Economics Basics: Production
Possibility Frontier, Growth, Opportunity Cost and Trade
Production Possibility Frontier (PPF)
Under the field of macroeconomics, the production
possibility frontier (PPF) represents the point at which an economy is most
efficiently producing its goods and services and, therefore, allocating its
resources in the best way possible.
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If the economy is not producing the
quantities indicated by the PPF, resources are being managed inefficiently and
the production of society will dwindle. The production possibility frontier
shows there are limits to production, so an economy, to achieve efficiency, must
decide what combination of goods and services can be produced.
Let's turn to the chart below. Imagine an economy that can
produce only wine and cotton. According to the PPF, points A, B and C - all
appearing on the curve - represent the most efficient use of resources by the
economy. Point X represents an inefficient use of resources, while point Y
represents the goals that the economy 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 uses to produce cotton (point A). If the economy starts
producing more cotton (represented by points B and C), it would have to divert
resources from making wine and, consequently, it will produce less wine than it
is producing at point A. As the chart shows, 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. However, 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.
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. Point Y, as we mentioned above, represents an
output level that is currently unreachable by this economy. However, if there
was a change in technology while the level of land, labor and capital remained
the same, the time required to pick cotton and grapes would be reduced. Output
would increase, and the PPF would be pushed outwards. A new curve, on which Y
would appear, would represent the new efficient allocation of resources.
When the PPF shifts outwards, we know there is growth in an economy.
Alternatively, when the PPF shifts inwards it indicates that the economy is
shrinking as a result of a decline in its most efficient 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 be producing on the PPF curve only in theory. In reality,
economies constantly struggle to reach an optimal production capacity. And
because scarcity forces an economy to forgo one choice for another, the slope of
the PPF will always be negative; if production of product A increases
then production of product B will have to decrease accordingly.
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AKHAND PRATAP SINGH
