Why an economy operates inside its frontier

Overview

Occupational immobility of labour and shortage of one key input leave many other resources idle.

What you need to know

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Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Give three reasons why an economy might produce at a point inside its production possibility frontier.

   Model answer

   Unemployment of labour means willing workers are not producing anything. Unused capital, such as factories running below capacity or machinery lying idle, has the same effect. Inefficiency in the way resources are combined, so that firms produce at higher cost than necessary, also keeps output below the maximum attainable. Any of these leaves the economy short of the frontier.

2. 2

   Explain how a fall in aggregate demand can push an economy inside its frontier even though its resources are unchanged.

   Model answer

   The frontier shows what could be produced, but firms only produce what they expect to sell. When total spending in the economy falls, firms cut output and lay off workers, so factories stand partly idle and workers become unemployed. The stock of land, labour, capital and enterprise is exactly as before, but a smaller part of it is being used, so the production point moves inside the curve.

3. 3

   What is occupational immobility of labour, and how can it keep an economy inside its frontier?

   Model answer

   Occupational immobility is the inability of workers to move from one type of job to another because they lack the required skills or qualifications. A miner made redundant cannot immediately work as a software developer. Vacancies can therefore exist at the same time as unemployment, so labour that is available in principle is not being used, and output remains below the maximum the economy's resources could produce.

4. 4

   Explain how geographical immobility of labour contributes to an economy producing below capacity.

   Model answer

   Geographical immobility is the difficulty of moving to where the work is, caused by high housing costs in prosperous regions, family ties, schooling and the cost of moving. Unemployed workers in one region therefore remain unemployed while employers in another cannot fill posts. The resulting mismatch means part of the workforce is idle even though the jobs exist, holding output inside the frontier.

5. 5

   How can a shortage of one key input leave many other resources idle?

   Model answer

   Production usually requires several inputs together, so a missing component stops the whole process. If a factory cannot obtain a specific microchip, the assembly line halts and the workers, machinery and premises devoted to it produce nothing even though they are fully available. A bottleneck in one factor market therefore idles complementary resources across the economy, pulling the production point well inside the frontier.

6. 6

   Explain how market failure can cause an economy to operate inside its production possibility frontier.

   Model answer

   Market failure means resources are not allocated to their most productive uses. If firms have monopoly power they may restrict output to raise prices, leaving capacity unused. If information is poor, workers may train for the wrong occupations. If public goods such as street lighting, or quasi-public goods such as roads whose benefits spill over to firms that never pay for them, are under-provided, firms cannot operate at their potential. Each of these results in an economy producing less than its resources would allow.

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