Ahmed Javed

03228888542
AS Economics
BASIC ECONOMIC IDEAS AND RESOURCE ALLOCATION (part 3)

PRODUCTION POSSIBILITY CURVE

It is a curve that shows all maximum possible combinations of two goods and services a country can
produce using all available resources with efficient technique of production at given state of
technology.

ASSUMPTIONS OF PPC

1. There are only two goods produced in a country.

2. The economy is working at full-employment i.e. all available resources are utilized to produce
goods and services and quantity and quality of resources is fixed.
3. The country is using the best available technique of production i.e. efficient technique of
production (efficient technique of production is that technique of production whose output
cannot be exceeded by any other method in a given time period.
4. Finally, to construct a PPC and make it comprehendible, it is assumed that the state of
technology will not change in the given time constraint.

The assumptions mentioned above make it easier to construct and understand PPCs.

Let us say that following are the different combinations of two goods which an imaginary country can
produce.

COMBINATIONS AGRICULTURAL GOODS MANUFACTURED MRT= y

(y) GOODS (x) x
a 20 0
b 18 1 2
c 15 2 3
d 10 3 5
e 0 4 10

Agricultural goods

a MRT= Marginal rate of transformation

20 b
18 .U
c
15

10
d

S f

e
1 2 3 4
Manufactured goods 1|Page
Ahmed Javed
03228888542
AS Economics

The figure above shows the production possibility curve of a country producing agricultural goods and
manufactured goods, assuming that all available resources are fully employed in the most efficient way
at present state of technology.

Point ‘a’ represents the maximum production of agricultural goods if all resources are employed in the
production of agricultural goods and manufactured goods are not produced.

On the other hand, point ‘e’ represents the maximum production of manufactured goods when no
agricultural goods are produced. At any point on the curve (b, c, or d), there is a trade –off between the
two goods.

The production of manufactured goods can only be expanded by taking resources away from the
production of agricultural goods. When an economy moves from point ‘a’ to ‘b’ to have an extra unit of
manufactured goods, it must sacrifice two units of agricultural goods. In other words, choice of
production of one extra unit of manufactured goods at point ‘b’ involves the opportunity cost of two
units of agricultural goods.

Point ‘S’ or any other point below PPC shows that either the economy is under-utilizing its scarce
resources or it is using inefficient techniques of production.

The economy is capable of moving to point ‘c’ by producing more agricultural goods and without
sacrificing manufactured goods, by either employing idle resources or replacing inefficient techniques
with efficient ones.

It is also possible to produce more manufactured goods without sacrificing agricultural goods as shown
in the diagram by a movement from point ‘S’ to point ‘f’ on the PPC.

Alternatively, between points ‘c’ and ‘f’ a country can have more of both goods. This movement of an
economy from a point below PPC to the points on PPC is known as ‘SHORT TERM ECONOMIC GROWTH’.

Agricultural goods
Short-term economic growth

S
PPC

Manufactured goods
2|Page
Ahmed Javed
03228888542
AS Economics

Point U on the figure is, however, unattainable in the given time frame and production capacity. It can
be achieved in the long run when some of the assumptions of PPC are relaxed.

SHAPE OF PPC

PPC is always downward sloping because of the presence of trade-off (i.e. opportunity cost) between
the two goods. According to the basic assumption of PPC, as the country has used all of its available
resources in an efficient way, it is impossible to increase the production of one good without losing the
other. This is why PPC will always be downward sloping.

PPC is curved and bowed outwards rather than being a straight line in the above example. This is
because of non-homogeneity of resources or imperfect mobility of resources.

In other words, resources are specialized in their nature and cannot be equally efficient in the
production of both goods. Workers who are efficient in agriculture (farmers) are not equally efficient in
producing manufactured goods. All resources are specialized for particular products. At point ‘a’ where
all available resources are employed in the production of agricultural goods, the economy is using even
those resources in agriculture which were more efficient in the manufacturing sector. If resources most
efficient for manufactured goods and least efficient for agriculture are switched to produce some of the
manufacturing goods, we will be at point ‘b’ where a little sacrifice of agricultural goods can generate
more manufactured goods. This is shown by marginal rate of transformation of two units. Marginal rate
of transformation (MRT) shows the number of agricultural goods that would need to be sacrificed to
produce an extra unit of manufactured goods.

MRT= y
x

If we move from point ‘b’ to ‘c’ we have to switch those resources in the production of manufactured
goods which were also efficient in the production of agricultural goods. Consequently MRT will be
greater than it was before i.e. 3 units of agricultural goods.

This non-homogeneity of resources and increasing MRT (opportunity cost) causes the PPC to be curved
and bowed outwards.

PPC can also be a straight line if resources are perfectly mobile for both goods. For example brown and
black shoes as shown in the diagram below.

3|Page
 Ahmed Javed
03228888542
AS Economics

Black shoes
4
MRT= y = constant
x
3

1 2 3 4 Brown shoes

Resources will be homogeneous for both goods and equally efficient for both brown and black shoes.
Therefore there will be constant opportunity cost (MRT) of the country and PPC would be a straight-line.

