Production Possibilities Frontier
Because of scarcity, all economies face trade offs in what they choose to produce.
overwhelming to try to consider all of the possibilities, so we will consider an economy
that only produces two things: pizza and beer.
I know nothing about actual pizza or beer
production, so these numbers are made up.
But they illustrate a point.
Table 1 includes some statistics for the pizza and beer economy.
The first two columns
illustrate how many pizzas or beers the
economy could make using all
combinations are called the
Productions Possibilities Frontier
This economy could make 25 pizzas
and no beers, or 20 pizzas and 5 beers,
or 15 pizzas and 9 beers, and so on.
Where the people in the economy
chose to produce would depend on the
Lets say the economy started by producing 25 pizzas and no beers.
After eating all that pizza, people might want some beer to wash it down.
unfortunately at that moment, all of the resources in the economy are being devoted to
Therefore, in order to produce beer, the economy has to reallocate
some of those resources that are being used to produce pizza to instead produce beer.
This means that they have to give up some pizzas.
In the above example, when the
economy moves from producing 25 pizzas to 20 pizzas, it can now produce 5 beers.
We can now calculate the opportunity cost of those beers.
If you remember, the
opportunity cost of a good is what you have to give up in order to get that good.
you want to make 5 beers, you have to give up 5 pizzas.
Therefore the opportunity cost
opportunity cost (first five pizzas)
what yougive up
However, lets say that the people in this economy wanted more beer and where willing to
give up 5 more pizzas to get it.
Now, when they move from 20 pizzas to 15 pizzas they
only are able to produce 4 beers.
This is called
, and normally
happens in large-scale production.
Diminishing returns happens for a number of reasons.
If an economy is using all of its resources to produce pizza, then some of those resources
are probably not so good at producing pizza, and would be much more productive at
Maybe there is a brewer producing pizza, and some beer barrels are
being used to hold tomato sauce or something.
So the first time the economy shifts
resources from producing pizza to producing beer (ie gives up the first five pizzas), the
brewer takes his beer barrels and produces a lot of pizza considering the resources he can
However, if the economy shifts again and gives up another five pizzas so that it can
Table 1: Pizza and Beer Economy