Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.
Production Possibility Curve
Many economic decisions are based on how much a producer can produce with a limited number of scarce resources. Given the situation, what can we produce in the most efficient manner? To complicate our decision-making, the resources we need for production are scarce, and there are trade-offs we have to balance in order to help us make the most profitable decisions.
In this lesson, we look at scarcity, factors of production, the production possibilities curve, and opportunity cost to help us analyze trade-offs, economic efficiency and inefficiency, and economic growth.
In economics, we look at the choices we make given the resources we have, and many of those resources are scarce. Scarcity means that we do not have enough of a good or a service to meet all of the demand. Goods are things that we value, like cars, food, and medication. Services are the acts that others perform that we value, like providing medical care, teaching college, and maintaining emergency services.
Because goods and services are limited, a producer needs to know how much to produce, who to produce for, and how to produce given certain factors of production. All of these production decisions involve trade-offs.
Factors of Production
Factors of production are the inputs we need to produce our goods and services. These are the labor, capital, and natural resources, such as land, available for production. Labor is the effort used by workers to produce goods and services. Capital describes the goods used to produce other goods and services. Natural resources are the things from nature that can be used for production. We want to use these factors of production to find our highest level of economic efficiency.
Factors of production come in many shapes and sizes. For example, the factors of production to provide medical services include:
- Labor - doctors, nurses, and other staff
- Capital - hospitals, computers, and medical devices
- Natural resources - land and fuel
Given these factors of production, we would need to find the most economically efficient way to produce medical services.
How we use factors of production can be illustrated with a production possibilities curve. This helps us visualize how our resources are distributed.
The points along the curve are points where nothing additional can be produced given the factors of production we have. Economic efficiency is where the production for one good or service cannot be made better off without reducing another. These are the points on the production possibilities curve.
All other points off of the curve demonstrate points of economic inefficiency, a situation where the factors of production can be used differently to produce more of a good or service.
Goods Versus Services Example
Let us assume, for illustration, that we are in a simple economy made of two outputs, medical services and pools. The production possibilities, given only these two outputs, can be graphed along a curve, called a production possibilities curve. The production possibilities curve graphs all of the production possibilities of our two outputs, medical services and pools, given the factors of production and the available technology.
The curve ranges from the economy just producing medical services to the economy of only producing pools. If the majority of all of our resources in the economy are invested in creating pools, we could end up at point A on our production possibilities curve. If the majority of all of our resources are invested in providing medical services, we will end up at point C on the curve. Point B shows our economy when we produce a combination of medical services as well as pools. All of the points along the curve are economically efficient.
Combinations inside the production possibilities curve, such as point D, are possible production points; however, these do not require the full use of all available factors of production and are inefficient. Combinations outside the production possibilities curve, such as point E, are impossible production points. These cannot be reached with the available factors of production and existing technology.
What if technology improves? If new technology is created and the factors of production remain the same, the curve will shift outward. This type of shift outward also demonstrates economic growth, which allows for more production of goods and services. If a factor of production becomes scarcer, say from a union strike or natural disaster, or the economy shrinks, the curve will shift inward.
The production possibilities curve shows that when we produce more of one good or service, we produce less of another. If we produce at point B on the curve and we want to produce at point C on the curve, we have to give up producing a number of pools in order to do so. The money we earn from the number of pools we give up is the opportunity cost of producing more medical services.
Opportunity cost is our trade-off, the value of the next best production alternative that is not chosen. If we choose to go to the movies instead of working overtime, our opportunity cost of going to the movies is the amount of money we would have if we had gone to work instead of the movies.
In economics, all decisions involve looking at how to distribute resources differently and trade-off one good or service for another. With every redistribution, something is given up in order to produce something else. What is given up is the opportunity cost, the trade-off, or what we could have produced but chose not to.
In order to determine what production decisions we want to make, we use the production possibilities curve, which demonstrates economic efficiency and inefficiency. This curve shows all of the maximum output possibilities, given the factors of production and available technology - both of which are limited.
By using the production possibilities curve, companies, non-profits, and governments can look at a range of how to produce goods and services efficiently. Then, decision-makers can choose the best option along this curve, given the situation at hand.
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