Monday, 8 April 2013

Production Possibility Frontier (or Curve)

In micro-economics, a production–possibility frontier (PPF), sometimes called a production–possibility curve, production-possibility boundary or product transformation curve, is a graph that shows the various combinations of amounts of two commodities that could be produced using the same fixed total amount of each of the factors of production. 

The amount capable of being produced is limited by factors such as natural resources, time, or capital. 

Graphically bounding the production set for fixed input quantities, the PPF curve shows the maximum possible production level of one commodity for any given production level of the other, given the existing state of technology. The aim is to show the amount or one commodity capable of being produced against another. 

Efficiency- A PPF shows it takes the form of the curve on the right. For an economy to increase the quantity of one good produced, production of the other good must be sacrificed. Fruit picking: Say if you had a limited number of workers, time, and capital resources (ladders to pick the fruit) the number of oranges able to be picked must be sacrificed in order to pick more apples. The same applies the other way round, if you wish to pick more apples in the day, then the number of oranges picked must drop. PPFs represent how much of the latter must be sacrificed for a given increase in production of the former. 

Product A in the graph above (taken from investopedia) can be Oranges, Product B can be apples. Points A, B and C represent the points at which production of Good A and Good B is most efficient. Point X demonstrates the point at which resources are not being used efficiently in the production of both goods; point Y demonstrates an output that is not attainable with the given inputs (time, people, capital). 

Opportunity Cost- In the context of a PPF, opportunity cost is directly related to the shape of the curve. If the shape of the PPF curve is straight-line, the opportunity cost is constant as production of different goods is changing. But, opportunity cost usually will vary depending on the start and end point. In the diagram on the above, producing more oranges results in less apples, this can be carted on the line between the two. So producing 10 more oranges could be an opportunity cost of 5 less apples. 

Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money. It has received criticism as an over simplification of markets, but it does help economists understand the relation between goods and resources. 

Government policy, and technology can produce a dramatic shift in the PPF. 

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