4.1.1.5 Production Possibility Diagrams (AQA)

This study note looks at production possibility curves.

Production Possibility Diagrams and the Fundamental Economic Problem

Production Possibility Diagrams (PPDs) are graphical tools used in economics to illustrate various aspects of the fundamental economic problem. These diagrams help us understand how societies allocate their limited resources to produce a combination of goods and services. In this study note, we will explore the key features of PPDs and why all points on the boundary are productively efficient but not allocatively efficient.

Resource Allocation:

• PPDs depict the allocation of limited resources, such as labour, capital, and land, between the production of two goods or services.
• The position of a point on the PPD reflects the quantity of each good being produced. Choices must be made because resources are scarce.

Opportunity Cost and Trade-offs:

• The slope of the PPD represents the opportunity cost of producing one more unit of a good. If the slope is steep, the opportunity cost is high.
• Trade-offs are inherent in resource allocation. Moving along the PPD shows the trade-off between producing more of one good and less of the other.

Unemployment of Economic Resources:

• Points inside the PPD represent an inefficient use of resources. Resources are underutilized, and more could be produced without increasing the opportunity cost.
• Underemployment of resources can result from factors like inefficiencies, labour shortages, or technological limitations.

Economic Growth:

• Economic growth is represented by an outward shift of the PPD. It occurs for example when there is an increase in a society's resources or technological advancement.
• Growth allows for more of both goods to be produced without sacrificing one for the other.

Productively Efficient Points:

• All points on the boundary (the PPD curve) are productively efficient. This means that resources are fully employed, and it is impossible to produce more of one good without producing less of the other.
• Points on the boundary represent efficient resource allocation.

Allocatively Efficient Points:

• Allocative efficiency occurs when the combination of goods produced aligns with society's preferences and demands.
• Not all points on the boundary are allocatively efficient because efficiency in resource allocation does not necessarily mean that it reflects society's preferences.
• Allocative efficiency is achieved when the marginal benefit (utility) of the last unit produced equals the marginal cost (opportunity cost) of production. This often occurs at a point inside the boundary.

Why Not All Boundary Points Are Allocatively Efficient:

• In reality, society may prefer different combinations of goods than what the PPD produces at its boundary.
• The PPD assumes constant opportunity costs, but in practice, opportunity costs can change due to factors like technological advancements or changes in resource availability.
• Allocative efficiency often involves producing less of one good and more of another to better align with society's preferences, even if resources are fully utilized.

Production Possibility Diagrams are valuable tools for understanding resource allocation, opportunity cost, trade-offs, unemployment of resources, and economic growth. While all points on the boundary are productively efficient, allocative efficiency depends on whether the combination of goods produced matches society's preferences and needs.

Achieving allocative efficiency may require producing a different mix of goods than what the boundary suggests, reflecting the dynamic nature of real-world economies.