The Production Possibilities Model
The production possibilities model illustrates the opportunity costs (trade-offs)
that we face in utilizing our scarce resources. The model is based on: 1. Two
goods and services; 2. An assumption that there is a set amount of
available economic resources, and 3. Resources are used to their fullest
capacity, no matter which good is produced.
In the following illustration, our economy is producing just two products, pizza
and industrial robots. Pizza is symbolic of consumer goods, (those goods
that directly satisfy our wants. Robots are symbolic of capital goods, (those
goods that satisfy our wants indirectly by permitting more efficient production
of consumer goods.
The available resources are limited, thus the total amounts of robots and pizza
that our economy is capable of producing are limited. Limited resources
means a limited output. Since resources are limited in supply and fully
employed, any increase in the production of robots will necessitate the shifting
of resources away from the production of pizza. The opposite is also true: If
we choose to increase the production of pizza, needed resources must come
at the expense of robot production, the economic problem!
In Table 1.1, are some alternative combinations of robots and pizza, which
our economy might choose. At alternative A, our economy would be using its
resources to the production of robots. At alternative E, all available resources
would be devoted to the production of pizza. Both these alternatives are
clearly unrealistic extremes; any economy typically strikes a balance in
dividing its total output between capital and consumer goods. As we move
from A to E, we step up the production of pizza, by shifting resources away
from robot production.
To understand more fully the production possibilities model, it is necessary to
view the data graphically. We can draw a simple two-dimensional graph,
putting the output of robots on the vertical axisand the output of pizza on
the horizontal axis (Figure 1.1). Each point on the Production Possibilities
Curve represents some maximum output of the two products. All
combinations of pizza and robots on the curve represent maximum quantities
attainable only as the result of the most efficient use of all available resources.
Points lying outside the production possibilities curve, point x, would be
unobtainable, given the current supplies of resources and technology. The
production barrier of limited resources prohibits the production of any
combination of capital and consumer goods lying outside the production
possibilities curve.
Figure 1.1
Each point on the production possibilities curve represents some maximum
output of any two products. Society must choose which product-mix it
desires: more robots means less pizza, and vice versa – (Opportunity Cost).
Limited supplies of human and property resources make any combination of
robots and pizza lying outside the production possibilities curve, such as
X, unattainable.
What we can learn from the PPC
1. Illustrates Opportunity: the bowed out PPC curve shows that to produce
equal increments of output of one good requires giving up an increasing
amount of the other good (increasing opportunity costs)
2. Shows Cost of Inefficiency: Shows resources not being used efficiently –
that waste exists. The cost of inefficiency is the goods/services we give up
because resources are not being used to their potential. (any point inside the
PPC ).
3. Defines Economic Growth: A shift out in the PPC means that society can
have at least as much of one good, but more of another
4. Identifies the Causes of Economic Growth: Any shift to the right of the
curve is economic growth. This can be a result of:
a. more or higher quality resources
b. technological advance
c. institutional change that:
i. increases resources (reduction in marginal tax rates)
ii. makes economic system more efficient (deregulation)