Production Possibility Frontier (PPF) I A Level and IB Economics – Transcript

00:02Hi there. This is a topic video for year one microeconomics focusing on the production possibility frontier. The PPF is a combination of two products, could be goods, could be services, uh that shows the maximum output combinations using all available factors of production efficiently.

00:23Let's consider this example a business that could be supplying pizza or could be producing sugar. And A, B, and C are combinations that lie on the production possibility frontier. Now those combinations are efficient output combinations because they lie on the existing PPF. All of the available land, labor, and capital resources are being utilized efficiently.

00:48In contrast, the combination shown by point F is not yet attainable. It lies beyond the PPF. And uh in a few minutes we'll think about ways in which we could possibly reach combination F. Of course, it would require the PPF to shift outwards.

01:05Combinations uh labeled D and E lie within the PPF, and we call those inefficient combinations because not all resources are being either fully utilized or they're being used in an an inefficient way.

01:22So we could move, for example, from point E to point B and then it would more output of sugar and a greater output of pizza. Which for most people would probably be good news. So just a quick word on the PPF and economic efficiency.

01:38Any combination of, for example, consumer or capital goods that lie inside the PPF they happen when resources are either unemployed or being used inefficiently.

01:52Combinations of goods and services that lie outside the PPF are unattainable at the present moment. And to get there, we'd need either an increase in the supply of factor resources or higher efficiency, productivity, or perhaps improvements in the state of technology.

02:09Those would be factors causing an outward shift in the PPF. And trade between nations, trade and exchange, also potentially allows uh consumers in a given country to consume beyond the nation's own PPF.

02:25Producing more of both goods, assuming they're goods that give positive private or social utility, will improve economic welfare, and we call it a gain in allocative efficiency. Now, let's move on to look at the idea of the PPF and opportunity cost.

02:43Examiners are extremely keen that you understand how we can use the PPF to explore opportunity cost. Well, opportunity cost is the cost of a choice, measured in terms of the next best alternative that is given up or sacrificed.

03:00In our example, we're increasing the output of cotton by 100 units, uh moving from point A to point B on the PPF. That involves sacrificing 40 units of wheat. So, the opportunity cost of employing more resources into cotton is expressed in terms of the output or the supply of wheat that we have to sacrifice.

03:22And in this case, 100 extra tons of cotton involves sacrificing 40 tons of wheat. So, the opportunity cost is 4/10 of a ton of wheat for each extra ton of cotton that we produce. That's how we show the basic opportunity cost idea.

03:39However, of course, the the shape of the PPF is important. And uh the nature of this curve is there to illustrate diminishing returns. Let's have a look at how this works.

03:54So, but don't forget A, B, and C are on the production possibility frontier, so we are being efficient. The question is how we're allocating the resources between wheat and and cotton. So, with diminishing returns, the marginal extra output of cotton goes down as more resources are allocated to it.

04:15As you can see as we go from A to B to C, our output of cotton is going from 300 to 400, but then only from 400 to 480. It's becoming harder to increase the output of cotton. And that to get there, we're having to sacrifice more units of wheat.

04:33So, the result is that the opportunity cost, measured in lost wheat output, increases. So, diminishing returns uh help to explain the shape of the production possibility frontier as drawn in this diagram.

04:48Not every PPF is a curve. Sometimes you can have a straight-line PPF. Let's explore that for a second or two. So, if we have a straight-line PPF, that suggests that factors of production are substitutable with no loss of productivity.

05:04Another example here, we have output of consumer goods on the Y axis, could be a car for example, and an output of a capital good, let's say a computer, on the X axis. And as we move down the PPF, the opportunity cost will stay the same.

05:20So, if the PPF is a straight line, if it's a linear PPF, then the marginal opportunity cost of switching resources, in this case between consumer and capital goods, is going to be constant. The marginal opportunity cost will be constant.

05:38Example there is that the marginal cost of extra 15 capital goods as we move down the curve is 30 consumer goods. In other words, two consumer goods but extra capital good. So, a linear PPF has a constant marginal opportunity cost.

05:58Let's think now about how the PPF can move, shift outwards. In our example here, the PPF is shifted out from PPF 1 to PPF 2. This means, of course, that if we are producing 60 consumer goods, instead of, for example, being able to produce 25 capital goods, perhaps we can now produce 42.

06:20We can now produce more capital goods for any given level of output of consumer goods. And lots of factors shift the PPF out. But the crucial point is, in this case, that an improvement in technology, uh which has been available to produce capital goods, uh has led to an outward shift in the PPF.

06:41After the shift, more capital goods can be supplied for each level of output. An improvement, I hope you can see, in economic welfare. So, what causes a PPF to shift outwards?

06:56Let's focus on five key possible causes of an outward shift. Firstly, if factors of production become more efficient, if, for example, the output per worker employed increases, or the output per worker hour increases.

07:13This increases production for each unit of input used in production. Second cause could be better management of factory inputs. We can improve the quality of the management in businesses, we can reduce wasted resources, and we could also improve quality as well as quantity of production.

07:33The PPF also tends to shift out if we have more resources available. For example, investment might lift the stock of capital, And inward migration, perhaps, could increase the available supply of labor.

07:48PPF also is linked to innovation and invention. So, developing new products, new resources, and crucially, uh finding better ways to to make a good or service. We call that process innovation.

08:02So, businesses that become process innovation efficient can become much more productive over time. And also land, let's not forget uh the factor of production of land. So, the discovery of and the commercial extraction of new natural resources, uh that will drive an increase in productive potential.

08:23So, those are the key factors that cause the production possibility curve to shift outwards. Uh here's an interesting evaluation question. Can the production possibility frontier shift inwards? And the answer is yes.

08:38Indeed, for some countries, uh some extreme um events can have severely damaging effect on their production capabilities. So, for example, countries that are vulnerable to and affected by severe natural disasters, drought, floods, earthquake, or tsunami, they can have devastating human costs as well as economic costs.