The Production Possibilities Frontier (PPF) is arguably the most important economic model.  A fundamental problem facing every society is the scarcity of resources.  Is it possible to have enough food to feed everyone?  Absolutely.  And still have enough left over for some to overindulge.  Still yes.  And be able to divert some resources to produce all the athletic shoes everyone might want?  I’m not sure, but maybe.  And still produce all the automobiles, homes, luxury yachts, iPads, etc. that we might want?  Probably not.  And so, at least relative to our seemingly unlimited wants, there are insufficient resources to produce it all.  As a society, we have to make choices.  The PPF is a graphical representation of this unfortunate aspect of nature.  As economists we utilize it to describe this “problem” and then to explore how we might go about addressing it.

The following diagrammatic representation of the PPF includes only two goods, automobiles and houses.  Of course, in the real world we have literally thousands, if not millions, of competing uses for resources.  But, as with all models, the PPF is a gross simplification of reality.  By focusing on an abstracted world where there are only two products, we can identify the underlying principles governing a world facing scarcity.  Afterward, we can rely on these principles to help us understand the much more complex real world.

The number of automobiles is measured along the vertical axis and the number of houses along the horizontal.  As we move upward along the vertical axis, the number of automobiles being produced increases.  Likewise, with the houses along the horizontal axis.  Points A, B, and C represent three combinations of housing and automobiles.

At point A, we produce relative few houses but a very high number of automobiles.  At point B, we more houses but we produce fewer automobiles.  And at point C, we produce a large number of houses, but few automobiles.  What I’d like you to notice is that as we produce more houses, we necessarily produce fewer automobiles, and vice versa.  That’s because the production of a house requires the use of a scarce resource, a resource than can no longer be used to produce an automobile.

Consider your day tomorrow.  Like the rest of us, you only have 24 hours.  And so, time is a scarce resource that has to be allocated between competing uses.  For example, at every moment tomorrow you’ll be doing one of two things.  You’ll either be sleeping or you’ll be awake.  If you sleep 8 hours, then you’ll spend 16 awake.  But if you decide to go out with friends and stay up later, your allocation may end up being 6 and 18.  Or perhaps you go on vacation and spend 12 hours sleeping leaving you only 12 awake.

It’s the same with society, each time we choose to produce more of some good or service, we are indirectly choosing to produce less of another.  The exact process is beyond the scope of this explanation, but in a predominantly market economy, markets guide these decisions.  In more directive economies, public policy plays a more substantial role.

The following diagram includes a curve connecting points A, B, and C with all the remaining possible combinations of automobiles and houses.  This curve is referred to as the Production Possibilities Frontier.  “Production” because is refers to what we choose to produce.  “Possibilities” because it includes all possible combinations.  And “Frontier” because it’s not possible for society to choose a combination to the right or above the PPF.  As an aside, it is possible to be below and to the left.  In such a case, we simply have unemployed or misemployed resources.

Why should the PPF be curved like this?  This is where this example deviates from the example of your time.  An hour of sleep cost exactly one hour of being awake, no matter if you sleep six hours or sixteen.  Human and other societal resources don’t work exactly this way.  Bricklayers, for example, are very good at laying brick. But their skill doesn’t really translate to manufacturing automobiles.   Likewise manufacturing workers are generally better at making automobiles than laying brick.

To see why this matters, let’s say our society has three bricklayers and six manufacturing workers.  Each bricklayer can build half a house.  Each manufacturing worker can build only one-fourth a house.  Our maximum possible number of houses would be three.

Likewise, two manufacturing workers can build an automobile.  But it takes four bricklayers to build one.  Our maximum this time is 3.75 (whatever the 0.75 might mean).

Now let’s assume we start at the upper extreme where we are producing 3.75 automobiles and no housing whatsoever.  What would be the opportunity cost of producing the first house?  It depends on whether you used manufacturing workers or bricklayers to build it.  If we use manufacturing workers to build our first house, it’ll take four workers and they’ll forgo producing two automobiles.  If instead we use bricklayers to build the first house, it’ll take only two and we’ll only forgo producing one-half of a car.  (Take the time to prove this to yourself.)  So, let’s go with the bricklayers.

What about a second house?  We have only one bricklayer still working at car manufacturing.  In order to build that second house, we’ll have to supplement the bricklayer with two manufacturing workers.  So the opportunity cost of the second house is 1.25 automobiles (1 bricklayer giving up 0.25 + 2 manufacturing workers combined giving up 1).

And what about a third house?  We have no bricklayers left and so would have to utilize only the remaining four manufacturing workers.  It would take all four to build this house and this would entail forgoing the last two automobiles.  The resulting PPF, you’ll see, is bowed out.

This bowed out (or concave) PPF demonstrates what economists call increasing opportunity cost.  Sometime review the concept of Comparative Advantage to learn why market economies generally behave this way.  But the underlying reason for the curved shape is due to the relative specialization of resources. 

Before we leave this topic, one last point.  What about a combination of houses and automobiles that lay outside the frontier?  Above, I mentioned that it was unattainable.  But that can and usually does change.  If we find ourselves with more brick layers and more manufacturing workers, certainly we can produce more of both.  Or, even more common, if our technology improves, we can produce more with the same amount of resources.  This is referred to as Economic Growth.