If production is on the PPF, the country can only produce more of one good if it produces less of some other good. If the economy is producing less than the quantities indicated by the PPF, this is a sign that resources are not being used to their full potential. In this case, it is possible to increase the production of some goods without cutting production in other areas.
The production possibility frontier demonstrates that there are, or should be, limits on production. Each economy must decide what combination of goods and services should be produced in order to attain maximum resource efficiency.
In business analysis, the PPF operates under the assumption that the production of one commodity can only increase if the production of the other commodity decreases, due to limited available resources. Thus, PPF measures the efficiency with which two commodities can be produced simultaneously.
This data is of importance to managers seeking to determine the precise mix of goods that most benefits a company's bottom line. The PPF assumes that technological infrastructure is constant, and underlines the notion that opportunity costs typically arise when an economic organization with limited resources must decide between two products.
However, the PPF curve does not apply to companies that produce three or more products vying for the same resource. The PPF is graphically depicted as an arc, with one commodity represented on the X-axis and the other represented on the Y-axis. Each point on the arc shows the most efficient number of the two commodities that can be produced with available resources. Economists use PPFs to demonstrate that an efficient nation produces what it is most capable of producing and trades with other nations for the rest.
For example, if a non-profit agency provides a mix of textbooks and computers, the PPF may show that it can produce either 40 textbooks and seven computers, or 70 textbooks and three computers.
The agency's leadership must determine which item is more urgently needed. In this example, the opportunity cost of producing an additional 30 textbooks equals four computers. For another example, consider the chart below.
Imagine a national economy that can produce only two things: wine and cotton. For instance, producing five units of wine and five units of cotton point B is just as desirable as producing three units of wine and seven units of cotton. Point X represents an inefficient use of resources, while point Y represents a goal that the economy simply cannot attain with its present levels of resources. As we can see, in order for this economy to produce more wine, it must give up some of the resources it is currently using to produce cotton point A.
If the economy starts producing more cotton represented by points B and C , it would need to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A. Moreover, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output. But if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small.
Keep in mind that A, B, and C all represent the most efficient allocation of resources for the economy. The nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production. Markets play an important role in telling the economy what the PPF ought to look like.
Consider point X on the figure above. Being at point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine, given the potential of its resources. On the other hand, point Y, as we mentioned above, represents an output level that is currently unattainable by this economy. If there were an improvement in technology while the level of land, labor, and capital remained the same, the time required to pick cotton and grapes would be reduced.
The output would increase, and the PPF would be pushed outwards. A new curve, represented in the figure below on which Y would fall, would show the new efficient allocation of resources. When the PPF shifts outwards, it implies growth in an economy. When it shifts inwards, it indicates that the economy is shrinking due to a failure in its allocation of resources and optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology.
An economy can only be produced on the PPF curve in theory. In reality, economies constantly struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo some choice in favor of others, the slope of the PPF will always be negative.
That is, if the production of product A increases then the production of product B will have to decrease. The Pareto Efficiency states that any point within the PPF curve is inefficient because the total output of commodities is below the output capacity. Conversely, any point outside the PPF curve is impossible because it represents a mix of commodities that will require more resources to produce than are currently obtainable. Therefore, in situations with limited resources, only the efficient commodity mixes are those lying along the PPF curve, with one commodity on the X-axis the other on the Y-axis.
Consider a hypothetical world that has only two countries Country A and Country B and only two products cars and cotton. Notify me of new comments via email. Notify me of new posts via email. This site uses Akismet to reduce spam. Learn how your comment data is processed.
Production Possibility Curve is defined as A Production Possibility Frontier curve shows the maximum number of alternative combinations of goods and services that a society can produce at a given time when there is full utilization of economic resources and technology. Hence we can see following reasons why this curve is naturally and should be bent outwards: All the labor is not equally substitute-able.
So increasing number of labor in on sector causes the marginal product to fall. If economy produces more than one product, then labor has choice to select the product in which he is interested or comfortable. Like this: Like Loading Leave a Reply Cancel reply Enter your comment here Fill in your details below or click an icon to log in:.
Email required Address never made public. Name required. The production possibilities frontier can illustrate two kinds of efficiency: productive efficiency and allocative efficiency. Figure 2 illustrates these ideas using a production possibilities frontier between healthcare and education.
