also: List of Economic Topics
POSSIBILITY FRONTIER - microeconomics
economics, the production possibility frontier (the PPF, also called the production
possibilities curve (PPC) or the transformation curve) is a graph
that depicts the trade-off between any two items produced. It indicates the opportunity
cost of increasing one item's production in terms of the units of the other
shows the maximum obtainable amount of one commodity for any given amount of another
commodity, given the availability of factors
of production and the society's technology and management skills. The concept
is used in macroeconomics to show the production
possibilities available to a nation or economy (corresponding roughly to macroeconomic
notions of potential output), and also in microeconomics
to show the options open to an individual firm. All points on a production possibilities
curve are points of maximum productive efficiency or minimum productive inefficiency:
resources are allocated such that it is impossible to increase the output of one
commodity without reducing the output of the other. That is, there must be a sacrifice
-- an opportunity cost -- for increasing the
production of any good. All resources are used as completely as possible (without
the situation becoming unsustainable) and appropriately.
economy may have productive efficiency, but not allocative efficiency: the market
and other institutions of social decision-making (such as government, tradition,
and community democracy) may lead to the wrong combination of goods being produced
(and the wrong mix of resources allocated) compared to what individuals would
A in the diagram for example, shows that FA of food and CA of computers can be
produced when production is run efficiently. So can FB of food and CB of computers
points to the right of (or above) the curve are technically impossible (or cannot
be sustained for long). Most real-world economies and firms are operating well
inside the curve (i.e., inefficiently). In a situation where more than two commodities
are being produced this two sector model is not adequate. It would show firms
and economies well to the left of the curve for statistical reasons.
move from point A to point B indicates an increase in the number of computers
produced. But it also implies a decrease in the amount of food produced. This
decrease is the opportunity cost of producing more computers.
mentioned, the two main determinants of the curve are production functions (reflecting
the available technology and management techniques) and available factor endowments
since they define the resources available and the most efficient combination of
these resources to employ. If the technology or management know-how improves or
the supplies of factors of production increases, the production possibility frontier
shifts to the right (upward), raising the amount of each good that can be produced.
A military or ecological disaster might move the PPF inward and to the left.
neoclassical economics, production possibility frontiers can easily be constructed
from the contract curves in Edgeworth box diagrams of factor intensity. In other
interpretations (often seen in textbooks), the concave production possibilities
frontier reflects the specialized nature of the heterogeneous resources that any
society uses: the opportunity cost of shifting production from one mix to another
(e.g., from point A to point B) reflects the costs of using resources that are
not well-specialized for the production of the good which is being produced in
line describing this frontier is not straight, but is concave to the origin (that
is, curved inward toward the axes). This is due to a disparity in the factor intensities
and technologies of the two sectors. The concavity reflects the higher marginal
costs that become inevitable due to diminishing marginal returns in the production
of each good as output of the other good approaches zero (that is, at either extreme
of the curve). As we specialize more and more into one product, the opportunity
costs of producing that product increase, because we are using more and more resources
that are poorly suited to produce it.
example, in the second diagram, the decision to increase the production
of computers from 5 to 6 (from point Q to point R) requires a minimum loss of
food output. However, the decision to add a tenth computer (from point T to point
V) has a much more substantial opportunity cost.
the neoclassical interpretation, if the factor intensity ratios in the two sectors
were constant at all points on the production possibilities curve, the curve would
be linear and the opportunity cost would remain the same, no matter what mix of
outputs were produced. In other interpretations, a straight-line production possibilities
frontier reflects a situation where resources are not specialized and can be substituted
for each other with no cost.
marginal rate of transformation
slope of the production possibilities curve at any given point is called the marginal
rate of transformation. It describes numerically the rate at which one good can
be transformed into the other. It is also called the marginal opportunity
cost of a commodity, that is, it is the opportunity cost of X in terms of
Y at the margin.
Rate of Transformation
for example, the (absolute) slope at point "BB" in the diagram is equal
to 2, then, in order to produce one more computer, 2 units of food production
must be sacrificed. If at "AA" for example, the marginal opportunity
cost of computers in terms of food is equal to 0.25, then, the sacrifice of one
unit of food could produce 4 computers.
marginal rate of transformation can be expressed in terms of either commodity.
The marginal opportunity costs of computers in terms of food is simply the reciprocal
of the marginal opportunity cost of food in terms of computers.
costs, and pricing
production theory basics