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The Main Uses of Production

Possibility Curve
Article shared by Supriya Guru

The Main Uses of Production Possibility Curve!

Scarcity and Resource Allocation:
Production possibility frontier or curve is an important concept of modern
economics. This concept is used to explain the various economic problems
and theories. The basic economic problem of scarcity on which Robbins
definition of economics is based, can be explained with the aid of production
possibility curve.

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According to the problem of scarcity, because of the limited availabilities of the

resources, all wants of the society for goods cannot be satisfied; if a society
decides to allocate more resources to the production of one good, it has to
withdraw resources from the production of another good, as has been seen
above.
Given the amount of resources, the economy has to operate on the given
production possibility curve. As has been brought out above, when we
increase the production of one commodity moving along the production
possibility curve, we have to reduce the production of some other commodity.
If the given resources are being fully used and technology remains constant,
an economy cannot increase the production of both the goods represented on
the two axes. This illustrates the basic economic problem. Thus, the basic
economic problem is that, in view of the scarcity of resources, at what point of
the production possibility curve, the economy should produce so as to
maximise social welfare.

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Production Possibility Curve and Central Economic Problems:

Another use of production possibility frontier is that with its aid we can explain
the central problems of what, how and for whom to produce. Which goods
should be produced and in what quantities, implies that on what point of the
production possibility curve the economy should operate.

A glance at Figure 5.1 will reveal that if the economy is operating at point B on
the production possibility curve AF, then one thousand metres of cloth and
fourteen thousand quintals of wheat are being produced. If the economy operates at point E on this curve, four thousand metres of cloth and five thousand
quintals of wheat are being produced.

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Thus, operating at different points of the production possibility curve implies

different allocation of resources between the productions of two goods. At
which point of the production possibility curve, a free market economy will
operate depends upon the consumers demand for different goods. In other
words, in a free market economy, how the resources would be allocated
between the two goods on a given production possibility curve is determined
by the demand of the consumers.

How the goods are to be produced implies which methods or techniques

should be employed for the production of various goods. In. other words, what
resource combination should be used for the production of goods so as to
maximise the output or to minimise the cost.
A factor would be used for the production of a product for which it is more
efficient. It is obvious that this is the problem of technical efficiency. If for
producing goods such resource combinations as will minimise cost of
production are not employed, the economy will be operating at a point below
the given production possibility curve.
Thus, if in the production of various goods, efficient methods are not used or if
the resources are not employed in their efficient uses, the economy will not be
operating at a point on the production possibility curve, instead it will be
operating at a point below the production possibility curve such as U in Figure
5.2. The working of the economy below the production possibility curve
indicates that less than maximum possible production is being done which will
lower the welfare and standard of living of the people. The loss of production
is the result of inefficient use of the resources.

For whom to produce or how the national product is being distributed is not
directly revealed by the production possibility curve. However, we can obtain
some knowledge of the distribution of goods from the production possibility
curve.
If a production possibility curve is constructed in which necessaries are
represented on the one axis and luxuries on the other, we can know from the
actual position of the economy on this curve that how the national output is
being distributed. Consider Figure 5.4 in which on the X -axis necessary
goods and on the F-axis luxury goods have been measured.

If the economy is working at point R on the production possibility curve PP in

this figure, the g economy would be producing relatively more of luxury goods
such as refrigerators, televisions, motor cars, air conditioners and would be
producing relatively less quantities of essential consumer goods, such as
food-grains, cloth, edible oil, which indicates that distribution of national
income is very much uneven and the richer sections of the society will be
getting relatively more of luxury goods, whereas the poorer sections would be
deprived of even the necessaries of life.
On the contrary, if the economy is operating at point S on the production
possibility curve PP, then it implies that essential consumer goods will be
produced relatively more and luxury goods will be produced relatively less by
the economy. This indicates that the distribution of income and output in the
society in this case will be relatively more equal.
What quantities of various goods will be produced in a free market economy
i.e. how much of luxury goods and how much of necessaries would be
produced, depends upon the pattern of demand of the consumers. In other
words, pattern of production will correspond to the pattern of demand. But it

should be remembered that the pattern of demand depends upon the

distribution of income in a society. The more unequal is the distribution of
income in the society, the greater the amount of luxury goods produced in it.
The Problem of Unemployment and Underemployment of Resources:
As we have studied above, the problem of unemployment and
underemployment of resources can be illustrated and understood with the aid
of the production possibility curve. When all resources are being fully used the
economy will operate at a point on the production possibility curve.
But the economy will operate at a point on the production possibility curve if
aggregate demand is large enough to buy the total output produced by the full
employment of resources. If aggregate demand is somehow smaller, the
economy will not be able to use its productive capacity fully, that is, it will not
be able to utilise its resources fully, which will result in unemployment and
underemployment of resources.
In case of unemployment and underemployment of resources, the economy
will be working at a point below the production possibility curve (such as point
U in Figure 5.2). In such a situation if aggregate demand for goods increases,
the demand for resources and, therefore, their employment will rise and as a
result unemployment and underemployment will disappear and national
income will increase.
Thus, it follows that as a result of increase in aggregate demand the economy
moves from a point below the production possibility curve to a point on the
production possibility curve. Renowned economist J.M. Keynes, who
attributed unemployment and underemployment to the lack of aggregate