Productive efficiency means that, given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good. As a firm moves from any one of these choices to any other, either healthcare increases and education decreases or vice versa.
However, any choice inside the production possibilities frontier is productively inefficient and wasteful because it is possible to produce more of one good, the other good, or some combination of both goods. For example, point R is productively inefficient because it is possible at choice C to have more of both goods: education on the horizontal axis is higher at point C than point R E 2 is greater than E 1 , and healthcare on the vertical axis is also higher at point C than point R H 2 is great than H 1.
The particular mix of goods and services being produced—that is, the specific combination of healthcare and education chosen along the production possibilities frontier—can be shown as a ray line from the origin to a specific point on the PPF.
Output mixes that had more healthcare and less education would have a steeper ray, while those with more education and less healthcare would have a flatter ray. Allocative efficiency means that the particular mix of goods a society produces represents the combination that society most desires.
How to determine what a society desires can be a controversial question, and is usually discussed in political science, sociology, and philosophy classes as well as in economics.
At its most basic, allocative efficiency means producers supply the quantity of each product that consumers demand. Only one of the productively efficient choices will be the allocatively efficient choice for society as a whole.
Every economy faces two situations in which it may be able to expand consumption of all goods. In the first case, a society may discover that it has been using its resources inefficiently, in which case by improving efficiency and producing on the production possibilities frontier, it can have more of all goods or at least more of some and less of none.
In the second case, as resources grow over a period of years e. As it does, the production possibilities frontier for a society will tend to shift outward and society will be able to afford more of all goods. But improvements in productive efficiency take time to discover and implement, and economic growth happens only gradually. So, a society must choose between tradeoffs in the present.
For government, this process often involves trying to identify where additional spending could do the most good and where reductions in spending would do the least harm. At the individual and firm level, the market economy coordinates a process in which firms seek to produce goods and services in the quantity, quality, and price that people want.
But for both the government and the market economy in the short term, increases in production of one good typically mean offsetting decreases somewhere else in the economy. While every society must choose how much of each good it should produce, it does not need to produce every single good it consumes. Often how much of a good a country decides to produce depends on how expensive it is to produce it versus buying it from a different country.
In particular, its slope gives the opportunity cost of producing one more unit of the good in the x-axis in terms of the other good in the y-axis. Countries tend to have different opportunity costs of producing a specific good, either because of different climates, geography, technology or skills. Suppose two countries, the US and Brazil, need to decide how much they will produce of two crops: sugar cane and wheat.
Due to its climatic conditions, Brazil can produce a lot of sugar cane per acre but not much wheat. Conversely, the U. Clearly, Brazil has a lower opportunity cost of producing sugar cane in terms of wheat than the U.
The reverse is also true; the U. This can be illustrated by the PPFs of the two countries in Figure 3. When a country can produce a good at a lower opportunity cost than another country, we say that this country has a comparative advantage in that good. In our example, Brazil has a comparative advantage in sugar cane and the U. One can easily see this with a simple observation of the extreme production points in the PPFs of the two countries. If Brazil devoted all of its resources to producing wheat, it would be producing at point A.
If however it had devoted all of its resources to producing sugar cane instead, it would be producing a much larger amount, at point B. By moving from point A to point B Brazil would give up a relatively small quantity in wheat production to obtain a large production in sugar cane. The opposite is true for the U. If the U. The slope of the PPF gives the opportunity cost of producing an additional unit of wheat. When countries engage in trade, they specialize in the production of the goods that they have comparative advantage in, and trade part of that production for goods they do not have comparative advantage in.
With trade, goods are produced where the opportunity cost is lowest, so total production increases, benefiting both trading parties.
A production possibilities frontier defines the set of choices society faces for the combinations of goods and services it can produce given the resources available. The shape of the PPF is typically curved outward, rather than straight. Over time, a growing economy will tend to shift the PPF outwards. The law of diminishing returns holds that as increments of additional resources are devoted to producing something, the marginal increase in output will become smaller and smaller.
The specific choice along a production possibilities frontier that reflects the mix of goods society prefers is the choice with allocative efficiency. The curvature of the PPF is likely to differ by country, which results in different countries having comparative advantage in different goods. Total production can increase if countries specialize in the goods they have comparative advantage in and trade some of their production for the remaining goods.
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