Useful notes to help introduce you to the topic of PPC and Opportunity Cost.

1. Production Possibility Diagrams
EdExcel 1.1.4

2. Production Possibility Frontiers (PPF)
• We normally draw a PPF as
concave to the origin i.e. when
we move down along the PPF, as
more resources are allocated
towards Good Y the extra
output gets smaller
• This is explained by the law of
diminishing marginal returns, it
occurs because not all factor
inputs are equally suited to
producing items leading to
lower productivity
• Land, labour and capital are
imperfect substitutes
A PPF shows alternative combinations of two goods or services
attainable when all resources are fully and efficiently employed
A
B
C
Output
of
Good X
Output of Good Y
X1
X2
X3
Y1 Y2 Y3
Remember to express output
in a given time period

3. Production Possibility Frontier (PPF)
Output of
Pizza
Output of Sugar
A
B
A, B and C are
all efficient
output
combinations
as they lie on
the existing
PPF
C
D
E
F
D and E are
inefficient
combinations – i.e.
not all resources
fully utilized
F is an output
combination
that is not yet
attainable as it
lies beyond
the PPF

4. Understanding the PPF and Economic Efficiency
• Combinations of the output of consumer and capital goods lying
inside the PPF happen when there are unemployed resources or
when resources are used inefficiently. We could increase total
output of goods and services by moving towards the PPF
• Combinations of goods and services that lie beyond the PPF are
unattainable at the moment
• A country would require an increase in factor resources, an
increase in productivity and/or an improvement in technology to
achieve an outward shift of the PPF
• Trade between countries also allows nations to consume beyond
their own PPF potentially leading to gains in economic welfare
• Producing more of both goods with the same resources
represents an improvement in welfare and a gain in allocative
efficiency

5. The PPF and Opportunity Cost
Output of
Wheat
Output of Cotton
200
160
300 400
A
B
The opportunity cost of
employing more resources
into cotton production is
expressed in terms of the
output of wheat given up
One hundred extra
tonnes of cotton
involves sacrificing 40
tonnes of wheat – the
opportunity cost is
4/10ths of a tonne of
wheat for each extra
tonne of cotton
Examiners are keen that you understand the
concept of opportunity cost in relation to the PPF!

6. PPF, Diminishing Returns and Opportunity Cost
Output of
Wheat
Output of Cotton
200
160
300 400
A
B
With diminishing returns,
the marginal (extra) output
of cotton diminishes as
more factor resources are
allocated to it.
C
80
480
The result is that the opportunity
cost measured in lost wheat output
increases
To be productively
efficient, an
economy must be
on its production
possibility frontier

7. Drawing a Linear Production Possibility Frontier
Output of
consumer
goods
Output of capital goods
PPF1
A straight line PPF is an indication of perfect factor substitutability of resources
90
60
30
10 25 40
If the production possibility frontier is a straight
line, then the marginal opportunity cost of
switching resources between consumer and
capital goods is constant.
For example, the marginal
opportunity cost of producing an
extra 15 capital goods is 30
consumer goods i.e. the
opportunity cost is 2 consumer
goods per extra capital good

8. An Outward Shift in the Production Possibility Frontier
Output of
consumer
goods
Output of capital goods
PPF1 PPF2
Changes in production technology or more factor inputs can cause the PPF to
shift outwards – this leads to an increase in a country’s potential output
60
25 42
An improvement in the technology available to
produce capital goods (other factors held
constant) will lead to an outward shift in the
production possibility frontier.
After the shift in the PPF
more capital goods can be
produced for each level of
output of consumer goods

9. Causes of Shifts in the Production Possibility Frontier
Cause of an outward shift in the
Production Possibility Frontier
Brief comment on the cause of
the shift in the PPF
• Higher productivity / efficiency
of factor inputs
This increases the output per unit
of input used in production
• Better management of factor
inputs
Improved management reduces
waste and improves quality
• Increase in the stock of capital
and labour supply
e.g. from inward labour migration
/ capital investment
• Innovation and invention of
new products and resources
Improved production processes
helps to boost efficiency
• Discovery / extraction of new
natural resources (land)
Discovery of commercially viable
land inputs drives extraction

10. Can the Production Possibility Frontier shift inwards?
Yes – productive potential can contract – here are some causes
Damaging effects of natural
disasters such as drought, a
tsunami, an earthquake and
severe floods
Destruction / loss of factor inputs
caused by civil war and other
forms of conflict that last for
many years
Large scale net outward labour
migration e.g. due to an
economic depression that leads
to a brain drain of skilled workers
A trend decline in the
productivity of inputs perhaps
caused by a persistent recession
which causes net investment to
be negative
Causes of an
inward shift of the
a nation’s PPF

11. Resource Depreciation and Resource Depletion
Resource Depreciation
Human
Capital Flight
Capital
Scrapping
Natural
Disasters
Deforestation
Machinery Skills Atrophy
Buildings Basic
Infrastructure
Resource Depletion

12. Economic Recovery and the PPF Diagram
During an
economic recovery,
aggregate demand
will be rising. This
leads to an
increase in real
national output
and a fall in the
amount of spare
capacity i.e. we
move closer to the
PPF boundary from
E to F
Capital
goods
Consumer goods
PPF
A
B
C D
E
F

13. Economic Growth using PPF Diagrams
Economic Growth
A rise in a
country’s
productive
capacity causes
the PPF to shift
out from PPF1 to
PPF2 and this
then allows
increased supply
both of consumer
and capital goods.
Capital
goods
Consumer goods
PPF1
PPF2
A
B
C D
Successful supply-side
policies can help to bring
about an outward shift of the
a country’s PPF
E
F

14. Production Possibility Diagrams
EdExcel 1.1.4