Production Possibility Diagrams (AQA A-Level Economics): Revision Notes

Production Possibility Diagrams

What is a production possibility diagram?

A production possibility diagram is one of the most important tools in economics. It helps us understand how economies deal with the fundamental problem of scarcity and the need to make choices about what to produce.

A production possibility frontier (PPF) is a curve that shows all the different possible combinations of two goods or types of goods that can be produced when all resources in the economy are being used to their maximum capacity with no waste. The PPF is sometimes also called a production possibility curve.

Technical progress refers to new and improved methods of producing goods, as well as new techniques that allow us to produce more output from the same amount of scarce resources.

Understanding the basic PPF diagram

Let's look at a typical PPF diagram showing the trade-off between producing capital goods and consumer goods for an entire economy:

This diagram illustrates several important features:

The PPF curve connects points Y, B, and A. Each point on the curve represents a different combination of capital goods and consumer goods that the economy can produce. For example:

• Point Y shows the maximum output of capital goods when no consumer goods are produced
• Point X (on the horizontal axis) shows the maximum output of consumer goods when no capital goods are produced
• Points A and B show different combinations where both types of goods are produced

The choice between capital goods and consumer goods is particularly significant for an economy. Capital goods (like machinery and factories) help produce other goods in the future, while consumer goods (like food and clothing) satisfy immediate wants and needs. The combination chosen reflects society's decisions about allocating scarce resources between competing uses.

Macroeconomic applications of PPF diagrams

Production possibility frontiers can be used to illustrate several important macroeconomic concepts. Let's explore two key applications.

Using a PPF to show economic growth

Economic growth is defined as the increase in the potential level of real output that the economy can produce over a period of time. It's important to note this refers to potential output, not actual output at any given moment.

This diagram shows two forms of economic growth:

Short-run economic growth occurs when the economy moves from a point inside the PPF (like point C) to a point on the frontier (like point A). This happens when previously unused or underutilised resources are brought into production. The economy is taking up slack and making use of spare capacity. The PPF itself hasn't moved - the economy is simply moving towards its existing productive potential.

Long-run economic growth is shown by an outward movement of the entire frontier from PPF₁ to PPF₂. The shift from point A to point B represents this type of growth. Long-run economic growth increases the total productive capacity of the economy. This can happen through:

• Investment in new capital goods
• Improvements in technology
• Increases in the workforce
• Better education and training (improving human capital)
• Discovery of new natural resources

Using a PPF to show full employment and unemployment

Production possibility diagrams are also useful for illustrating the difference between full employment and unemployment in an economy.

All points on the production possibility frontier (such as points A and B) represent situations where the economy is achieving full employment. This means that all who are able and willing to work are employed, and all available resources are being utilised to their maximum potential.

Full employment occurs when everyone who is able and willing to work has a job. It's important to understand that full employment doesn't mean zero unemployment - there will always be some people between jobs or temporarily out of work.

By contrast, a point inside the PPF (such as point X) represents unemployment. When the economy operates at a point inside the frontier, some resources (including labour) are not being employed. There is unused capacity in the economy. If long-run economic growth were to move the PPF outwards, points A and B on the old frontier would then be inside the new frontier and would represent unemployment relative to the new productive potential.

Unemployment means that not all of those who are able and willing to work are employed. This represents wasted potential in the economy and is associated with productive inefficiency.

Microeconomic applications of PPF diagrams

While the examples above focused on the whole economy (macroeconomic applications), PPF diagrams can also be used at the microeconomic level to illustrate decisions made by individual firms or industries.

Scarcity, resource allocation and choice

This diagram shows a microeconomic PPF for a firm that can produce mobile phones and laptop computers. We can identify this as a microeconomic diagram because it focuses on the production choices of a single firm rather than the entire economy.

Resource allocation is the process through which available factors of production are assigned to produce different goods and services. In a modern economy, resources must be allocated among many competing uses such as food, cars, healthcare, defence, and countless other goods and services.

