Back To CourseEconomics 102: Macroeconomics
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Jon has taught Economics and Finance and has an MBA in Finance
The production possibilities frontier (PPF) is an economic model used to illustrate how people and nations should decide what goods to produce, how much to produce, and for whom they should produce it. It's a model and a concept that looks at only two goods at a time. For example, what combination of cars and computers should a nation produce?
The production possibilities curve illustrates all the possible combinations of how we can produce these two goods given the constraints we have, including the fact that resources are scarce. The question we're answering in this lesson is, 'What causes the production possibilities curve to shift?'
Before we answer this, let's review some of the basic ideas about the production possibilities curve, using two types of curves. Let's say we have a production possibilities curve showing the production of two goods: cars and computers.
Economists also use the PPF model to illustrate two categories of goods, both consumer goods and capital goods. So here is what that PPF curve looks like.
In any economy, investments into capital goods will do more to increase economic growth than investments into consumer goods will. For both of these types of curves, every point along the curve is efficient, meaning this combination of producing two goods is at our capacity. We're producing the most that we can with the least amount of costs. Movement along this curve reveals the trade-offs that are required to produce more or less of a good. We said that any point inside the curve is not efficient, and any point outside the curve is unobtainable.
The best example in history of when America's economy was inside the curve was during the Great Depression. At that time, unemployment was extremely high, and production was extremely low. But eventually, during World War II, our economy moved from inside the curve to somewhere on the curve. Now we're producing things as fast as we can, largely driven by the war, but we are on the curve. Even though we were producing a lot more, we still had a limit, a capacity that we couldn't exceed, unless something major changed. That's why any point that is outside the curve is not possible.
The production possibilities curve, whether it is showing two specific goods, such as cars and computers, or two types of goods, such as capital goods and consumer goods, shows us how much is produced, which means it's showing us a picture of output.
So, now we can talk about shifts in the entire curve. The basic idea is that anything that causes economic output to increase or decrease will shift this curve. In any economy, the major goal that you're trying to achieve is growth, which is to say, producing increasing amounts of the goods and services that consumers demand.
Given the fact that resources are scarce, we have constraints, which is what the curve shows us. When the economy grows and all other things remain constant, we can produce more, so this will cause a shift in the production possibilities curve outward, or to the right. If the economy were to shrink, then, of course, the curve would shift to the left. When the curve shifts outward, or to the right, that means output is increasing. When the curve shifts inward, or to the left, that means output is decreasing.
Shifts in the production possibilities curve are caused by changes in these things:
• Advances in technology
• Changes in resources
• More education or training (that's what we call human capital)
• Changes in the labor force
Let's briefly explore each one of these and see how they shift the curve. Probably what you hear about most in economics is how changes in technology affect the curve.
For example, let's say the country discovers a new technology, such as a new computer system that improves productivity. Anything that improves the productivity of workers is good. This causes output to increase, so the production possibilities curve shifts outward, or to the right. On the other hand, let's say a major war causes destruction of capital equipment in the country. This would cause output to decrease, so in this case, the production possibilities curve shifts inward, or to the left.
Changes in resources are also going to shift the curve - for example, if a country discovers a new energy source, like new solar panels, let's say. This causes output to increase, which shifts the production possibilities curve outwards, or to the right. On the other hand, if the country gets devastated by a major hurricane, it's not too difficult to imagine that this setback would make it more difficult to produce things. This causes output to decrease, which in turn shifts the production possibilities curve inward, or to the left.
Now let's talk about education and training. When more people in the work force get educated or trained, we refer to that as human capital. Education and training increase knowledge, and knowledge tends to increase productivity, so this would shift the production possibilities curve to the right.
Finally, if there was a sudden increase in the labor force, either from a population boom or, more likely, from immigration, then the production possibilities curve shifts outward, or to the right. Why is this? It's because more people working means more production possible.
This works in reverse as well. If the country experiences more unemployment, then the unemployment rate goes up. That means the labor force is shrinking, so more people are not working and not being productive. This would decrease the output of the nation, and shift the production possibilities curve inward, or to the left.
To summarize, the production possibilities frontier (PPF) is a model that helps us decide what to produce, how to produce it, and for whom to produce it.
Consumer goods are final goods that are purchased directly by consumers, while capital goods represent machinery, tools, and equipment, or anything that is used to produce consumer goods.
Shifts in the production possibilities curve are caused by things that change the output of an economy, including advances in technology, changes in resources, more education or training (that's what we call human capital) and changes in the labor force. Increases in the production possibilities curve are represented by shifts outward, or to the right, while decreases are represented by shifts inward, or to the left.
By the end of this lesson you'll be able to:
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Back To CourseEconomics 102: Macroeconomics
15 chapters | 123 lessons
Next LessonOpportunity Cost: Formula & Analysis