Thus, PPF measures the efficiency with which two commodities can be produced simultaneously. This data is of importance to managers seeking to determine the precise mix of goods that most benefits a company's bottom line. The PPF assumes that technological infrastructure is constant, and underlines the notion that opportunity costs typically arise when an economic organization with limited resources must decide between two products. However, the PPF curve does not apply to companies that produce three or more products vying for the same resource.
The PPF is graphically depicted as an arc, with one commodity represented on the X-axis and the other represented on the Y-axis. Each point on the arc shows the most efficient number of the two commodities that can be produced with available resources. Economists use PPFs to demonstrate that an efficient nation produces what it is most capable of producing and trades with other nations for the rest. For example, if a non-profit agency provides a mix of textbooks and computers, the PPF may show that it can produce either 40 textbooks and seven computers, or 70 textbooks and three computers.
The agency's leadership must determine which item is more urgently needed. In this example, the opportunity cost of producing an additional 30 textbooks equals four computers. For another example, consider the chart below. Imagine a national economy that can produce only two things: wine and cotton.
For instance, producing five units of wine and five units of cotton point B is just as desirable as producing three units of wine and seven units of cotton. Point X represents an inefficient use of resources, while point Y represents a goal that the economy simply cannot attain with its present levels of resources. As we can see, in order for this economy to produce more wine, it must give up some of the resources it is currently using to produce cotton point A.
If the economy starts producing more cotton represented by points B and C , it would need to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A. Moreover, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output.
But if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B, and C all represent the most efficient allocation of resources for the economy. The nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production. Markets play an important role in telling the economy what the PPF ought to look like.
Consider point X on the figure above. Being at point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine, given the potential of its resources. On the other hand, point Y, as we mentioned above, represents an output level that is currently unattainable by this economy. If there were an improvement in technology while the level of land, labor, and capital remained the same, the time required to pick cotton and grapes would be reduced.
The output would increase, and the PPF would be pushed outwards. A new curve, represented in the figure below on which Y would fall, would show the new efficient allocation of resources. When the PPF shifts outwards, it implies growth in an economy. When it shifts inwards, it indicates that the economy is shrinking due to a failure in its allocation of resources and optimal production capability.
A shrinking economy could be a result of a decrease in supplies or a deficiency in technology. An economy can only be produced on the PPF curve in theory. In reality, economies constantly struggle to reach an optimal production capacity.
And because scarcity forces an economy to forgo some choice in favor of others, the slope of the PPF will always be negative. For example, the introduction of team working to the production of motor vehicles in the s reduced wastage and led to considerable efficiency improvements. The widespread use of computer controlled production methods, such as robotics, has dramatically improved the productive potential of many manufacturing firms.
Growth in the size of the working population enables an economy to increase its potential output. This can be achieved through natural growth, when the birth rate exceeds the death rate, or through net immigration, when immigration is greater than emigration.
A PPF will shift inwards when an economy has suffered a loss or exhaustion of some of its scarce resources. If key non-renewable resources, like oil, are exhausted the productive capacity of an economy may be reduced. This happens more quickly as a result of the application of ultra-efficient production methods, and when countries over-specialise in producing goods from non-renewable resources.
Sustainable growth means that the current rate of growth is not so fast that future generations are denied the benefit of scarce resources, such as non-renewable resources, and a clean environment.
Real capital, such as machinery and equipment, wears out with use and its productivity falls over time. As the output from real capital falls, the productivity of labour will also fall. The quality and productivity of labour also depends on the acquisition of new skills.
Therefore, if an economy does not invest in people and technology its PPF will slowly move inwards. Allocating scarce funds to capital goods, such as machinery, is referred to as real investment. If an economy chooses to produce more capital goods than consumer goods, at point A in the diagram, then it will grow by more than if it allocated more resources to consumer goods, at point B, below.
Later this semester we'll discuss the various definitions of Economic Growth, but here we'll use this more fundamental definition:. This means we are ABLE to produce more, but it doesn't necessarily mean we do produce more. More on this later. If we only had more resources we could produce more goods and services and satisfy more of our wants. This will reduce scarcity and give us more satisfaction more good and services. All societies therefore try to achieve economic growth.
We can use the production possibilities model to demonstrate how economic growth can reduce scarcity. Since this increase maximum output that we are able to produce it shifts the PPF outward.
To achieve our new potential levels of output we also need full employment and productive efficiency. A second possibility is that, if inflation has been occurring for several years, a certain level of inflation may come to be expected. For example, if consumers, workers, and businesses all expect prices and wages to rise by a certain amount, then these expected rises in the price level can become built into the annual increases of prices, wages, and interest rates of the economy.
These two reasons are interrelated, because if a government fosters a macroeconomic environment with inflationary pressures, then people will grow to expect inflation.
Macroeconomics takes an overall view of the economy, which means that it needs to juggle many different concepts. For example, start with the three macroeconomic goals of growth, low inflation, and low unemployment. Aggregate demand has four elements: consumption, investment, government spending, and exports less imports. Aggregate supply reveals how businesses throughout the economy will react to a higher price level for outputs. Finally, a wide array of economic events and policy decisions can affect aggregate demand and aggregate supply, including government tax and spending decisions; consumer and business confidence; changes in prices of key inputs like oil; and technology that brings higher levels of productivity.
Increases in exports or declines in imports can cause shifts in AD. Changes in the price of key imported inputs to production, like oil, can cause shifts in AS.
Library of Economics and Liberty. Organization for Economic Cooperation and Development. University of Michigan. Skip to content Chapter Suppose, after five years of sluggish growth, the economy of the European Union picks up speed.
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