production-possibility-diagrams

An Introduction to Production Possibility Diagrams

• The Production Possibility Curve (PPC) is an economic model that considers the maximum possible production (output) that a country can generate if it uses all of its factors of production to produce only two goods/services

• Any two goods/services can be used to demonstrate this model

• Many PPC diagrams show capital goods and consumer goods on the axes

  • Capital goods are assets that help a firm or nation to produce output (manufacturing). For example, a robotic arm in a car manufacturing company is a capital good

  • Consumer goods are end products and have no future productive use. For example, a watch

Diagram: Production Possibility Curve (PPC) 

Diagram Explanation

• The use of PPC to depict the maximum productive potential of an economy

  • The curve demonstrates the possible combinations of the maximum output this economy can produce using all of its resources (factors of production)

  • At A, its resources are used to produce only consumer goods (300)

  • At B, its resources are used to produce only capital goods (200)

  • Points C and D both represent full (efficient) use of an economy’s resources as these points fall on the curve. At C, 150 capital goods and 120 consumer goods are produced

• The use of PPC to depict opportunity cost

  • To produce one more unit of capital goods, this economy must give up production of some units of consumer goods (limited resources)

  • If this economy moves from point C (120, 150) to D (225, 100), the opportunity cost of producing an additional 105 units of consumer goods is 50 capital goods

  • A movement in the PPC occurs when there is any change in the allocation of existing resources within an economy such as the movement from point C to D

Productive & Allocative Efficiency on a PPC

• Efficiency is a key concept in economics

• Economists generally identify two types of efficiency – productive and allocative efficiency

An Explanation of Productive and Allocative Efficiency

Type of Efficiency	Explanation
Productive Efficiency	Producing at any point on the PPC represents productive efficiency, as it is the maximum output that can be produced from the available factors of production to produce goods and services There is no wastage of scarce resources  Any point inside the curve represents inefficiency (point E) It does not use all possible combinations of factors of production to produce goods and services
Allocative Efficiency	Makes the best possible use of scarce resources to produce the combinations of goods and services that are optimal for society, thus minimising resource waste Not all points on the PPC are allocatively efficient This is because more of one good or service cannot be produced without reducing output of another good/service Any change to the allocation of resources in this market will make either the consumer or producer worse off (excess demand or excess supply would occur)

Changes in Production Possibilities

• As opposed to a movement along the PPC described above, the entire PPC of an economy can shift inwards or outwards, thereby changing its production possibilities

Diagram: Inward & Outward Shift of PPC

Outward shifts of a PPC show potential economic growth and inward shifts show economic decline

Diagram explanation

• Economic growth occurs when there is an increase in the productive potential of an economy

  • This is demonstrated by an outward shift of the entire curve. More consumer goods and more capital goods can now be produced using all of the available resources

• This shift is caused by an increase in the quality or quantity of the available factors of production

  • One example of how the quality of a factor of production can be improved is through the impact of training and education on labour. An educated workforce is a more productive workforce and the production possibilities increase

  • One example of how the quantity of a factor of production can be increased is through a change in migration policies. If an economy allows more foreign workers to work productively in the economy, then the production possibilities increase

• Economic decline occurs when there is any impact on an economy that reduces the quantity or quality of the available factors of production

  • One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated the production possibilities of Japan for many years. It shifted their PPC inward, resulting in economic decline