Sunday, April 14, 2013

Production Possibilities Frontier

(PPF ) is the boundary between those combinations of goods and services that can be produced and those that cannot.

Figure 2.1 shows this production possibilities frontier. The table lists some combinations of the quantities of pizza and cola that can be produced in a month given the resources available.  The PPF illustrates scarcity because we cannot attain the points outside the frontier. These points describe wants that can’t be satisfied. We can produce at any point inside the PPF or on the PPF. These points are attainable. Suppose that in a typical month, we produce 4 million pizzas and 5 million cans of cola.   

Figure 2.1 shows this combination as point E and as possibility E in the table.

We might stop producing pizza and move all the people who produce it into producing cola. The quantity of cola produced increases to 15 million cans, and pizza production is 0 million .Alternatively, we might close the cola factories and switch all the resources into producing pizza. as a result we produce 5 million pizzas at Point F

Production Efficiency

We achieve production efficiency if we produce goods and services at the lowest possible cost. This outcome occurs at all the points on the PPF. At points inside the PPF, production is inefficient because we are giving up more than necessary of one good to produce agiven quantity of the other good.

For example, at point Z , we produce  3 million pizzas and 5 million cans of cola. But we have enough resources to produce 3 million pizzas and 9 million cans of cola. Our pizzas cost more cola than necessary.

We can get them for a lower cost. Only when we produce on the PPF do we incur the lowest possible cost of production. Production is inefficient inside the PPF because resources are either unused or misallocated or both.

Resources are unused when they are idle but could be working. For example, we might leave some of the
factories idle or some workers unemployed. Resources are misallocated when they are assigned to tasks for which they are not the best match. For example, we might assign skilled pizza chefs to work in a cola factory and skilled cola producers to work in a pizza shop. We could get more pizzas and more cola from these same workers if we reassigned them to the tasks that more closely match their skills.

Tradeoff Along the PPF 

Every choice along the PPF involves a tradeoff.  we trade off cola for pizzas. Tradeoffs arise in every imaginable real-world situation in which a choice must be made. At any given point in time, we have a fixed amount of labor, land, capital, and entrepreneurship. By using our available technologies, we can employ these resources to produce goods and services, but we are limited in what we can produce. This limit defines a boundary between what we can attain and what we cannot attain. This boundary is the real-world’s production possibilities frontier, and it defines the tradeoffs that we must make. On our real-world PPF, we can produce more of any one good or service only if we produce less of some other goods or services.All tradeoffs involve a cost—an opportunity cost.

Opportunity Cost 

The opportunity cost of an action is the highest-valued alternative forgone. The PPF makes this idea precise and enables us to calculate opportunity cost. Along the PPF, there are only two goods, so there is only one alternative forgone: some quantity of the other good. Given our current resources and technology,
we can produce more pizzas only if we produce less cola. The opportunity cost of producing an additional
pizza is the cola we must forgo. Similarly, the opportunity cost of producing an additional can of cola is the quantity of pizza we must forgo. In Fig. 2.1, if we move from point C to point D, we get 1 million more pizzas but 3 million fewer cans of cola. The additional 1 million pizzas cost 3 million cans of cola. One pizza costs 3 cans of cola. We can also work out the opportunity cost of moving in the opposite direction. In Fig. 2.1, if we move from point D to point C, the quantity of cola produced increases by 3 million cans and the quantity of pizzas produced decreases by 1 million. So if we choose point C over point D, the additional 3 million cans of cola cost 1 million pizzas. One can of cola costs 1/3 of a pizza.

Opportunity Cost Is a Ratio

When we move along the PPF from C to D, the opportunity cost of a pizza is 3 cans of cola. The inverse of 3 is 1/3. If we decrease the production of pizza and increase the production of cola by moving from D to C, the opportunity cost of a can of cola must be 1/3 of a pizza. That is exactly the number that we calculated for the move from D to C.

Increasing Opportunity Cost

The opportunity cost of a pizza increases as the quantity of pizzas produced  increases. The outward-bowed shape of the PPF reflects increasing opportunity cost. When we produce a large quantity of cola and a small quantity of pizza— between points A and B in Fig. 2.1—the frontier has a gentle slope. An increase in the quantity of pizzas costs a small decrease in the quantity of cola—the opportunity cost of a pizza is a small quantity of cola. When we produce a large quantity of pizzas and a small quantity of cola—between points E and F in Fig. 2.1—the frontier is steep. A given increase in the quantity of pizzas costs a large decrease in the quantity of cola, so the opportunity cost of a pizza is a large quantity of cola. The PPF is bowed outward because resources are not all equally productive in all activities.
Do you like this post?


Post a Comment

Related Posts with Thumbnails