Individuals are limited in what they can buy because the resources available to them are limited. The societies and countries too are limited in what they can produce with the given amount of resources. Production possibilities curve is a graphical representation of a combination of two goods that a country can produce with a given amount of resources.
Production possibilities curve demonstrates that:
- There is a limit to what the society/individual can achieve, given the existing institutions, technology and resources.
- Every choice the society/individual makes has an opportunity cost – to get more of one good, we need to give up some of another good – every choice has a tradeoff.
Let’s assume that a country can produce either 15000 units of bags of wheat or 15000 units of guns or a combination of two goods with the full employment of all its available resources. The following production production possibilities table shows possible combinations of this country.
|Production of Guns (1000 guns)||Production of bags of wheat (1000 bags)|
This production possibility table shows the opportunity cost of each production choice. It specifies the alternative outputs that can be achieved with different levels of inputs. This information is represented on a curve known as Production Possibility Curve as shown below. The downward slope of the PPC represents the opportunity cost concept.
If all of the economy’s resources such as land, labour and capital were used in producing guns, then 15000 of guns would be produced and none of wheat would be produced.
Alternatively, if all resources were transferred to wheat production, 15000 units of wheat would be produced and none of guns would be produced.
If resources were divided between the two industries, then a range of combinations of production is possible.
To increase production of wheat from 0 to 3000 units, the production of guns must be decreased to 3000. This opportunity cost remains the same even at the other extreme, where increasing the production of guns from 12000 to 15000, it still requires that of guns to be decreased by 3000 units of wheat.
In general, along a production possibilities frontier is a straight line, the marginal opportunity cost is constant, because, the amount of one good we have to give up in order to get the more of the other does not change. PPF is important analytical tool used by economists to illustrate various concepts such as, scarcity, choice, opportunity cost, economic efficiency and economic growth.
PPF and the concept of choice
Different points of PPF denote alternative combination of two commodities that the country can choose to produce. The points from A to F in the above diagram shows this.
PPF and the concept of production efficiency
PPF also illustrates the concept of efficiency. The combination of goods depicted on the curve are attainable only if all the resources are fully employed, with the most efficient means of production possible. All of the points on the frontier such as A and B are said to be productively efficient, because they are fully utilising the economic resources that they have.
If the economy is producing a combination of products on the PPF, then it is productively efficient. However, an economy may be operating within the frontier (for example at the point G in the following diagram), in which case it is productively inefficient. No economy should be operating within PPF because it would be wasting its resources.
This is because it could produce more of both products by using the existing resources effectively. Imagine, you are driving around a country and notice lots of factories that were closing down, high levels of unemployment and shops with very few customers in them; this economy would be productively inefficient. This can be illustrated using a PPF diagram; for example, if an economy produces at point C and not G, then it would be making more of both oranges and sugar canes. Therefore, moving from point G to a point on the PPF involves 0 opportunity cost.
PPF and the concept of scarcity
All of the points in the frontier such as A and B are said to be productively efficient because they are fully utilizing the economy’s resources that they have. This is attractive because the resources are being used properly and not wasted. When an economy is productively efficient, it can only produce an additional unit of one product by producing less of the other product; resource have to be shifted from one product to the other. This happens because the resources available in the economy are limited in numbers – meaning that resources are scarce (i.e the land, capital and the labour in the economy are limited in any given time – and cannot be increased in the short-run)
The point F will be unattainable. This is because the economy does not have the capacity to reach that level of production with the available resources. Thus, PPF shows the concept of scarcity of resources.
PPF and the concept of opportunity cost
Opportunity cost is illustrated by PPF because, along the PPF, to produce more of one good, production of the other good has to be reduced.
At this stage we consider the difference between shapes of the PPC curves. The difference between the different PPC curves depends on the opportunity cost. The linear PPC shows constant opportunity cost and the concave PPC shows increasing opportunity cost.
