What Is the Production Possibilities Frontier Curve?
By Indeed Editorial Team
Published April 20, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The production possibilities frontier has applications in the fields of economic and business analysis. It's one factor that companies and economies consider when making decisions relating to resource allocation and specialization. Understanding what it is, and how it relates to the decision to specialize, is essential for those considering a career in the field. In this article, we discuss what the production possibilities frontier is, detail its uses in the business world, discover how it shifts and its shape, learn how it influences opportunity cost, specialization, and comparative and absolute advantage.
What is the production possibilities frontier curve?
The production possibilities frontier (PPF) is the curve that illustrates the varying production quantities of two products when both products depend on the same limited resources. The PPF is the maximum quantity of each product that a business can produce based on the resources they have available to use in production. Typically, those illustrating the PPF draw it as a simple graph, where the x-axis represents product A's production quantiles, and the y-axis represents product B's production quantities. The PPF typically takes the shape of an arc. Some analysts and businesses refer to the PPF as the transformation curve.
If a business increases the production of product A, then there is a decrease in the production of product B because the resources available to produce product B decrease due to product A's increased requirements. Many organizations use the PPF as a decision-making tool when they determine the optimum product mix for the organization. In some instances, the production quantities of the two products may fall inside the curve. If this occurs, then production isn't running at optimal levels. Each point on the curve is a representation of a maximum efficiency level.
What are the PPFs uses in the business world?
Businesses and governments make use of the PPF as follows:
Macroeconomic uses for the PPF
When macroeconomists use the PPF, it has a slightly different scope but adopts the same principles that companies consider when using the tool. The PPF curve illustrates the points at which a country's economy is allocating its resources efficiently to produce as many goods as possible. If the economy produces more of product A, then it produces less of product B, due to the limited nature of the resources.
The PPF illustrates that production has limitations. If a country's economy is to reach its maximum potential, then it's important the combination of goods it produces sits on the PPF, with the PPF helping to determine those goods that are most beneficial to the economy.
Business uses for the PPF
Business analysts use the PPF to measure the efficiencies of two products they produce simultaneously. The basic assumption being that an increase in the production of one results in a decrease in production for the second good. When businesses use the PPF, they are using it to determine the exact mix of goods relative to production capabilities. It's important to understand that the PPF relates only to companies that produce two products. If companies produce over two products, the PPF is not relevant.
Shifting the PPF curve
When the business or country isn't realizing the full potential of its resources, the production quantities sit within the PPF curve. The area beyond the PPF curve represents production at a level that's currently unattainable. This is simply because the economy or business doesn't have the resources available to support production at the higher level. This doesn't mean that a production level beyond the PPF is permanently unattainable. Below are some implications of the PPF shifts:
Outward shifts of the PPF
There are several factors that might cause the PPF curve to shift outward and to the right, resulting in an increase in the production capacity of one of both of the products. These factors include:
Advances in production technology
Changes in the resource availability
Improvements to human capital through education and training
Changes in the labour force.
When only one product benefits, the PPF shifts outward only along the axis of that product.
Related: What Is Quantitative Analysis?
Inward shifts of the PPF
A PPF curve can also shift inward and to the left. The circumstances that lead to this shift relate to a decrease in the quality or quantity of the goods the organization or country produces. If the change impacts on only one good, then the inward shift occurs only on the side of the PPF that relates to that good.
What do shifts at a country level mean?
At a country level, an outward shift in the PPF curve generally represents economic growth. An inward shift represents economic regression. The regression might be due to poor resource allocation, a reduction in the availability of resources, or technological failure with ongoing consequences. Despite the theory suggesting economies operate on the PPF curve, the reality is most operate inside the PPF due primarily to resource scarcity.
The shape of the PPF
Usually, analysts represent the PPF as an outward curve rather than a straight line. This is primarily due to the law of diminishing returns, which states the benefits or profits that are gained when the organization invests additional resources, money, or energy in production gets proportionately smaller. This means the PPF typically takes the shape of an outward curve.
When the PPF is linear, the opportunity cost of producing either product A or product B is constant. There's no advantage or disadvantage of producing more or less of one product over the other. This scenario is relatively uncommon in the real world.
Opportunity costs and the PPF curve
Organizations can also use the PPF curve to calculate opportunity costs. The opportunity cost is what you give up when you make a choice. A PPF illustrates the opportunity cost that's associated with each production level and is useful when calculating the opportunity cost. It's a case of checking the relevant axis and making the simple calculation.
Let's say a country produces motorbikes and robots. The following list contains information from the country's PPF:
Example: The country is planning to increase motorbike production from 70 to 90, but first wants to know the opportunity cost. To determine this, you subtract the number of robots the company makes when they produce 70 motorbikes, from the number they make when they produce 90 motorbikes (35 - 20). The opportunity cost is 15 robots.
Comparative and absolute advantage
While an economy can exist in isolation, producing all the goods it requires, the reality is very different. Although the economy can produce the goods to meet its needs, this doesn't mean that it's the best option. This situation has the potential to result in an inefficient allocation of resources. In the long term, this is likely to lead to the regression of the economy.
Economies that trade with other economies can reap the benefits of specialization. This means they can concentrate on specific goods becoming experts in those specific areas, so they maximize the efficiencies relating to the allocation of resources. Following are advantages to specialization, including an example:
This is the advantage that a specific economy has over another when producing specific goods. The economy has an opportunity cost that's lower than the economies it trades with. This results in the economy being able to supply the goods to its trading partners at a lower price. Comparative advantage is typically the basis by which economies specialize. Another way of understanding comparative advantage is to think of it as what a company does best while giving up the least.
In contrast, absolute advantage refers to the superior production capability one economy has over its trading partners. The economy that produces the goods at the lowest absolute cost has an absolute advantage. Absolute advantage doesn't mean that it's necessarily the most efficient allocation of resources, and even though the economy can produce the goods at the lowest cost, it might benefit more by producing another product. In many respects, absolute advantage is a key contributor to the economy realizing comparative advantage.
Example of comparative and absolute advantage
If Canada produces oil at $100 per barrel, Saudi Arabia produces it at $150 per barrel, and the US produces it at $80 per barrel, then the US has the lowest cost of production, which means it has an absolute advantage. Canada uses fewer resources producing its oil, and, as a result, has the lowest opportunity cost of $30 per barrel, while the US and Saudi Arabia have an opportunity cost of $50 per barrel. This means that Canada has a comparative advantage.
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