1.1.4a Uses of production possibility frontiers

The Production Possibility Frontier

1. It is drawn with one good on each axis, for example capital goods against consumer goods, and usually curves outwards, concave to the origin.
2. Its power is capturing scarcity, choice and opportunity cost in a single picture: the trade-off is built into the shape of the curve itself.

Points On, Inside and Outside

1. Any point on the PPF shows the economy at its maximum productive potential, using all resources fully and efficiently.
   1. At such a point more of one good can only be made by producing less of the other.
2. A point inside the curve shows an inefficient allocation of resources, with factors unemployed or underused.
   1. The economy could produce more of both goods, so output is being wasted.
3. A point outside the curve is currently unobtainable with existing resources and technology.
   1. It could only be reached after economic growth shifts the frontier outwards.

Opportunity Cost

1. Because the curve is concave, opportunity cost rises as more of one good is produced.
   1. Resources are not equally suited to both goods, so switching them becomes increasingly costly.
2. Marginal analysis reads this as the extra amount of one good sacrificed for each additional unit of the other.

Economic Growth or Decline

1. Growth can come from more or better resources, such as investment, a larger workforce or improved technology.
2. Decline can follow a natural disaster, a shrinking workforce or the depletion of key resources.
3. A move from inside the curve towards it is a recovery using spare capacity, not growth, because potential is unchanged.

Is the PPF a realistic model?

1. It holds because it captures scarcity, choice and opportunity cost more clearly than almost any other model, all in a single diagram.
2. But it simplifies to just two goods and assumes resources and technology are fixed, which is only true at a single point in time.
3. But it shows what an economy can produce, not what it should produce, since that depends on society's value judgements.
4. On balance, its usefulness depends on treating it as a snapshot: it is a powerful analytical tool, but it must not be read as a forecast or a policy recommendation.

1.1.4b Movements along and shifts in the PPF

Movements and Shifts

1. An outward shift represents economic growth, while an inward shift represents decline.
2. The key contrast is that a movement changes only what the economy chooses to make, whereas a shift changes what it is capable of making at all.

Causes of Shifts

1. More resources shift the frontier outward.
   1. A larger workforce, more capital or newly discovered raw materials all raise capacity.
2. Better quality resources also shift the frontier outward.
   1. Improved technology, education and higher productivity let the same resources produce more.
3. Loss of resources shifts the frontier inward.
   1. Natural disasters, war or a falling workforce reduce what the economy can produce.

Significance of the Distinction

1. It separates a reallocation of resources from a genuine change in capacity.
2. It shows growth as an expansion of what is possible, not just producing more within current limits.
3. It links the micro PPF to the macro idea of long-run growth.

Does an outward shift always raise living standards?

1. It holds because a larger frontier means more can be produced, which usually supports higher living standards.
2. But it depends on whether the extra capacity is actually used, since an economy can still operate inside the frontier.
3. But it also depends on the mix: growth in goods people do not value, or in capital goods that sacrifice today's consumption, may not raise welfare now.
4. On balance, whether a shift improves living standards depends on both using the new capacity and producing the goods people actually want.

1.1.4c Capital and consumer goods

Capital and Consumer Goods

1. The balance an economy strikes between the two shapes its future growth: more capital today means more of everything tomorrow.
2. The link runs through the PPF: producing more capital goods now pushes the whole frontier outward later.

The Trade-Off

1. Choosing consumer goods raises living standards today.
   1. It does little for future capacity, because it does not expand the economy's ability to produce.
2. Choosing capital goods sacrifices some consumption now but expands future production.
   1. More capital goods today shift the whole PPF outward in the future.

Capital and Long-Run Growth

1. Capital goods raise productivity, so each worker can produce more.
2. Higher productivity expands the economy's productive capacity over time.
3. This is why investment in capital is central to long-run economic growth.

Is more capital always better?

1. It holds because investing in capital raises future output and productivity, expanding what the economy can produce.
2. But it reduces consumption today, which may be painful if incomes are already low.
3. But the gain depends on the quality of the investment, since poorly chosen capital adds little.
4. On balance, the right amount depends on striking a balance, because an economy that never consumes gains nothing from its extra capacity.