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IAI Actuarial Core Principles · Business Economics · Relationship between economics and business

An economy's output of two goods is described by a production possibility frontier. It currently produces at a point strictly inside the frontier while many workers are unemployed. Which conclusion is most accurate?

Output of one or both goods could rise without reducing the other. A point inside the frontier shows idle or inefficiently used resources, so moving towards the frontier gives extra output at no opportunity cost, though the frontier itself is unchanged.

  1. AOutput of one or both goods could rise without reducing the other, as resources are underusedCorrect
  2. BThe economy has reached allocative efficiency
  3. COpportunity cost of both goods is zero at every output level
  4. DThe frontier must have shifted inwards permanently
  5. Output beyond the frontier is attainable by reallocating labour only

Explanation

A point inside the PPF means resources are idle or used inefficiently, so more of one or both goods can be produced without sacrifice. Opportunity cost is zero only for moves from the inside point to the frontier, not at all levels, and the frontier itself has not necessarily shifted. Points beyond the frontier are unattainable with current resources.

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