Production Possibilities Curve

What it Does

1. Say What?: Production possibilities analysis sets the stage for how society goes about answering the "What?" question of allocation. Scarcity dictates that an economy must choose among millions of different goods. What goods does society ultimately decide to produce? An answer to this question depends in part on what goods society can produce, which is production possibilities analysis.


2. Terms, Terms, More Terms: A number of important terms pop up throughout the study of economics, including unemployment, opportunity cost, full employment, investment, and economic growth. Production possibilities provides insight into, and a graphical representation of, these terms.


3. Making Graphs: A useful side benefit of production possibilities is hands-on work with the graphical techniques that are essential to the study of economics. Production possibilities is a basic analysis that illustrates how graphical models are constructed, interpreted, and used to analyze real world events.

Four Assumptions

1. Two Goods: Resources are used to produce one or both of only two goods. This is a simplifying assumption that makes it easy to display production alternatives using graphs. More than two goods could be analyzed using advanced mathematics.


2. Fixed Resources: The quantities of labor, capital, land, and entrepreneurship resources do not change. This is a reasonable assumption, but it can be relaxed to analyze the consequences of changes in these resources.


3. Fixed Technology: The information and knowledge that society has about the production of goods and services is fixed. This is another reasonable assumption that can be relaxed to analyze the effects of technology changes.


4. Technical Efficiency: Resources are used in a technically efficient way. That is, the maximum possible production is obtained from the resource inputs.

Satisfaction Not Included

Moreover, because there is no information about satisfaction there is no insight into economic efficiency. Although production possibilities relies on the assumption of technical efficiency, the analysis cannot be used to determine if the combination of goods produced achieves the greatest possible level of consumer satisfaction, or something less.

Concepts for Further Review

• Opportunity Cost: This is indicated by the negative slope of the production possibilities curve (or frontier). As more of one good is produced, less of the other goods is produced. This production reduction is opportunity cost.


• Full Employment: This is indicated by producing on the production possibilities curve. The curve indicates the maximum production obtained with existing technology, given that all available resources are engaged in production.


• Unemployment: This is indicated by producing inside the production possibilities curve. If some available resources are not engaged in production, then the economy is not achieving maximum production.


• Economic Growth: This is indicated by an outward shift of the production possibilities curve, which is achieved relaxing the assumptions of fixed resources and technology or by increasing the quantity or quality of resources.


• Investment: This is indicated by a tradeoff between the production of consumption goods and capital goods. Investment results if society moves along the production possibilities curve, producing more capital goods and fewer consumption goods.