The PPF in the diagram shows the different possible ways scarce resources can be allocated between mobile phone and laptop computer production:

• Point Y shows maximum mobile phone production (zero laptop computers)
• Point X shows maximum laptop computer production (zero mobile phones)
• Points between these extremes show various combinations of both products

Point C shows one particular allocation of resources. At this point, the firm produces MP₂ mobile phones and LC₂ laptop computers. Compared to the resource allocation at point A, point B shows the effect of shifting more resources into mobile phone production, which means fewer resources are allocated to laptop computer production.

Opportunity cost revisited

Production possibility diagrams provide an excellent way to illustrate the concept of opportunity cost. Remember that opportunity cost is the value of the next best alternative foregone when a choice is made.

Let's work through an example using the microeconomic PPF for mobile phones and laptop computers:

Suppose the firm initially produces MP₁ mobile phones and LC₁ laptop computers (point A). If the manufacturer decides to increase mobile phone production from MP₁ to MP₂, then laptop computer production must fall from LC₁ to LC₂. Moving from point A to point B on the curve, the fall in computer production is the opportunity cost of increasing mobile phone production.

The shape of the PPF tells us something important about opportunity costs. The curve slopes downward and is concave (bowed outward). This shape shows that opportunity costs increase as more of a good is produced.

Here's why: When mobile phone production increases from MP₁ to MP₂, laptop computer production falls by LC₁ - LC₂. But suppose mobile phone production increases again by the same amount (MP₃ - MP₂ is the same as MP₂ - MP₁). In this situation, shown at point C on the curve, more laptop computers must be sacrificed than before: LC₃ - LC₂ is larger than LC₂ - LC₁.

The slope of the PPF shows the opportunity cost of producing more mobile phones in terms of the laptop computers that must be sacrificed. As we move up the curve from point A to point B to point C, the slope becomes steeper. This means the opportunity cost of producing mobile phones increases as more mobile phones are produced. Each additional mobile phone requires sacrificing a greater number of laptop computers than the previous increase.

This pattern of increasing opportunity costs occurs because resources are not perfectly adaptable between different uses. Some resources are better suited for making mobile phones, while others are better for making laptop computers. As production of one good increases, the economy must start using resources that are less and less well-suited to that task.

Worked example: calculating opportunity cost

This example demonstrates how to use a PPF to calculate opportunity costs by identifying the trade-off between two goods.

Productive efficiency and production possibility diagrams

The concept of productive efficiency is closely linked to production possibility frontiers.

Productive efficiency for the economy as a whole occurs when it is impossible to produce more of one good without producing less of another. For an individual firm, productive efficiency occurs when the average total cost of production is minimised.

Understanding productive efficiency using the PPF

All points on the production possibility frontier (including points A and B in the diagram) are productively efficient. At these points:

• All available resources are fully employed
• Resources are being used in the most efficient way possible
• Output is maximised from available inputs
• It's impossible to produce more of one good without producing less of the other

By contrast, all points inside the frontier (including point Z) are productively inefficient. At these points:

• Some resources are not being employed
• Resources are not being used efficiently
• The economy could produce more of both goods (or more of one without sacrificing the other)
• Output is not maximised from available inputs

Movement along the PPF

Consider a movement along the PPF from point A to point B. The diagram shows that when moving along the frontier, more capital goods can be produced, but only by reducing production of consumer goods. This represents another way of understanding productive efficiency: when the economy is productively efficient, producing more of one good requires giving up some production of other goods.

By contrast, when the economy is productively inefficient at point Z, more capital goods and consumer goods can both be produced by taking up the slack in the economy and making better use of idle resources. Moving from point Z to a point on the frontier increases output without requiring trade-offs between different goods.

Drawing a PPF from given data

Sometimes you'll need to draw a production possibility frontier from data provided in a table. Let's work through an example:

The straight line PPF is positioned between the two production possibility extremes, showing all the possible combinations of tanks and military aircraft that can be produced with available resources.

Exam tips for PPF diagrams

Summary