Non-linear production possibility frontiers

A production possibility frontier, or PPF, (also called a production possibility curve or boundary) shows the possible combinations of two goods that can be produced using all an economy’s resources. 

What are PPFs non-linear?

In the example, increasing a given quantity of Sector B goods, X0 to X1, leads to a small loss of Sector A goods, Y12 to Y11 - the opportunity cost is ‘1Y’.

Increasing X by a further given amount, X1 to X2, leads to a loss of 2 units of Y -Y11 to Y9 - with an opportunity cost of ‘2Y’.

Increasing Sector B goods from X2 to X3 creates an opportunity cost of ‘3Y’, and finally increasing Sector B goods to X4 creates an opportunity cost of ‘6Y’. Opportunity cost increases as more goods are produced.

The law of diminishing returns

There are several ways to explain why opportunity cost increases, but perhaps the most useful starting point is to consider the 'law of diminishing marginal returns'.

Assuming only two goods or sectors, as more of one is produced (say, in Sector B) - resources must be transferred from the other sector. At first, those factors best suited to being transferred, (including labour) leave the sector.

The effect of this is that the gain to Sector B from the transferred resource is much greater than the loss to Sector A from losing the resource.

However, as Sector B continues to expand, less suitable workers (and other factors) must eventually be transferred - hence, the gains from transferring diminish, and hence the opportunity cost gradually increases.

Video on PPFs

The principle is also referred to as the diminishing marginal rate of transformation.


Demand curves

Why do they slope downwards?

Demand curves
Equilibrium

How is equilibrium determined?

Equilibrium
Welfare

How does equilibrium create welfare?

Welfare

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