demand recommended construction of public works on a large scale by the

Government financed by deficit financing so as to raise the aggregate demand
which will help in utilisation of resources fully and therefore in solving the
problem of unemployment and underemployment.
The Problem of Capital Formation and Economic Growth:
Another important use of the production possibility curve is that with it we can
explain with it the problem of capital formation and economic growth. In order
to explain the problem of capital formation we have to construct such a
production possibility curve in which on one axis capital goods and on the
other axis consumer goods are measured.
This has been done in Figure 5.5 in which along the X -axis consumer goods
and along the Y-axis, capital goods are measured. If the economy is allocating
the available resources between capital and consumer goods in such a way
that it operates at point A on the production possibility curve PP, it will be
producing OC1 of consumer goods and OK1 of capital goods. Now suppose
that the society decides to produce more of capital goods.
To implement this decision society will have to withdraw some resources from
the production of consumer goods and use them for the production of capital
goods. As a result, the production of consumer goods will decline. It is clear
from Figure 5.5, that if the economy reallocates its resources between
consumer and capital goods and shifts from point A to point B on the
production possibility curve PP, it will now produce OK2 of capital goods and
OC2 of consumer goods.

That is K1K2 amount of capital goods will be produced more and C1C2 amount
of consumer goods will be produced less than before. We, therefore, conclude
that in order to step up the rate of capital formation the production of
consumer goods and therefore consumption has to be reduced.
But the above conclusion is based on the assumption that the economy is
using its resources fully and most efficiently and is operating at a point on the
production possibility curve. However, if some available resources are lying
unemployed and idle or the economy is not using them more efficiently, the
economy will be working below the production possibility curve.
When the economy is working at a point below the production possibility
curve, then more capital can be created without a reduction in the production
of consumer goods because by employing idle and unemployed resources,
economy can produce more of capital goods.
But, as has been explained above, if the economy is utilising its resources
fully then the rate of capital formation cannot be increased without the
reduction in consumption. But it is worth noting that when the rate of capital

formation is raised, this does not mean that amount of consumption is

reduced forever.
The accumulation of more capital enables economy to increase its production
of consumer goods in the future. That is, the accumulation of capital raises the
productive capacity of the economy. Thus, capital accumulation implies that
less jam today for more jam tomorrow.
Since the accumulation of capital raises the productive capacity, national
production will increase, that is, economic growth will take place. As a result,
the economy will not remain on the same production possibility curve and its
production possibility curve will shift outward which indicates that the economy
will be able to produce more than before.
The greater the rate of capital formation, the greater the extent of shift in the
production possibility curve, and the greater the rate of economic growth.
Consider Figure 5.6 in which in the beginning the economy is producing
OC1 of consumer goods and OK1 of capital goods on the production possibility
curve P1P1.
If the economy maintains this rate of capital formation, then the production
possibility curve will go on shifting and the economy will be growing annually
at a certain fixed rate. It should be noted that in Figure 5.6, as a result of low
rate of capital formation, production possibility curve shifts outward at a
relatively slow speed. Thus growth path OR in Fig. 5.6 represents a lower rate
of economic growth.

If the society wants to obtain a higher rate of economic growth, it will have to
raise its rate of capital formation. This is shown in Fig. 5.7 in which the
economy is producing at point t1 on the production possibility curve P1P1, with
OK2 of capital goods at OC1 of consumer goods.

If the economy maintains this rate of capital formation, production possibility

curve will go on shifting outward to a greater extent than in Figure 5.6. This
means that the rate of economic growth will now be relatively greater than in
Figure 5.6. In the two Figures 5.6 and 5.7, it will be noticed that, in the
beginning in Fig. 5.7; the production of consumer goods is less than in Figure
5.6, but when as a result of higher rate of economic growth, production
possibility curves reach their position P4P4 at time t4, it will be producing more
consumer goods in Fig. 5.7 exhibiting higher rate of economic growth than in

Figure 5.6, where the rate of capital formation and therefore the rate of
economic growth is relatively less.
We have explained above economic growth which has been brought about by
capital formation. Besides capital formation, there are other factors which
determine rate of economic growth. Progress in technology and expansion in
education also favorably affect rate of economic growth and cause production
possibility curve to shift outward.
We have explained above only some important uses of production possibility
curve. There are several other uses of production possibility curve. We can
understand better the concept of opportunity cost with the aid of production
possibility curve.
The concept of production possibility curve has also been extensively used in
welfare economics and in the theory of international trade. In the modern
economic theory gains from international trade have also been explained with
the aid of production possibility curve.
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