Production Possibility Curve Overview

Economics is founded on the principle that human wants to exceed the available resources by far. This limitation of means to meet our desires is why economics is essential. Every day, we find things that we wish we could have, but we know we cannot buy them because there are more pressing needs. While this simple decision to set aside our resources for a different need may seem natural, there are times when such decisions are more complex and require detailed analysis. Many tools can be used for this analysis; the production possibility curve is one of them.

A production possibility curve is simply a graph showing the quantity of two items that could be produced from the available resources when all other production factors are constant. It, graphically, illustrates the amount of two goods that can be produced within an economy when both products depend on the same production resources. (Investopedia)

This curve also called the transformation curve or production possibility frontier determines the quantity of one item that must be sacrificed to increase the production of the other item. Through this, the opportunity cost can be accurately measured.

There are three types of production possibility curve:

1. Sloping down straight-line curve: it has a fixed negative gradient, which implies that the percentage of decrease in the production of one item leads to a corresponding increase in the other. Thus, if item X production is reduced by 5, that of item Y will rise by 5, and vice versa. This curve, with its constant opportunity cost curve, is not practical.

2. Convex curve: it has a decreasing ratio, which implies that a drop in the production of one item leads to a corresponding reduction in that of the other. With its negative opportunity cost, a curve of this sort does not reflect real-life situations, although some have claimed it could occur in the agricultural sector.

3. Concave curve: it has an increasing ratio, which implies that a reduction in the amount of one item produced will lead to an increase in the production of the other. This is the curve that mirrors the real-life economy with its positive opportunity cost.

Assumptions of the Production Possibility Curve

Although it is used to determine production efficiency in real-life situations, the curve cannot completely mirror the prevailing unstable market conditions that exist in reality. It will become complicated and fail in its goal. Thus, four assumptions are made in drawing the curve.

1. The assumption that only two goods exist in the market: by reducing the unlimited number of products in the market to just two, the accurate opportunity cost can be easily determined.

2. The assumption of fixed production resources: it is assumed that the available resources are constant throughout. Thus, it is easier to measure the efficiency of production with the resources and compare it with the available resources during another period

3. The assumption of fixed technology: while technology, in reality, is dynamic with constant advancements. The curve assumes that technology remains at the same level all through the period so that future improvements in technology or the degrading of existing ones can be easily compared.

4. Assumption of efficiency: it is also assumed that market is producing at an optimal level with no resources going to waste. The total utilization of resources for production is not achievable in real life with the various variables within the economy. Not all machines will work efficiently, and not all labor force would be employed or perform their job effectively.

Application

The curve is useful for individuals, households, businesses, and nations in determining where their production is most efficient, where the available resources are best utilized, and make both economic and financial decisions based on that knowledge.

For Nations, they can determine their trade advantage by using the curve; this includes both the comparative and absolute advantage. Usually, the curve illustrates what amount of items X and Y that a country can produce by using all its available resources. This shows the production efficiency of both products and which one the state has the chance of higher production and generating more value from. The country can take advantage of this to specialize in producing this item, either absolutely or by prioritizing it over other products. By doing this, it can effectively monitor how it is maximizing its resources. Such specialization will give the country an advantage in the international balance of trade and boost its economy.

On the other hand, companies use the curve during business analysis to determine which products to produce and how to vary the quantity of each item produced to achieve efficiency. With the right product mix, a company can quickly turn profitable.

Economic Growth

The curve can be used to measure economic growth over time. An outward shift to the right means that the resources are being used efficiently. Thus, this increase in production capacity means the economy is improving. A lot of factors could be responsible for the growth; this includes improved production methods, technological advancements, increased labor force, etc.

Conversely, an inward shift to the left means the economy is shrinking, and production capacity has reduced. This could be due to a reduction in the labor force or available raw materials, inefficient production methods, or weak technological strength. Identifying where the problem is and solving it is essential to turn the tide.

Pareto Efficiency

This occurs when resources are allocated to the highest level of efficiency, such that reallocating resources to make one individual better will harm another individual. It is a theoretical concept used in measuring how efficient the Production Possibility Curve is. (Investopedia)

It states that any point within the curve is inefficient since there’s no full utilization of resources. Any point outside the curve is impossible because there are no resources to produce at that capacity.

Thus, the only efficient allocation of resources is with those lying along the curve.

This essay has elaborated on the key features of the PPC and its significance to the optimum allocation of resources on a microeconomic level with individuals, households and businesses, and a macroeconomic level with the country. Given the scarcity of resources at all levels and the multiplicity of competing needs. Resources must be only allocated to the most critical needs that will generate the highest output.