PPF Outward Shift - Theme 1 Micro

A production possibility frontier (PPF) illustrates the combinations of output of two products that a country can supply using all of their available factor inputs in an efficient way. One way the PPF can shift outwards is if there is an increase in the active labour supply.

This might come about either from the natural growth of a country’s population especially for nations with a low median age. For example Ethiopia has a median age of 17.8 years and Rwanda has a median age of 19.0 years. The labour supply might also grow because of the impact of net inward migration of people of working age. The UK has seen strong inward migration over the last fifteen years (averaging over 200,000 a year) as has Canada. Several middle-eastern countries including the UAE have relied heavily on migrant workers to increase their labour supply to sustain economic growth.

However, the extent to which a growing population leads to improved living standards and sustainable development is open to question. An expanding population puts increasing pressure on natural resources and also increases demand for public services such as education and health together with a growing need for affordable housing. Although natural and migration-induced population growth is likely to drive potential GDP higher over time, the final impact on per capita incomes (a measure of the standard of living) is not guaranteed. Much depends on the extent to which the quality of the labour force (i.e. the human capital) can improve.

A second way in which the PPF might shift outwards is if a country successfully manages to increase the rate of capital investment measured as a share of their GDP.

Investment in capital goods such as new plant and machinery, factories, new hardware and software and investment in critical infrastructure leads to a higher capital stock. New capital tends to be more efficient / productive than ageing capital inputs, and higher productivity means that more output can be supplied from a given amount of factor resources. Higher productivity tends to lead - over time – to improved wages, growing per capita incomes and lifts many people out of poverty since it allows them to increase their consumption of essential products. China and India are two countries whose investment-to-GDP ratio has both risen over the last twenty years. In China’s case, investment in 2010-12 reached nearly half of their annual GDP!

However, although investment is important for causing an outward shift of the PPF and contributing towards long-term economic growth, there are also some possible downsides to consider. One is that a shift towards investment (shown in my diagram) might actually hurt short-term living standards since there are fewer resources allocated to consumer goods and services. This might be alleviated by the ability to import. Second, the quality of investment is probably as important as the quantity of capital spending. Poorly constructed buildings and investment in technologies inappropriate to a country’s stage of development might limit the impact of investment on average living standards.

Key summary

Ways of increasing the supply of labour available to an economy:

1. Positive net inward migration
2. Tax free (subsidised) child care working mothers and fathers
3. Higher minimum wage, extension of the (voluntary) living wage
4. Changes to the official state retirement age (i.e. increase from 65 to 67)
5. Tax incentives e.g. increased tax-free allowance or cut to basic rate