The above PPF shows that the opportunity cost remains constant as we increase the output of one good. For example, if we increase the production of wheat, from 3000 units to 6000 units, then we lose 3000 (12000 – 9000) of guns. If wheat production is increased from 6000 to 9000, then we lose, 3000 (9000-60000) units of guns once more. (thus an linear PPC will have constant opportunity costs.
However, a typical PPF is bowed to the origin and shows that, as more of one good is produced, an increasing amount of the other is forgone – the opportunity cost rises.
This is because, in reality, some resources are better suited for the production of certain kinds of goods, than for others. The reasoning here is that, when the production of a good requires the use of a resource that is well suited to its production, but poorly suited to the production of the other good (using more verses less fertile land) then, increases in production means that resources that are less and less suitable need to be used. Example, Evan can grow both roses and carnations in his garden. His production possibility is given below. If he is currently producing 110 roses, his opportunity cost of producing 40 more roses is:
|Choice||Number of roses||Number of carnations|
|> 20 carnations|
|> 26 carnations|
|> 31 carnations|
|> 78 carnations|
Each choice is a point on the PPC but taking differences in quantity when moving from one choice to another, we are actually computing the opportunity cost.
As we can see, the straight line PPC curve has constant opportunity cost. This, however, is not realistic as no resource will be totally adjustable for the production of both the goods.
A curved PPC is more realistic as the opportunity cost of diverting resources towards product B leads to a relatively lower increase in the output of the product B and a relatively higher loss of the product A.
The difference between the shapes of the PPCs as we can see from the above examples, depends on the opportunity cost. The negative slope of the PPCs indicate that, in order to increase the output of one good, a country has to reduce the output of the other good.
There are two reasons why economists argue that the PPC must be bowed out.
- The law of diminishing marginal return states that as we add more and more resources(variable factors in the short-run) to a particular factor (fixed factor), the output will, at first, increase and then eventually decrease.
- Not all resources are equally suitable for all the industries. If resources are transferred from good A to good B, initially the resources to be transferred will be those resources that are more suitable and efficient for B, and those which could be the least efficient for A. Later, as more of good B needs to be produced, the resources that may be very efficient for good B and not so efficient for the good B may also have to be transferred. In this situation the economy loses on both sides. That means the economy is usually inefficient on both ends of the PPC curve while it is the most efficient when resources are appropriately allocated for both the goods according to their suitability, which makes the PPC bowed out.
PPC and the concept of economic growth
Economic growth refers to an increase in the output of goods and services produced in an economy. The usual measurement for growth is GDP. An increase in Real GDP is therefore considered as economic growth.
Economic growth can take place in two ways:
– In the short-run, if the economy uses more of its unemployed resources, then it will be able to produce more goods and service. This is known as short-run economic growth. In this case, growth can be illustrated by a move from point D to any point on the PPC such as A,B or C. Such a move does not have any opportunity cost as the economy is not efficient at D.
– The shifts of the PPC outwards are known as long-run economic growth. Once attaining the output to the level of PPC, that is any point on the curve, an economy can produce more of both products only by shifting the PPF curve outwards. This means, increasing the amount of both products that can be produced with the economy’s resources. This is what happens over time when an economy grows. Economic growth enables more goods and services to become available to consumers.
An outward(rightward) shift of the frontier might be due to:
=> More training of employees, enabling them to be more productive;
=> Greater investment in in capital goods such as machines and equipment;
=> An increase in the population size, for example, through immigration;
=> Improvements in technology, providing better ways of doing thiings;
=> Discovery of new resources.
Sometimes improvements could happen only in the production of one product, while the other product could remain the same. For example, if technological improvement is specific to one sector, but not the other, then then the effect will be biased. This will rotate the PPC outward, but only in that specified area.
For example, if the improvement in technology only in the cheese production sector, the PPC will shift outward only from the cheese production output, while the steel output will remain the same.
While PPC can move outwards as mentioned above, it can also move inwards for the opposite reasons. For example, man-made and natural disasters can shift or rotate the PPC inwards.
Contributor: Mohamed Aseel(currently a student at CHSE)