Lecture Notes on Production Possibilities Frontier and Allocative Efficiency

Key Concepts

• Production Possibilities Frontier (PPF): A curve depicting all maximum output possibilities for two or more goods given a set of inputs.

  • Points on the PPF represent productive efficiency.
  • Moving along the PPF involves opportunity costs.
  • Points inside the PPF are inefficient as more of one good can be produced without reducing the quantity of other goods.

• Productive Efficiency: Achieved when it is impossible to produce more of one good without decreasing the quantity of another good.

Scenarios

• Six different scenarios (A, B, C, D, E, F) on the PPF are considered.
  • Productive efficiency is achieved at any of these points.
  • To gain more of one product (e.g., rabbits), you must give up some of the other product (e.g., berries).

Inefficient Points

• A point inside the PPF means you can increase the production of goods without any trade-offs.
  • Example: Moving towards Scenario B or D from an inefficient point increases efficiency.

Allocative Efficiency

• Definition: Achieving the mix of goods most desired by society.
• It is somewhat subjective and depends on preferences.
• Achieved when marginal cost equals marginal benefit (MC = MB).

Marginal Cost and Marginal Benefit

• Marginal Cost (MC): The cost of producing one additional unit of a good.
• Marginal Benefit (MB): The benefit or satisfaction gained from consuming one additional unit of a good.

Scenarios and Marginal Costs (Measured in Berries)

• Scenario F: 0 rabbits, MC of 1 rabbit = 20 berries.
• Scenario E: 1 rabbit, MC of 1 rabbit = 40 berries.
• Scenario D: 2 rabbits, MC of 1 rabbit = 60 berries.
• Scenario C: 3 rabbits, MC of 1 rabbit = 80 berries.
• Scenario B: 4 rabbits, MC of 1 rabbit = 100 berries.

Marginal Benefit Analysis

• Scenario F: High MB, willing to pay 100 berries for a rabbit.
• Scenario E: Slightly less MB, willing to pay 80 berries.
• Scenario D: MB = 60 berries.
• Scenario C: MB = 40 berries.
• Scenario B: Low MB, willing to pay 20 berries.

Plotting MC and MB

• MC and MB are plotted as functions of the number of rabbits.
• The intersection of MC and MB determines the allocative efficiency.
  • Allocative efficiency occurs where MC = MB.
  • Based on the given scenario, Scenario D achieves allocative efficiency.

Decision-Making Based on Scenarios

• Rational decisions involve moving towards points where MB > MC.
• Do not over-allocate resources when MC > MB.
• Aim to balance production and benefits, achieving Scenario D in this context.