(3)
THE PRODUCTION POSSIBLITY FRONTIER
In an economy there are generally two types of goods. One is
consumer goods and the other one is capital goods.
Consumer goods refers to goods and services that are made
for the purpose of consumption by the consumers. Those can include both durable
consumer goods such as cars, washing machine, refrigerators, and non durable
goods such as milk, vegetable etc.
Capital goods refer to any thing which is used to produce
consumer goods in the economy. For example machineraies used to produce
consumer goods.
Production
possibility curve / Frontier (PPC/PPF)
It shows combination of two goods that can be produced in an
economy when all the resources are fully employed at the given state of
technology.
The following diagram shows a production possibility
frontier of an economy.
In the above frontier, point A is called inefficient point.
At this point, the factors of production of the economy are unemployed or lying
idle. When a country is producing at point A, there is significant spare
capacity in the economy which exists. The output of a country can be increased
without decreasing the output of another product. Thus there is no opportunity
cost of moving from point A to point B
At point B, the economy has fully employed all the
resources. Therefore, the output of the country in one good cannot be increased
without reducing the output of another good.
Point C is called unattainable. This point is unable to
achieve due to lack of resources. In other words, the current amount of
resources are not enough to achieve the output required for point C. In the
long run, point C can be achieved if there is an increase in the availablity of
resources, productivity and technology.
Movement of in PPF
and its significance to a country
Look at the following Production Possibility Frontiers
If the economy is at inefficient point (Point X) movement to any of the points indicates that there will be no opportunity cost since the factors of productions are not fully employed. The production of one good will not force the other good to reduce its production.
If the economy is producing any point in the PPF boundary,
then movement from one point to another will incur opportunity cost. For
instance, assume that the economy is operating at point M producing 100 units
of capital goods and 200 units of consumer goods.
If the economy wants to operate at point M, by increasing
the output of consumer goods from 100 units
to 200 units, then at the current resources, it has to reduce the
prodcution of capital goods from 150 to 100 units. Therefore due to movement
from pont L to Point M incur an opportunity cost. The opportunity cost is 50
Units of capital goods.
Another way to explain this is margin analysis. Margin
analysis is a point of possible change. Therefore the margin of producing 100
more units of consumer goods is 50 units of capital goods.
Opportunity Cost and
PPF
- Straight Line PPF (Convex) or Constant Opportunity Cost PPF
If the PPF is a straight Line, then the opportunity cost of producing either good will be constant.
A
straight line PPF denotes constant opportunity cost. In this example, the
opportunity cost of increasing production of capital goods from 160 units to
200 units is 30 units of consumer goods. At any point in the PPF, the
opportunity cost of increasing capital good is units of consumer goods.
Similarly,
the opportunity cost of increasing consumer goods from 60 to 90 units is 40
units of capital goods. The opportunity cost remains at 30 units for any
increase in the production of consumer goods.
If the PPF is concave to origin,
it represents increasing opportunity cost. As more and more of one unit is
being produced, there will be higher opportunity cost in the production of the
other product. For example, if the consumer goods increase, the opportunity
cost of producing consumer goods in terms of capital goods will increase, this
indicates more units of consumer goods will be produced by forgoing more
capital goods.
Shift of production
possibility frontier
PPF may shift to rightward (outward) or leftward (inward)
for two reasons. They are
- Economic Growth
If the PPF shift
to the right, it is an indication of economic growth. Economic growth is an
increase in productive potential of the economy. The following diagram shows
outward shift of PPF
In the above
diagram, the PPF has shifted outward or to the right indicating economic
growth. The possible causes of this is economic growth are:
·
The quantity of the resources available for
production of goods and services has increased. For example there may be
increase in number of worker in the economy, new factories and offices being
built, and discovery of new resources such as new oil fields.
·
Increase in quality of the resources. This might
be due to better education and training leading to improvement in the
productivity of the workforce, technological improvement and installation of
high tech machines.
2)
Decreasing
Productive potential of the economy
PPF may shift
inward (left) due to decrease in productive potential (economic growth) of the
economy. It may result due to existing resources being destroyed. For example
natural disaster such as hurricanes, tsunami and outbreak of diseases will
cause the PPF to shift inward. The following diagram shows inward shift of PPF.
