Doug is a Chartered Alternative Investment Analyst who spent more than 20 years as a derivatives market maker and asset manager before “reincarnating” as a financial media professional a decade ago.
Before joining Britannica, Doug spent nearly six years managing content marketing projects for a dozen clients, including The Ticker Tape, TD Ameritrade’s market news and financial education site for retail investors. He has been a CAIA charter holder since 2006, and also held a Series 3 license during his years as a derivatives specialist.
Doug previously served as Regional Director for the Chicago region of PRMIA, the Professional Risk Managers’ International Association, and he also served as editor of Intelligent Risk, PRMIA’s quarterly member newsletter. He holds a BS from the University of Illinois at Urbana-Champaign and an MBA from Illinois Institute of Technology, Stuart School of Business.
Karl Montevirgen is a professional freelance writer who specializes in the fields of finance, cryptomarkets, content strategy, and the arts. Karl works with several organizations in the equities, futures, physical metals, and blockchain industries. He holds FINRA Series 3 and Series 34 licenses in addition to a dual MFA in critical studies/writing and music composition from the California Institute of the Arts.
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What is the production possibilities frontier (PPF)?
The production possibilities frontier (PPF), also called the production possibilities curve (PPC), is a graph that illustrates the maximum combinations of two goods or services an economy can produce with its available resources and technology. It helps explain why scarcity forces individuals, businesses, and economies to make trade-offs. By showing what can be produced efficiently, what is currently unattainable, and how production changes when resources are reallocated, the PPF illustrates several core economic concepts, including opportunity cost, efficiency, and economic growth.
What does a point inside or outside the production possibilities frontier mean?
The location of a point relative to the production possibilities frontier reveals whether resources are being used efficiently. Points on the frontier represent the most efficient use of available resources. A point inside the frontier is attainable but inefficient, meaning output could increase without adding new resources. A point outside the frontier represents a level of production that is currently unattainable with existing resources and technology. As an economyâs productive capacity expands through technological innovation, investment, or improvements in labor and skills, the frontier can shift outward, making previously unattainable combinations possible.
How does the PPF illustrate opportunity cost?
The production possibilities frontier illustrates opportunity cost by showing what must be given up to produce more of another good or service. Moving along the frontier means increasing production of one output while reducing production of another because resources are limited. In a simple example, the trade-off may remain constant, producing a straight-line frontier. In most real-world situations, however, opportunity costs increase because workers, equipment, and other resources are not equally suited to every task. That increasing trade-off produces the bowed shape commonly associated with the production possibilities frontier.
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Analyzing five economic ideasâscarcity, trade-offs, opportunity cost, efficiency, and growthâfor efficient production.
Scarcity. Itâs one of the foundational concepts in economics. Land, materials, labor, capital, and time are all finite. Because resources are limited, producers must choose what to produce. Yet every choice carries an opportunity cost, meaning that every resource devoted to producing one thing will no longer be available for another. Economists have a tool for visualizing exactly how much of one good must be sacrificed to produce more of another: the production possibilities frontier (PPF), also called the production possibilities curve (PPC).
What is the production possibilities frontier?
The production possibilities frontier is a chart that illustrates the maximum combinations of two goods or services an economy could produce given its current resources and technology. The same concept can also be applied to a business, an individual, or any producer that must decide how to allocate limited resources.
Example 1: Constant opportunity costs
To see how the model works, itâs easiest to start with a single person. Once you understand the trade-offs facing an individual, you can scale the same idea to businesses and entire economies.
Imagine youâre deciding how to spend your time earning extra money, and youâve narrowed it down to two choices:
Food delivery driver, where you can deliver up to five meals per day
Tutor, where you can teach up to five students per day
Every hour you spend delivering meals is an hour you canât spend tutoring students. If you can deliver up to five meals a day or tutor up to five students a day, every combination in between represents the same one-for-one trade-off. Figure 1 plots the possible combinations of food deliveries and tutoring sessions you can produce in a day, given your limited time.
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Figure 1: CONSTANT OPPORTUNITY COST. The frontier forms a straight line when the production trade-offs are equal.
EncyclopĂŠdia Britannica, Inc.
In this simplified example, every additional meal delivered means giving up one tutoring session. Because the trade-off remains the same at every point along the frontier (one meal="one" student), economists describe this as constant opportunity cost.
Beyond illustrating the trade-offs, figure 1 also shows whether a given combination is efficient, inefficient, or unattainable.
Points AâF (the frontier). Every point along the frontier represents an efficient use of your available time. To deliver more meals, you must give up tutoring sessions, and vice versa.
