Production Possibility Diagrams

Production Possibility Diagrams

1. aka Production Possibility Boundary (PPB)

2. The PPB indicates the MAXIMUM POSSIBLE OUTPUT that can be achieved given a fixed set of resources and technology in a particular time period

3. The diagram COMPARES TWO POSSIBLE GOODS OR SERVICES being produced, e.g. financial services and computer software

   • • The curve indicates where the maximum output is being achieved (when all the resources are being fully utilised)

4. Opportunity Cost

   • The PPB can illustrate choice and OPPORTUNITY COST, If we are operating on the PPB then to INCREASE OUTPUT for one product, we must REDUCE OUTPUT of another product
     • Example: in order to produce more financial services you must produce less computer software
     • • e.g. to shift production from X to Y you would produce OD of computer software but must give up AC of financial services
   • OPPORTUNITY COST= the next best alternative foregone when an economic decision is made

5. PRODUCTIVE EFFICIENCY= when a firm operates at minimum average total cost, producing the maximum possible output from inputs into the production process. This is at any point on the PPB, it considers only the method which involves the least wastage of resources, not the combination that maximises economic welfare.

6. ALLOCATIVE EFFICIENCY= this is achieved in an economy when it is not possible to make anyone better off without making someone worse off, or you cannot produce more of one good without making less of another. This is achieved at points on the PPB.

7. KEY POINTS...

   • all points on the PPB are productively and allocatively efficient
     • it is not possible to achieve output levels beyond the PPB
       • points within the PPB are not using all the resources to full capacity
         • so from points within the PPB it is possible to increase output without an opportunity cost
           • shifts between two points on a PPB will always carry an opportunity cost

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