Production Possibility Frontier: Meaning
Production Possibility Frontier (PPF) is a macroeconomics concept that shows various combinations of two products or services using almost the same and finite raw materials for production. It is a graphical representation of two products or services which are dependent on the same finite inputs for the production process. Here both the combination of the goods and services takes place in such a way that the resources are used most efficiently and optimally. Thus PPF makes allocation of resources in the best possible manner that benefits both the organization and the country.
It is popularly also known as Transformation Curve or Production Possibility Curve. Here both the products and services produced have a retroverted relationship with each other. As a result, an expansion in the production of one product lowers the production of another product.
- Production Possibility Frontier: Meaning
- Assumptions of Production Possibility Frontier
- Graphical Representation of Transformation Curve
- Interpretation of PPF
- Points above and below the Graph? What it signifies?
- Relationship of Production Possibility Curve with other Elements
- Why Production Possibility Frontier is useful?
In other words, we would like to get the best possible curve to give us the optimum utilization of the limited resources between the two competing products dependent upon the same resources.
Thus PPF is the level at which all inputs are used optimally, and all goods and services are produced most efficiently in the country.
Assumptions of Production Possibility Frontier
- The first assumption of PPF is that it assumes the technological infrastructure or setup remains unchanged.
- The second assumption is that it takes into consideration only two products or services using the same resources. The companies having three or more such products cannot use the PPF curve.
- The third assumption of PPF is that both the products under the study have an opposite relationship with each other. According to this principle, the production of one product can only be increased with a decrease in the production of others. This is because of limited input resources.
These are the vital assumptions, though not fully comprehensive in nature; there could also be other assumptions.
Graphical Representation of Transformation Curve
For better and clear understanding, this exercise is always represented in a graphical form, referred to as the PPF curve or transformation curve. It is a downward sloping Concave curve. The slope of the PPF curve shows the Marginal Rate of Transformation or MRT. The curve of PPF would be always negative because of the opposite relationship between the two products. On the X-Axis of the graph, there’s one product, and on Y-Axis, there’s another product. All the points on the curve show optimum utilization of all resources, with the best possible combination of two products. All the points above the curve are out of the capacity of production, while all the points below are underutilization of resources.
Let’s understand PPF with an example:-
Below is the tabular data of two products (Soap and Pencil), production of which can be done optimally with the help of Production Possibility Frontier. With the increase in the production of one product, there is a decrease in the production of others as the resources are finite/limited.
|Soap (Units)||Pencil (Units)|
Let’s plot the data points in the Graph:-
Interpretation of PPF
Thus, as shown in the above Graph, all the points on the PPF curve are optimal for the Company/Country. The combination could be 0 units of Soap and 30 units of a pencil. It can be 20 units of pencil and 9 units of soap and so on. All the points on the curve equally use all inputs in the finest way. Thus producing any combination of units on the Graph is fully efficient.
The PPR curve bows out. The highest point of the curve is when only one product is produced on the Y-axis, and the other product is left out. This is 30 pencils in our example. Opposite of that on the X-axis is the widest point of the graph when only soaps are produced, i.e., 12 soaps on the X-axis.
If we observe closely, this curve is nothing but a shows a trade-off of producing competing goods demanding the same limited resources. And various points of the curve indirectly also convey the opportunity cost of producing these two products.
Points above and below the Graph? What it signifies?
If any points below the graph are taken, then the optimum and efficient use of available resources would not have been done. Thus it shows inefficiency. Any production point above the curve is out of the capacity of the Organization or the Country. Thus it is unattainable.
Thus PPF helps to select the best possible combination of units of products by optimally using resources. Any combination of units on the curve is the most efficient.
Relationship of Production Possibility Curve with other Elements
At times, due to technological advancement, the output capacity might increase. Here all the factors of production remain the same, and the production increases only because of technology. In such circumstances, the curve would shift upward. Thus the upward shift is an indication of economic growth in the country. On the other hand, a downward shift in the curve shows a deteriorating economic condition.
Pareto Efficiency is a concept based on the PPF. It says that any points below the curve do not use their full production capacity. At the same time, any points outside the curve are outside the capacity. The resources required for producing outside the line are not available, making it unachievable.
In the PPF principle, when the focus shifts from one product to another, there exists a hidden cost known as Opportunity cost. It is an indirect cost of overlooking the benefits. Which might have been derived if the earlier product which has been now replaced is selected.
Law of Diminishing Marginal Returns
According to the principle of ‘Law of Diminishing Marginal Returns,’ after one point in time, adding marginal input resources for the production process creates a negative return. Thus this principle completely complements the PPF principle, where for efficiently using the input resources, a combination of input for two different products is created. The moment the product starts creating negative returns, the input resources are shifted to the next product, thus reaching the optimal level.
Why Production Possibility Frontier is useful?
PPF is useful for both the corporate organization and the government. It is useful for determining the best product mix with less cost and higher returns in companies. On the other hand, the Government uses the PPF tool for deciding which goods and services to produce and which goods and services to import. The Transformation Curve tells the government which products it can produce with its full efficiency. It also tells the government that it is better to import a few goods, as producing the same in the economy will not be beneficial.
Suppose a country is not producing goods and services according to the PPF. In that case, it can be safely concluded that the limited resources at command are not managed in an efficient way, and the country’s economic stability, growth potential, cost of production, and GDP will be impacted. Thus this macroeconomic principle is useful for both the Organization and any Government at large.
Production Possibility Frontier is one of the most useful concepts of Macroeconomics. Irrespective of its limitations and assumptions, it is very useful for determining products and services for exports and imports of the country. It makes the country or the company to work with its full productivity and optimal utilization of available critical and limited resources. This tool becomes important and comes in handy while analyzing the Economic Growth of the country. It gives various permutations and combinations of units of products on the same curve and also shows the likely change and impact on economic growth with its shifting. Thus it has become a dominant tool for enhancing productivity.