Monday, June 1, 2015

Production Possibility Curve

A-X-Z-B, extended both ways to meet the axes, is the PPC Curve
A full-employment economy must always, in producing one commodity, be giving up something of another. Satisfaction is the law of life in a full-employment economy. The Production Possibility Curve (PPC) depicts society's menu of choices. It is also called the country's Production Possibility Frontier.

Let us explain the concept with the help of the adjoining diagram.

Any point inside the PPC is a point of less than full employment. If we move from X to Z, we sacrifice XY of food and get YZ of clothing. Thus a full-employment economy must sacrifice some amount of one commodity to get some amount of another commodity. The opposite thing will happen if we move from Z to Y. We will sacrifice YZ of clothing to get XY of food. Thus a Production Possibility Curve shows the options open to a society. It shows the maximum possible combined output of two commodities.

If we are at a point, which is inside the Production Possibility Curve, then it implies less than full-employment. At this point we can increase the production of both the commodities and eventually move to a full-employment point on the PPC. After attaining full-employment we can choose any point on the Production Possibility Curve, like A, B, X, Z etc.

Opportunity Cost: As the economy decides to produce more of one commodity at full-employment level, it will have to give up some units of some other commodity. At full-employment no factor of production remains unutilized. The opportunity cost of a product at full-employment level is the alternative, which must be given up to produce that product. In the above diagram when we move from point X to Z, we have to give up XY of food to get YZ of clothing. Therefore, XY of food is the opportunity cost of YZ quantity of clothing.  As we further increase the production of cotton, the opportunity cost increases. This is because first of all we will plant cotton in those areas, which are not very suitable for food grain cultivation. If we go on increasing cotton production, more efficient food grain-producing lands will have to be brought under cotton production. Thus the opportunity cost also increases.

But a Production Possibility Curve does not include all options. It does not include options under less than full-employment.
We can select any point on the PPC if we manage the economy well and maintain a high level of employment. Otherwise, if we mismanage the economy, we will end up inside the curve, say at point I.
But we cannot be at a point, which is outside the PPC, (say at point Q) with our present land, labour, capital and technology.

Outward shift of the Production Possibility Curve.
With passage of time it may be possible for us to attain the point translated above. This will be possible when our economy grows and the productive capacity increases.
Reasons for growth:
1. Technological improvement - better and more economical ways of producing goods
2. Increase in capital
3. Increase in labour force
Growth of the economy will be slower if more of the current resources are used for the production of consumption goods to satisfy current wants.
Conversely, growth of the economy will be faster if more resources are directed towards production of capital goods to take care of future needs.  


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