The production possibility curves is a hypothetical representation of the amount of two different goods that can be obtained by shifting resources from the production of one, to the production of the other. The curve is used to describe a society’s choice between two different goods. Figure 1, shows the two goods as consumption and investment. Investment goods are goods that are involved in the production of further consumption goods. They include physical capital such as machines, buildings, roads etc. and human investments such as education and training. The sums of all investments make up the capital stock of a society. To show the point where all resources were used to produce consumption goods, one should move straight up the vertical axes to the curve. To show the point were all resources were used to produce investment goods, one should move straight on the horizontal axes to the curve. Both points are extreme and unrealistic. Both points A and B represented more realistic combinations, with point A showing more consumption and less investment, while point B shows more investment and less consumption.
Figure 1.
The production possibility curve of figure 1., shows
the trade off in production between investments and consumption goods.
Any two categories of different goods could be chosen. What they are is
arbitrary. The curve is used to show during a specific period,
what could be produced of the combination of the two goods, if all resources
are fully employed, while technology and institutions do not change. Given
those conditions, societies output potential is realized anywhere on the
curve (which is called the production possibility curve’s frontier). Unemployed
resources (labor, capital, physical resources) of any kind would result
in an inefficient production level, and
would be shown as a point to the left, or inside the curve. By definition
all point to the right or outside of the production possibility curve (frontier)
are impossible, given the limits of resources and technology.
Opportunity cost is different than accounting cost,
and unfortunately is not so easily calculated. Opportunity cost has a subjective
element. For instance, to determine
the opportunity cost of a new highway, includes the obvious cost of materials,
of labor, of land, (these are the easily determined accounting cost), but
there are also intangible cost, such as the cost to the community of the
disruption involved with new construction, and the change in the communities
effected by the highway. Also there may be costs connected to increase
pollution (with health effects), increased noise, and an increase in general
unattractiveness. These cost
are real, but are difficult to both measure and evaluate. Putting a dollar
value on these cost adds a subjective element to the evaluation. As a result
sometimes they are ignored.
Economist are often asked to make cost/benefit studies
of economic projects, to help determine their overall value. But because
of the intangibles, and subjective nature of both benefits and opportunity
costs, no definitive answer can be given. The studies should be viewed
only as one input into the decision process, and not as definitive.
Figure 2.
In Figure 1, a country that
selected point B (selected less consumption and more investments), would
increase its resources (capital) faster than if it had selected point A.
Therefore by selecting point B, a country would find its production possibility
curve shifting outward faster than if it had choosen Point A. The tradeoff
between consumption and investment suggest that consumption today is at
the expense of faster economic growth in the future.
The simple tradeoff is not
enough to explain why growth has occur historically. There are many countries,
which consumed relatively little of their total output, but still manage
not to grow economically. Other countries, most notably the United States
has managed to grow, in spite of its high level of consumption. During
the 1990s consumption in the United States had reached record levels (levels
of aggregate personal savings, which is inversely related to consumption,
were close to zero for a number of years), while economic growth continued,
and actually reached record rates of growth during the latter years of
the 1990s.
The actual reasons for the
shift in the production possibility curve, and the increased growth (measured
as the percentage change in the gross domestic product), therefore has
many causes. Besides the increase in investments, improvements in technology
and a change in institutions can be responsible for growth. It is hard
practically to differentiate these different elements. There
is no simple relationship, and causation can go in both directions. Economic
growth could be responsible for the increased investment, which incorporates
improve technology and requires changes in institutions.
The production possibility
curve is strictly hypothetical and static in nature. There
are no practical ways to actually apply and calculate such a curve. It's
use is as the starting point for conceptualizing, and it provides an example
of neoclassical economic’s fondness for methodological deduction (starts
from general premises).
Alternative schools of economics
that question these simple assumption of neoclassical economics has less
use for the production possibility curve. No
tool or analytical device is truly neutral or objective, and this is true
for the production possibility curve itself. The
increased production possibility's that come with growth, for instance,
do not question the environmental consequences of that growth. The
downside effects of economic growth are ignored.
Also the humanistic paradigm
have little use for of the curve as a tool of analysis. This paradigm,
which in contrast to neoclassical economics, question the unlimited wants
of consumers for goods and service. The humanistic paradigm argues that
once basic physical needs are secured, now and into the future, the real
needs becomes social and achievement needs. They
would further argue that these needs are not met effectively in the process
of buying and consuming of goods and services, even though this may be
the attempt on the part of some. With the strong cultural value of
work (work ethic), these needs are more effectively fulfilled in the process
of doing and contributing by work to something outside of oneself. Whatever
that is, it certainly will very within the context of one's culture and
society. In the United States,
work for many fulfilled these needs, or at least provides the hope for
fulfilling these needs. Not
any job, of course, but good jobs which besides securing one's physical
well-being also allows one to belong, to have self-esteem and to feel a
sense of achievement.
Various alternative schools
of economic thought believe that human needs and wants are not absolute
but can be manipulated. And
such needs and wants are all relative to our particular culture and our
status within that culture. Therefore
the production possibility curve, and its simple assumptions misses the
mark, and scarcity is misapplied. For humanistic economist opportunities
to satisfy the higher social and achievement needs are what is really scarce.