I. By the end of this chapter, you should be able to define PPF, draw and use PPF for economic analysis.
II. Understand, memorize, and able to define all terms highlighted in red bold-face.
(a) Can a country produce at point D
as in Diagram 2?
(e) A point such as E in Diagram 2 is desirable
us refer to Diagram 3 and assume that the current PPF is at PPF1 and
the economy is actually producing at point D, this is known as the
de facto output.[In the classroom setting, you can
think of a student performing at level C although he has the potential
of obtaining level A.] PPF can shift from PPF1 to PPF2 through investment
in human capital, physical capital, resource exploration, and technology.
But notice that this shift is not parallel to the original PPF. In
this case, the improvement in production capacity only benefits
the production of material goods and has no effect in improving
environmental quality. Unfortunately, this sort of shift is rather
prevalent in many countries. You can think of certain cities in China
(Dong guan in Guangdong for instance) where new investment brings
in new factories, machineries and modern production technology. However,
most Chinese cities are powered by the burning of coal that pollutes
the air, and factories discharges pollution into the air, land and
Although the PPF has shifted from PPF1 to PPF2, the economy can still be producing at point D. In this case, the economy is said to have potential growth or increase in potential output without changing its de facto output.
If the economy, moves from point D to point C and at the same time PPF shifts from PPF1 to PPF2 then it experiences both economic growth and potential growth. Point C also represents development (see box 2)because at C it is producing more material goods as well as enjoying more environmental quality when compared to D.
PPF can shift towards the origin when
1: A non-standard analysis with Indifference Curve. [Extension]
It is perhaps clear that if an economy is only able to produce at point D as in Diagram 2 above, the economy is not producing at its potential capacity. Thus, there is an efficiency argument for the economy to produce at a combination closer if not on the PPF. Points A, B and C in Diagram 2 above represent combinations where the economy is producing at its potential in which all scarce resources are fully and efficiently used. Having said that, whether or not point A is better than point B depends on the total satisfaction of the citizens in consuming different combination of goods and services.
Here we will introduce a new concept of Indifference Curve. An indifference Curve is a curve that joins together or shows different combinations of goods and services that will given an individual consumer the same level of satisfaction or utility. In most textbooks, an indifference curve is drawn with reference to only two goods or services. However, you should note that it is difficult to compare one person's utility with another person's utility and it is debatable whether or not one can some up the utility of a group of consumers. Diagram 4. Here we see three indifference curves. Each curve is convex because of diminishing marginal rate of substitution in which to consume more of good X, the consumer is prepared to give up less additional unit of good Y. You can think of Y being more scarce and thus "valuable" when the level of Y available for consumption is already low. The curve I3 has the highest utility because for a fixed q1 unit of good X, at I3 the consumer can consume more good Y compared to a combination in I1. Similarly argument can be made by holding q2 unit of good Y fixed.
Diagram 5. We will assume that there is an individual that accurately represents the average consumers in the economy. Say there are 8 million people in the economy and aggregate indifference curves can be thought of as the product of 8 million people and the representative indifference curves. This aggregate (social) indifference curves are plotted as above in Diagram 5. [Actually this aggregate indifference curve is also called Social Marginal Rate of Substitution.] In this situation, point B is at a higher indifference curve when compared to point A. Thus, although both points A and B is on the PPF, the economy derives more utility form combination B than from combination A.
Box 2: Growth and Development.
Economic growth is achieved when there is steady process by which the productive capacity of the economy is increased overtime usually to bring about rising levels of national income.
It is important to
note that all economic growth may not be development. By economic
development, we usually mean a process of improving the
quality of all human lives that often include
Sustainable development is a development strategy that does not compromise future consumption in which the stock of overall capital remain constant or rise over time. To this, I will add that the overall capital should include environmental capital such as forests, soils quality, fresh water supply and clean air.
In Diagram 6, the PPF has a parallel outward
shift from PPF1 to PPF2.
(b) Evaluate the statement that "Economic growth will necessary
involve a shift as shown in Diagram 6."
Answers to Discussion A.
(a) Yes. Feasible production mix but not efficient. (b) No because the economy can produce more with the same amount of resources. (c)Unmotivated workforce or poor management, inefficient use of resources (e.g. wasting raw materials), and refusal to use new production technology that is more efficient. (d) Yes, the economy can get more outputs with the same resources. (e) E represents more of both goods for the economy- increase in utility. (f) No, it will have to shift PPF out to E or beyond.
Notes || Production Possibility Curve || Economic Systems