SHIFTS IN PRODUCTION POSSIBILITY CURVE

PPC can shift:

1. INWARD or OUTWARD
2. PARALLEL or PIVOTAL

Y Y Y Y

X X X X
Parallel inward shift Parallel outward shift Pivotal inward shift Pivotal outward shift

4|Page
Ahmed Javed
03228888542
AS Economics

SOURCES OF SHIFTS IN PPC

There are three major sources of shift in the PPC of a country:

1. Change in quantity of resources

2. Change in quality of resources

CHANGE IN QUANTITY OF RESOURCES

a) LAND
Land may increase because of: Land may decrease by:
Discovery of oil, metal or mineral reserves by Depletion of non-renewable natural resources
active search e.g. oil reserves
Erosion caused by deforestation which will
reduce agricultural usage of land
Water-logging which may reduce agricultural
usage of land
Natural disasters like floods, earthquakes

OUTWARD SHIFT OF PPC INWARD SHIFT OF PPC

Y Y

X X

5|Page
Ahmed Javed
03228888542
AS Economics

b) LABOUR
Labour may increase by:
Increase in population
Change in the structure of population from
less dependent population to more working
population even without an increase in total
population
Immigration > emigration
Increase in women participation in jobs
Lower school leaving age
Higher retirement age
Improvement in health facilities
Labour may decrease by:
Decrease in total population
Dependent population
Working population
Emigration > immigration
Decrease in women participation
Higher school leaving age
Lower retirement age
Poor health facilities and hence high mortality

Death rate

Working population

OUTWARD SHIFT OF PPC INWARD SHIFT OF PPC

Y Y

X X

6|Page
Ahmed Javed
03228888542
AS Economics

c) CAPITAL

Capital stock is the total amount of capital goods (buildings, factories, machines, etc.) at a point in
time.

Investment is the total spending on capital goods and services in a given period of time usually one
year (gross investment)

OR

Investment is the increase in capital stock of a country in one year (net investment)

NET INVESTMENT = GROSS INVESTMENT – DEPRECIATION

Depreciation is the loss in value of an asset due to wear and tear, obsoleteness or just passing of
time.

EXAMPLE

Suppose that a company has a capital stock of 10 computers at the beginning of year 1. During the
year, the company bought 5 new computers (gross investment). However, 2 out of 10 existing
computers became old and were therefore discarded.

Capital stock in year 1 = 10 computers

Gross investment in year 1 = 5 computers

Depreciation in year 1 = 2 computers

Net investment = gross investment – depreciation

=5–2
= 3 computers

Capital stock in year 2 = capital stock in year 1 + net

investment
= 10 + 3
= 13 computers

7|Page
 Ahmed Javed
03228888542
AS Economics

IF,

Gross Investment > depreciation net investment= +ve capital stock outward shift in PPC

Gross Investment < depreciation net investment= –ve capital stock inward shift in PPC

Gross Investment = depreciation net investment= zero capital stock unchanged no shift in PPC

Investment depends on various factors. Among these are:

1. Rate of return on capital

2. Interest rate
3. Business optimism or pessimism
4. Govt. policies on taxation and subsidies
5. Political stability
6. Level of technology

CHANGE IN QUALITY OF RESOURCES

PRODUCTIVITY is defined as output per unit of input (per unit of time).

Productivity = output
input

Productivity is the efficiency of factors of production used to produce goods and services. Productivity of
factors of production can be influenced by technology, education and training of labour force, research
and development and management techniques.

8|Page
Ahmed Javed
03228888542
AS Economics

Improved technology makes capital more productive and increases the productive capacity of a country.
Education and training contribute to human capital (labour) and improve its productivity. Educated and
skilled labour is also able to use capital more efficiently.

Research and development also contribute towards the productivity of land. Better techniques of
extraction, improved methods of farming and fishing and the use of fertilizers can enhance the
productivity of existing land. All of these increase the productive potential of a country and hence lead
to an outward shift of PPC.

Better technology can also help entrepreneurial abilities of a country. Improved communication,
transportation new management techniques can contribute a lot towards the productive potential of
entrepreneurs, hence shifting the PPC outwards.

PARALLEL AND PIVOTAL SHIFTS

I. Parallel shift
Parallel shift of PPC occurs when increase in quantity and quality of resources is equally suitable
or equally disastrous for both goods.

Y Y

X X
Parallel inward shift Parallel outward shift

II. Pivotal shift

Pivotal shift occurs in PPC when change in quantity and quality of resources affects only one
good or affects one good more than the other. For example, a genetic breakthrough in the
productivity of wheat, rice or cotton seeds will only increase the productive capacity of a
country in manufactured goods. Similarly, when a car assembly line was developed, it had no
effect on the productive capacity of agricultural goods. PPC will pivot towards the good in which
its productivity has increased.

9|Page
Ahmed Javed
03228888542
AS Economics

Y Y

X X

Pivotal outward shifts

PPC can also pivot inward due to a decline in quantity of resources for one product only.

Y Y

X X

Pivotal inward shifts

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Ahmed Javed
03228888542
AS Economics

Unequal suitability will lead to different rates of growth in different goods.

Consumer goods

PPC1

PPC2

Capital goods

It may be possible that productivity of one good falls and rises for the other.

Consumer goods

PPC1

PPC2

Capital goods

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