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Faced with the universal problem of scarcity, societies of all types must determine (i) what to produce with limited resources and how much of each commodity to produce, (ii) how to produce desirable goods and services (i.e., which methods of production to use) and (iii) for whom to produce (how to distribute society’s output among different individuals and groups taking part in the production process).
So an economic system has to perform three main functions – (i) output determination (or fixing standards), (ii) organisation of production and (iii) output distribution. Any society’s economic problems can be illustrated by using the production possibilities curve. This curve throws light on the problems of scarcity and choice and illustrates the concept of opportunity cost which is a key concept for decision making and resource allocation. Since it is a boundary line it is called a frontier.
Any society’s choice problem is illustrated by using a diagram, called production possibilities curve (PPC) or production possibilities frontier (PPF). A PPF joins together the different combinations of goods and services which a country can produce using all available resources and the most efficient techniques of production. A PPF is shown in Fig 1.1. The graph is based on the data shown in Table 1.1.
Let us suppose economy uses all its resources — land, labour and capital — to produce just two goods, food and cloth. Various possible combinations that could be produced over a given period of time (e.g., a year) are shown in the table. Thus the country, by using all its resources to produce food, could produce 15 million units of food but no cloth.
Alternatively by producing, say 14 million units of food it could release enough resources to produce 1 millions units of cloth. At the other extreme it could produce 5 millions units of cloth with no resources at all being used to produce food.
The information in the table is presented graphically in Fig 1.1. We measure units of food on the vertical axis and units of cloth on the horizontal axis.
Choice and Opportunity Cost:
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A PPF also illustrates the issues (concepts) of choice and opportunity cost. If the country chose to produce more cloth, it would have to sacrifice the production of some food. This sacrifice of food is the opportunity cost of the extra cloth.
The fact that to produce more of one good involves producing less of the other is illustrated by the downward sloping nature of the curve. For example, the country could move from point B to C in Fig. 1.1. In doing so it would be producing an extra 1 million units of cloth, but 2 million units less of food. Thus, the opportunity cost of the 1 million units of cloth could be the 2 million units of food foregone.
The PPF also illustrates the phenomenon of increasing opportunity cost. This means that as an economy produces more of one good it has to sacrifice ever increasing amounts of the other. The reason for this is that different factors of production have different properties.
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People have different skills; land differs in different parts of the country; raw materials are also not only of the same kind or quality; and so on. In short, the PPF is curved rather than a straight line because not all resources are equally efficient in the production of two goods.
Thus as the nation concentrates more and more on the production of one good, it has to start using resources that are less and less suitable — resources that would have been better suited to produce other goods. In our example, then, the production of more and more cloth will involve an increasing marginal cost; ever increasing amounts of food will have to be sacrificed for each additional unit of cloth produced.
It is because opportunity cost increases that the PPF is concave to the origin (bowed outward) rather than being a straight line. Thus in Fig 1.1 as the society moves from point C to D to E, the amount of food sacrificed rises for each additional unit of cloth produced. The opportunity cost of the 3rd million units of cloth is 3 million units of food. But the opportunity cost of 4th million units of cloth is 4 million units of food.
At point A in Fig 1.1 the country is producing only food and no cloth. If the country has decided to produce some cloth, we might expect the opportunity cost of the first few units of cloth to be relatively small as those resources which are more efficient in the production of cloth move from food production into cloth production.
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As more and more units of cloth are produced, however, it becomes necessary to move into cloth production those factors which are more efficient in the production of food. As this happens, the opportunity cost of the extra units of cloth produced will get larger and larger. This is the case of increasing opportunity cost.
Efficient Vs. Inefficient Production:
The PPF is the method of illustrating the economic problem of scarcity. The PPF shows the maximum amount of goods and services that can be produced by an economy at a given point of time with available resources and technology. Fig 1.1 shows a PPF for food and cloth, assuming all resources are fully employed in the most efficient way.
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Point A represents the maximum output of food if no cloth is produced, while point F shows the exactly opposite situation — the maximum production of cloth if no food is produced. At any point along the PPF, such as C, there is a trade-off between the two goods. Cloth production can be expanded only by taking resources away from food production.
The PPF shows all the combinations of the two goods that can be produced with all the nation’s resources fully and efficiently employed. For example, production could take place at point D, with 9 million units of food and 3 million units of cloth being produced. The PPF is called a frontier or a boundary line because any point on the curve represents full employment of resources.
Production cannot take place beyond the curve. For example, production is not possible at point U. The nation does not have enough resources to do this. Any point inside the PPF shows unemployment of resources or idle capacity. In other words, any point on the PPF implies that production is taking place with maximum possible efficiency.
However, there is no guarantee that resources will be fully employed, or that they will be used in the most efficient way possible. The nation may thus produce at a point inside the curve as at point I in Fig 1.1. Point I indicates unemployment. More of both goods can be produced by using idle resources up to the limit set by the PPF.
In this case the economy is producing less of both goods than it could possibly produce, either because some resources are not being used (for example, workers may be unemployed), or because it is not using the most efficient method of production possible, or a combination of the two.
By using its resources to the full, however, the nation could move out on the curve, to point C, or C or D for example. It could produce more food (and the same amount of cloth), more of both food and clothing or more of cloth (and the same amount of food).
In short all points inside the PPF represent combinations, which can be produced using less than the available supply of resources or by using the available supply with less than maximum efficiency. Points outside the line represent combinations which are unattainable.
The PPF thus provides us with an illustration of the problem of scarcity and choice facing a country when deciding which goods and services to produce. Here we are not concerned with the combinations of goods produced (a microeconomic issue), but with whether the total amount produced is as much as it could be (a macroeconomic issue).
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