Every science is based on fundamental questions, theorems and principles. Thus, solving any issues, it is better to understand the question from the beginning. According to Mankiw’s (2004: 4-13) studies, there are ten main economic concepts which include the rational choice thinking, the opportunity cost and the fact that people have to compromise. The purpose of this essay is to define which of them are illustrated by the production possibility frontier. “The Production Possibility Frontier shows the maximum output that can be produced in an economy at any given moment, given the resources and technology available” (Gillespie, 2016: 27). After firstly mentioning main assumptions, causes of the boundary shape and key points on the PPF will be explored in the essay. Finally, the reasons of shifting curve will be discussed.
Firstly, before drawing and describing this model, some assumptions has to be made in order to simplify things. As McConnell, Brue and Flynn (2009) determined that the resources as well as the technology are constant. And also for the reason that it is an ideal situation they assumed that the economy is using all available factors of production and manufactures only two goods A and B, private and public sector goods or capital and consumer goods, because there are only two variables.
The production possibility frontier helps easily understand the concept of opportunity cost which “is the cost of any activity measured in terms of the best alternative forgone” (Sloman, Garratt, 2016: 7). The bowing outwards curve illustrates growing opportunity cost because more amount of product A has to be sacrificed for producing one unit of product B (Lypsey, Chrystal, 2015: 11; Gillespie, 2016: 27). According to the graph, a difference between outcomes Q1 and Q3 of good A is the opportunity cost of increasing the production of good B from Q4 to Q2.
Colander (2013) claims: “The production possibility curve helps us see what is meant by efficiency” what cannot be denied. A case where the economy makes a combination of outcomes on the PPF, points C and B, is called productive efficiency which is “achieving as much output as possible from a given amount of inputs or resources” (Colander, 2013: 28). The points in area below the PPF, A on the graph, represent inefficiency because not all resources are utilized in any two industries, every situation upper the curve is unattainable due to scarcity of given factors of production (Begg, et al, 2014: 12).
The concave shape of the PPF is determined by the law of diminishing returns. “A law states that, as extra units of one factor of production are employed, with all others held constant, the output generated by each additional will eventually fall” (Bannock, et al, 2003: 98). In other words, the definition says that there is a point from which the enlarging a number of workers for example will lead to falling in the outcome because resources are becoming less and less suitable for particular industry. So every extra unit of resources adds less number of goods than previous one (Begg, et al, 2014: 11). This principle encourages to allocate given factors of production in a “better way”.
Market variables always change due to many factors affected free market economy; therefore, entrepreneurships have to reallocate their resources to satisfy new demand according to Gillespie (2016: 29). He illustrates his ideas via the graph, where the significant increase in demand of good B makes this industry more attractive for investors and entrepreneurs. Moving from the manufacturing good A to B, firms will increase the demand; hence, the price for labour, capital and raw materials will also grow what will engage more these resources in the industry B. The transposition them from one branch of economic activity to another takes place because of the market force consisted of desire to maximize a satisfaction (Gillespie, 2016: 29). Observing this case from the society as well as from business point of view, Pareto (n.d.) said: “For given tastes, inputs and technology, an allocation is efficient of no one can then be made better off without making at least one other worse off” (cited in Begg, 2009: 152). In this example industry A loses while B wins.
The economy can move along the curve by the resources reallocation as well as the boundary may be shifted outwards, due to the fact that the economic ability of production grows. Alluding to Gillespie (2016: 32), there are four main factors of shifting. The first is the new inventions of technology which improve the manufacturing process. The second is the growth of population, what enlarges the labour market. The third is the educating and training workers so they will become more specialised in narrow field. The last one is large investments in technology and equipment in a short-term what will reduce output of private goods and shift the whole frontier outwards in a long run. All these cases cause economic growth. Anderton (2000: 3) defined: “Economic growth in the quantity of quality of the inputs to the production process means that an economy has increased its productive potential.” And it makes it possible to produce a combination of goods at the point D on the graph.
In summary, this essay directed the attention towards five economic principles and examine how they are explained on the PPF. The production possibility frontier can’t be used in analysing without other tools because it’s greatly simplified, resources are given and fixed and the manufacture of only two products can be shown. In addition, this model doesn’t provide clear solution in which combination of goods it will be efficient and profitable to produce, while “ceteris paribus” (Anderton, 2000: 4). However, this boundary helps to understand present position of the economy and decide where to move, which products to make and in which proportion in order to achieve goals of efficiency and the slow, controllable economic growth.
Reference list
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Colander, D.C. (2013) Macroeconomics. 9th edition. New York: McGraw-Hill/Irwin.
Gillespie, A. (2016) Foundation of Economics. 4th edition. New York: Oxford University Press.
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Sloman, J. and Garratt, D. (2016) Essentials of Economics. 7th edition. Edinburgh Gate: Pearson Education Limited.