Production Possibility Curve - Full Explanation

PRODUCTION POSSIBILITY CURVE OR FRONTIER (PPC OR PPF)

Production: Technological transformation of input (factor: Ld, Lb, K, Org. & non-factor: water, electricity, raw materials) into output (finished goods and services: cloth, food, electricity).

An economic model and visual representation of the ideal production balance between two commodities given finite resources.

A PPF or PPC is a curve which shows various possible/attainable combinations of  output (the amounts of two goods) which can be produced at the maximum level within the given (fixed) resources and technology. Where the given resources are fully and efficiently utilized at the given period of time.

A PPF illustrates several economic concepts

·       Allocative Efficiency

·       Economies of Scale

·       Productive Efficiency or capability

·       Scarcity of resources (the fundamental economic problem that all societies face)

·       Different choices that an economy faces

·       Opportunity Cost (or marginal rate of transformation or trade-off)

Trade off: PPC shows trade-off between producing one good versus another. Making more of one good will cost society the opportunity of making more of the other good. It means, one good can only be produced by diverting resources from other goods, and so by producing less of them.

Nowadays Trade-off in Nepal...

Can Anyone Guess ?????

Production of Medicinal Kits or Production of Hydro-electricity

3 Types of PPC:

1.     Straight-line sloping down: Constant negative gradient or constant ratio, constant opportunity cost

• one item/good decreases by fixed amount, the other item/good will increase by one,
• not realistic because it cannot represent the market/economy.

Combination	Clothes (Thousand Meters)	Food (Metric Tons)	Opportunity Cost
A	20	0	-
B	15	1	(-5 : 1)
C	10	2	(-5 : 1)
D	5	3	(-5 : 1)
E	0	4	(-5 : 1)

2. Concave Curve: increasing ratio, increasing opportunity cost

• one item/good decreases by more and more, the other item/good will increase by one,
• more realistic and it represent the whole market or economy.

Combination	Clothes (Thousand Meters)	Food (Metric Tons)	Opportunity Cost
A	20	0	-
B	18	1	(-2 : 1)
C	14	2	(-4 : 1)
D	8	3	(-6 : 1)
E	0	4	(-8 : 1)

3.     Convex curve: decreasing ratio, Decreasing opportunity cost

• one item/good decreases by less and less, the other item/good will increase by one,
• does not really exist in the real-life economy, some says that in agriculture, this type of curve does exist but mostly it is not.

Combination	Clothes (Thousand Meters)	Food (Metric Tons)	Opportunity Cost
A	20	0	-
B	12	1	(-8 : 1)
C	6	2	(-6 : 1)
D	2	3	(-4 : 1)
E	0	4	(-2 : 1)

  

Assumptions

To simplify illustration or calculation, we have some assumptions

• Economy is producing only two goods X and Y
• Constant Technology or no change in technique of production (Labor intensive & Capital intensive)
• Fixed resources (inputs) supply to the economy but comparison with another time is possibl
• Productive resources are fully utilized or employed and no waste of resources but in reality the resources are never been utilize fully. For eg. Labor without motivation or incentives, maintenance of machines
• Time period is given

Explanation of PPC Using Table & Diagram

The following table gives the various production possibilities of clothes and food.

Combination	Clothes (Thousand Meters)	Food (Metric Tons)	Opportunity Cost
A	20	0	-
B	18	1	(-2 : 1)
C	14	2	(-4 : 1)
D	8	3	(-6 : 1)
E	0	4	(-8 : 1)

If all available resources are employed for the production of clothes, 20,000 meters of it can be produced. If, on the other hand, all available resources are utilized for the production of food, 4 metric tons are produced. These are the two extremes represented by A and E and in between them are the situations represented by B, C and D.

At B the economy can produce 18,000 meters of clothes and 1 metric ton of food. At C the production possibilities are 14,000 meters of clothes and 2 metric ton of food, as we move from A to E, we give up some units of clothes for some units of food.

For instance, moving from A to B, we sacrifice 2000 meters of clothes to produce 1 metric ton of food, and so on. As we move from A to E, we sacrifice increasing amounts of clothes.

This means that, in a full-employment economy, more and more of one good can be obtained only by reducing the production of another good. This is due to the basic fact that the economy’s resources are limited.

The following diagram illustrates the production possibilities set out in the above table. PPCs are normally drawn as bulging upwards or outwards from the origin ("concave" when viewed from the origin). The curve is represented to show the number of products that can be created with limited resources and pausing the use of technology in between. 

• A shows the production level of clothes alone
• E indicates the production level of food only
• B, C & D shows various possible combination of production of both food and clothes

In this diagram AE is the PPC or PPF, which shows the various combinations of the two goods which the economy can produce with a given amount of resources. If the country wants to produce more food, they must produce fewer clothes, based on limited resource availability. Likewise, if they want to produce more clothes, they must produce less food.

The PPC is also called transformation curve, because when we move from one position to another, we are really transforming one good into another by shifting resources from one use to another.

PRODUCTIVE EFFICIENCY

At Point A, B, C, D, E & F : Points that lie on the frontier/curve are efficient. PPC for an economy shows Pareto efficiency or allocative efficiency or productive efficiency. 

At Point F: below the PPC are possible/attainable (but not desirable), the quantities can be produced with currently available resources and technology. 

• Allocative Inefficiency: Inefficient production due to allocative inefficiency, because the economy can produce more of at least one good without sacrificing the production of any other good, with existing resources and technology. For eg. More fertile land for housing & less fertile land for agriculture
• Under employment, idle factor of production & wastage of resources: Some workers without jobs, some buildings without occupants, some fields without crops.   
• Lack of Specialization of labor (division of labor): low level of production

At point G: Points that lie above the PPC are not possible/unattainable (but desirable) because the quantities cannot be produced using currently available resources and technology.

The combined output of the two goods can neither be at F nor G. This is so because at F the economy will be under-employing its resources and G is beyond the resources available.

SHIFT IN PPC

Shift of the PPC indicates either economy is growing or shrinking.

  

Outward Shift in PPC (Economic Growth)

Output increases without sacrificing any good.

Results From

• Country discovers new resources
• Quantitative & qualitative growth of availability of inputs (labor & capital)
• Improvement in technological development or progress in knowledge of how to transform inputs into outputs.
• More Education or Training 
• Managerial efficiency (management expertise)

Inward Shift in PPC

Results From

• Natural or human-made disaster, like earthquake destroying a factory and machinery.
• Labor force shrinks,
• Depletion of supply of raw materials

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