PPF shifts and economic growth

What shifts a PPF outwards or inwards, biased shifts, actual versus potential growth, and capital goods against consumer goods.

Ukraine’s economy shrank by about 29% in 2022.

After Russia’s full-scale invasion in February 2022, factories, power stations, bridges and farmland were destroyed or occupied, and millions of people fled. The World Bank estimated that Ukraine’s output fell by about 29% that year.

What happens to the maximum a country can produce when it loses factors of production?

Source: World Bank, Ukraine economic update (2023).

What shifts a PPF?

A PPF is drawn for given quantity and quality of resources and given technology. Change those and the whole frontier moves.

• Outwards: more resources (investment in capital, more workers through migration or a growing population, new natural resources), better quality resources (education and training), and better technology.
• Inwards: war, natural disasters, the loss of workers through emigration or running out of natural resources.

An outward shift is an increase in the economy’s productive potential: potential economic growth.

Think first

A country’s factories, roads and power stations are badly damaged.

Many workers also leave the country.

What happens to its PPF?

Fewer factors of production mean the economy can produce less of everything: its PPF shifts inwards. The World Bank estimated Ukraine’s output fell by about 29% in 2022 after Russia’s invasion destroyed capital and millions of people left.

Step by step

1. New technology raises productivity in making both kinds of goods. The economy can now produce more of both: the PPF shifts outwards from PPF1 to PPF2. That is an increase in productive potential.

2. Losing factors of production, as in a war or a natural disaster, shifts the PPF inwards: the economy can no longer produce what it could before.

   Check: War destroys factories and many workers leave. The PPF:

   Fewer resources mean less can be produced of both goods.

3. A shift does not have to be even. New farming technology raises productivity in consumer goods but not capital goods. The frontier pivots outwards along the consumer goods axis only: a biased shift.

4. Careful: moving from U, inside the frontier, to A, on it, raises output, but the frontier has not moved. That is actual growth: using spare resources, such as getting unemployed people back into work. Potential growth is the frontier moving out.

   Check: An economy moves from a point inside its PPF to a point on it. This is:

   Output rises because unemployed resources are brought back into use. The frontier itself has not moved.

5. Both K and C are on the frontier, but they split output differently between capital goods and consumer goods.

   Check: K and C are both on the PPF. Which choice is likely to make the PPF shift outwards faster in future?

   Capital goods such as machines and buildings add to future productive capacity. Consumer goods are used up now.

6. Choices today shape tomorrow’s frontier. At K the economy makes more capital goods, machines and buildings, and fewer consumer goods now. Those capital goods raise future productive capacity, so the PPF shifts out faster. At C, people enjoy more now but the frontier grows more slowly.

What your diagram must show

• An original PPF bowed outwards, labelled PPF1
• A new PPF further out from both axes, labelled PPF2
• An arrow showing the outward shift
• Axes labelled with the two goods

A common mistake

The frontier has not moved. Going from U to A uses unemployed resources: actual growth. A shift of the PPF needs more or better resources or technology: potential growth.

Exam question

Using a PPF diagram, explain the difference between actual and potential economic growth.

Model answer

Actual economic growth is an increase in the real output an economy produces. Potential economic growth is an increase in its productive capacity: the maximum it could produce.

[Diagram: PPF1 with point U inside and A on it, and an arrow from U to A; PPF2 outside PPF1 with an arrow showing the outward shift.]

If an economy has unemployed resources, it is at a point inside its PPF, such as U. Bringing those resources into use, for example by getting unemployed people back into work, moves it towards the frontier, to A: actual growth, with the PPF unchanged.

Potential growth is shown by the PPF shifting outwards, from PPF1 to PPF2. It comes from more or better resources, such as investment in capital or better education and training, or from improvements in technology. Only potential growth allows output to keep rising once all resources are in use.

However, potential growth has an opportunity cost: resources used to make capital goods now mean fewer consumer goods today. How far the PPF shifts also depends on how productive the new investment, training or technology turns out to be.