Production Possibility Curves

We know that the availability of resources determines the productivity of goods in an economy. But how would you decide on the resource allocation to produce these goods? How would you know how the resource allocation is going to affect the production of goods? The production possibility curve is one tool that we use in economics to understand the different possible product combinations in the economy when it comes to resources allocation.

What is the production possibility curve?

The Production Possibility Curve is also known as the Production Possibility Frontier (PPF) or Transformation Curve.

This curve helps economists to illustrate different features such as scarcity, opportunity costs, and economic growth. The PPC shows the maximum production capacity.

While plotting the PPC, it is assumed that the country has a fixed quantity of resources and a constant state of technology.

Figure 1 shows an example of a basic production possibility curve:

Fig. 1 - Production Possibilities Curve

Production possibility diagrams

In Figure 2, point X shows maximum wheat production and zero sugar production. Point Y shows maximum sugar production and minimum wheat production.

Fig. 2 - Points along the production possibility curve

Points such as A and B on the curve show maximum production that can be achieved by the economy. Any point on the curve also shows maximum production of products. It is important to remember that the production of one product can not be increased without the decrease in the production of another product.

The points that fall under the curve, such as point P, mean that the resources are either inefficiently employed or are not fully employed. The points above the PPC, such as point Q, are output combinations that are unsustainable at the given time. To attain these levels the country will have to increase their resources, improve its technology, and productivity.

Shifting the production possibility curve

A PPC will shift inwards or outwards when there is a change in the factors of production. The factors of production are land, labour, capital, and enterprise.

When a factor of production such as capital increases, the PPC shifts outwards, indicating that the economy can produce more. In this situation, the curve, X1Y1, shifts outwards to the curve X₂Y₂. This is illustrated in Figure 3. On the flip side, when a factor of production such as capital decreases, the PPC shifts inwards, indicating that the economy is producing fewer quantities.

Fig. 3 - The shift in the production possibility curve

The shifts in the PPC is linked to the shift of the economy’s Long Run Aggregate Supply curve or LRAS curve. Similar to the PPC, the LRAS curve also depends on the factors of production. This means that when there is a change in the production factors such as the resources, labour capacity, advancements in technology etc., the LRAS curve will change. The LRAS curve of an economy represents a point on the country’s PPC.

When there is negative economic growth, both the PPC and LRAS curves are negatively affected. The PPC shifts inwards as shown in Figure 3, when the graph XY shifts to X1Y1, and the LRAS curve shifts to the LRAS 1 curve on the left, as shown in Figure 4, when the graph Y shifts to Y1. The negative economic growth could be due to a decrease in production factors, or a decrease in demand, both of which lead to a decrease in supply.

Fig. 4 - The shift in the LRAS curve

An outward shift in PPC means economic growth. This is shown in Figure 3 where the graph XY shifts to X2Y2. Simultaneously, the LRAS curve also shifts to the LRAS 2 curve on the right, as it is positively affected by economic growth. This is represented in Figure 4 with the shift of the graph Y to Y2. This is because when there is economic growth, that means more supply resulting from an increase in demand.

Macroeconomic production possibility curve diagrams

The PPC can be used to explain and understand the macroeconomic environment.

Production possibility curves and economic growth

The PPC in the figure below has 3 main points: A, B, and C. Point A in figure 5 shows the economy’s production at its full potential when all resources are used in their entirety. This is an ideal situation.

Point B indicates a state where resources, such as labour or raw materials, are not fully used, and there is a decrease in aggregate demand. A short-run economic growth can be brought about by using the rest of the resources and increasing aggregate demand. The economic growth can increase until it reaches point A. For it to further increase, the country will have to increase the existing production factors. This will represent long-run economic growth.

The move from point A to point B represents short-run economic growth, and from point B to point C, long-run economic growth.

Fig. 5 - PPF used to explain economic growth

Production possibility frontier and employment of economic resources

The production possibility of an economy depends on the employment of economic resources. The resources must be fully employed to achieve maximum production capacity. Failing to fully employ the resources results in an inward shift of the curve. When the resources are not fully employed, productivity decreases. This could be because the aggregate demand is low, and not so much productivity is required to meet the country’s demand. Full employment of resources when the demand is low will lead to a surplus of produced goods.

Microeconomic production possibility diagrams

The PPC can also be used to explain and understand the microeconomic environment.

Figure 6 below shows the PPF of tables and chairs to help the manufacturer to understand the best possible combination. Point P on the graph shows the situation where the most number of tables are produced. But this can only be achieved when no chairs are produced. Similarly, the production of most numbers of chairs is depicted on point Q, implying that no tables are produced. The points in between show the different combinations of production.

Fig. 6 - PPC and opportunity costs

Production possibility curves and resource allocation

Resource allocation allows different combinations of productions. You can see these various combinations in Figure 6. It shows how the difference in resource allocation of one production affects the other. Allocating more resources to produce tables leaves fewer resources available to produce chairs. Allocating more resources for a product depends on choice and demand.

Production possibility curves and opportunity costs

The PPC also illustrates opportunity costs.

In Figure 6, points C1 and T1 show the initial production of chairs and tables respectively. When this firm decides to increase the production of tables from T1 to T2, the fall in the chair production is equal to the opportunity cost of the increase in the table production.

However, when this firm increases the production of tables from T2 to T3, the production of chairs falls from C2 to C3. That fall in the production of chairs is larger than the initial fall of C1 to C2. Hence, the opportunity cost of producing more tables than chairs increases as more chairs will have to be sacrificed.

Fig. 6 - PPC and opportunity costs

Production possibility curves and economic efficiency

Economic efficiency is when all resources in the economy are used or distributed in the most useful manner, and waste is minimised.

Productive vs allocative efficiency

Economic efficiency can be explained using productive and allocative efficiency.

This is exactly the concept behind the PPC, although it shows the combination of two products. Points A and B in Figure 7 show productive efficiency, and all points inside the curve show productive inefficiency. Unemployment is a major reason for productive inefficiency.

Fig. 7 - Points along the production possibility curve

Any point on the curve is productively efficient, but not all points on the curve are allocative efficient. This is because the allocative efficiency point relies on consumers’ tastes and preferences.