MGT Notes

Reference, ‘Principles of Economics,’ by N. Gregory Mankiw, 3e, Pg 24

Unlike the Circular Flow Diagram, the Production Possibilities Frontier is a more mathematical model. It forces one to focus on just two products in the economy. It is assumed that together they use up all factors of production. The resultant graph shows all possible combinations of the two goods that an economy can produce using all available factors of production with the available production technology that can convert the factors into finished goods.

The two ends of the PPF represent two extreme possibilities of production (all of one good and none of the other). An economy can produce on the frontier (efficient market) or inside the frontier (inefficient market), but not outside since not enough resources are available.

The PPF demonstrates tradeoffs the economy faces and highlights the opportunity cost of one good in terms of the other. This tradeoff can change over time. Technological advances can move the PPF outward – in this case the economy can enjoy more of both goods.

Thus, the PPF is a good model to study scarcity, efficiency, tradeoff, opportunity cost and economic growth.