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An analysis of the alternative combinations of two (or more) goods that an economy can produce with existing resources and technology in a given time period. Production possibilities analysis provides insight into the fundamentals of economic thinking, including the introduction of key economic concepts. This analysis usually centers on either a convex production possibilities curve (or frontier) that reflects alternative production combinations of two goods.
The analysis of production possibilities is one of the most fundamental, and usually one of the first, analyses undertaken in the study of economics. A representative production possibilities curve is presented here. For this particular curve, the two goods produced by society are "Crab Puffs" and "Storage Sheds."
|Production Possibilities Curve
What it DoesProduction possibilities analysis is undertaken early in the study of economics for three reasons: (1) it sets the stage for answering the basic "What?" question of allocation, (2) it can be used to illustrate several basic economic concepts, and (3) it introduces the fundamental techniques of graphical analysis that are essential to other economic analyses.
- 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.
- 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.
- 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 AssumptionsThe four key assumptions of production possibilities analysis are: (1) resources are used to produce one or both of only two goods, (2) the quantities of the resources do not change, (3) technology and production techniques do not change, and (4) resources are used in a technically efficient way.
- 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.
- 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.
- 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.
- Technical Efficiency: Resources are used in a technically efficient way. That is, the maximum possible production is obtained from the resource inputs.
Satisfaction Not IncludedProduction possibilities analysis only indicates what can be produced. It provides no information about the desirability of, or satisfaction derived from, the goods that are produced. The economy might be able to produce 1000 Wacky Willy Stuffed Amigos. But does anyone want Wacky Willy Stuffed Amigos? Who knows? This information is not to be found anywhere in the production possibilities analysis.
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 ReviewThe most important economic concepts illustrated using production possibilities analysis are: opportunity cost, full employment, unemployment, economic growth, and investment.
- 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.
PRODUCTION POSSIBILITIES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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