Point inside the frontier (inefficient). This combination is attainable, but it doesnât make full use of your available time. In other words, you could produce more without adding resources.
Point outside the frontier (unattainable). This combination isnât possible with your current time and resources. Reaching it would require more hours in the day or a change that increases your productive capacity.
Example 2: Increasing opportunity costs
Imagine a diversified company thatâs capable of producing both driverless cars and personal computers. At maximum capacity, it can produce either 400 driverless cars or 2,000 PCs. It can also produce any combination of the twoâbut in contrast to the previous example, the trade-offs are not equal.
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Figure 2: INCREASING OPPORTUNITY COSTS. The frontier is curved, as existing resources are less efficient for some outputs than others.
EncyclopĂŠdia Britannica, Inc.
Like the straight-line frontier in figure 1, points on the curve in figure 2 represent efficient production, points inside the curve represent an inefficient use of resources, and points beyond the curve are unattainable given current resources and technology. The difference is that the curved frontier reflects increasing opportunity costs as resources become less suited to producing one good instead of another.
The formula behind opportunity cost
The opportunity cost shown by a PPF can be expressed as the amount of one good that must be given up to produce more of another.
Opportunity cost="units" of good B given up / units of good A gained
Economists call this relationship the marginal rate of transformation (MRT) because it measures the opportunity cost of producing one additional unit of a good in terms of the amount of another good that must be given up. For example, if producing 10 more computers requires giving up 2 cars, the opportunity cost is 2 Ă· 10="0.2" cars per computer.
Figure 1 illustrates a constant MRT (constant opportunity cost): Every additional unit of tutoring requires you to give up the same amount of food delivery. Figure 2 illustrates an increasing MRT: As production shifts from driverless cars to computers, the opportunity cost of producing additional computers rises.
Shifting the curve and expanding the production frontier
So far, the production possibilities frontier has assumed a fixed level of resources and technology. In reality, productive capacity typically increases over time, shifting the frontier outward. This can happen for several reasons:
Technology and innovation. New technologies can help producers get more output from the same resources. Examples include more efficient machinery, drought-resistant crop varieties, robotics, and artificial intelligence.
Investment in productive capacity. Building new factories, expanding infrastructure, or purchasing additional equipment allows producers to make more goods and services.
Labor and skills. A larger workforceâor one thatâs healthier, better educated, or more highly trainedâcan increase an economyâs productive capacity.
Although the curve can shift outward, it can also move inward. An economic slowdown, war, or natural disaster can contribute to the destruction of resources or the depletion of the labor force, causing production to slow.
From businesses to economies
The previous examples used an individual and a business to illustrate the model in its simplest forms. But economists originally developed the production possibilities frontier to describe the choices facing entire economies. Instead of deciding how to divide time between tutoring and food deliveryâor resources between computers and automobilesâa nation must decide how to allocate its limited resources between consumer goods and capital goods.
Consumer goods are things that people use directly and/or regularly. This includes food, clothing, and electronics. Capital goods, on the other hand, are the goods used to produce other goods later. This category includes manufacturing equipment, machinery, and infrastructure.
PPF: Five economic concepts in one graph
The production possibilities frontier is a simple model, but it captures several fundamental economic concepts at once:
Scarcity. Foundational to all economic thinking, scarcity is the reason why the frontier exists at all.
Trade-offs. Increasing the production of one good will necessarily limit the production of another.
Opportunity cost. Choosing to produce one product will cost you the potential benefit derived from producing the other.
Efficiency. Points on the frontier represent efficient production, while points inside the frontier indicate underused resources.
Economic growth. An outward shift in the frontier signals an increase in an economyâs productive capacity.
Now consider the same model at the national level. A country that invests heavily in capital goods is trading present consumption for a greater productive capacity in the future. By contrast, a country that focuses primarily on consumer goods may be choosing more immediate benefits, but at the cost of slower long-term growth in its production possibilities frontier.
Whether the decision is made by a country, a business, or an individual, the PPF illustrates the same fundamental trade-off: how much to consume today versus how much capacity to build for tomorrow.
The production possibilities frontier is still relevant today because it provides insight thatâs both valuable and rare. It compresses five economic ideasâscarcity, trade-offs, opportunity cost, efficiency, and growthâinto a single line. Whether the decisions are made by an individual, a business, or an entire economy, the PPF asks the same underlying question: How much can you make with what you have, and what are you willing to give up to produce more of something else?
This article was most recently revised and updated by Karl MontevirgenThis article was most recently revised and updated by Doug Ashburn
