks say that point B is possible if a country borrows money or is given foreign aid. This I believe is incorrect! If a loan is arranged or foreign aid given, the country’s resources have increased and the whole PPF will move outwards – see 3. below.

3. Economic Growth

Although this use of the PPF more properly belongs in the macroeconomics section of the course, it is included here because it is useful to look at whilst PPF diagrams are discussed.

We looked at the factors of production earlier. If we want the economy to grow when we are at point A we can just use resources more efficiently. But if we are point B we need more or better factors of production. Whether we are at point A or point B, it is still possible to increase the potential output of the economy and this is illustrated in the next diagram, where the PPF moves outwards from PPF1 to PPF2.