(Illustrate the concept of scarcity by using a production possibility frontier)
Production possibility theory is the first model we examine, which demonstrates the problems of scarcity, choice and opportunity cost. We start with static analysis of the production possibility model and proceed to dynamic analysis. The difference between the two models is the element of time. The static model assumes a fixed amount of resources at a given point in time, while the dynamic model allows for change over time. These two models are well explained below:
(1) The Static Production Possibility Model:
The static production possibility model can be explained in the following way:
This static model analyses an economy at a fixed point in time and depends on five crucial assumptions:
(i) There is a fixed quantity of resources.
(ii) The economy uses these resources to produce only two goods.
(iii) The resources can be used interchangeably to produce either good.
(iv) The economy uses all the resources; there are no resources left over.
(v) Resources are used at maximum efficiency; there is no wastage, no idle capacity.
Schedule or Table:
The production possibility schedule is a table that shows the various amounts of the two goods that can be produced, given the above assumptions. Ignore the unrealistic nature of the assumptions that an economy can produce only two commodities which both use the same inputs. Remember it is a simplified model used to illustrate a theory.
Following table 1.1, shows the production possibilities. From the table, we can see that, with a given quantity of inputs, if the economy devoted all its resources to producing CD players, 800 CD players would be produced, but there would be no computers. This is shown as production possibility A. There are no computers because the fixed quantity of resources at our disposal cannot be used to produce both CD players and computers at the same time. It is one or the other, we need to make a choice and there will be an opportunity cost in any choice we make.
Table 1.1: Production Possibility Schedule in a Two-Output Economy:
Alternative production possibilities are indicated at output E, where this economy is producing 400 computers but no CD Players. At production possibility D, 300 computers and 200 CD players are produced. In moving from point E to point D, we gained 200 CD players, but the opportunity cost of doing so was 100 computers.
If this economy reaches point C, but requires more CD players, it has to give up some computers to produce the additional CD players. Such is the nature of scarcity, choice and opportunity cost. The more we want of one product, the more we have to give up of the other product.
Production Possibility Frontier:
The production possibilities can be shown graphically and maximum output levels are indicated by a line known as the production possibility frontier (sometimes referred to as the production possibility curve). The frontier shows the maximum efficient level of output combinations that are available to this economy with a finite level of resources. It also allows vertical axis and CD players on the horizontal axis (figure 1.3).
Diagram – Production Possibility Curve:
Static Production Possibility Frontier in a Two-Output Economy:
Given our assumptions, the economy in static production possibility theory cannot produce unlimited outputs. Points such as Z are impossible with fixed resources and factors of production or economic resources. Point Z shows a production possibility of 600 CD players and 300 computers.
However, if we were to produce 600 CD players, with limited resources we could only produce a maximum of 100 computers (point D). Alternatively, if we were producing 300 computers, the maximum resources available allow 200 CD players to be produced, not the 600 indicated by point Z. So points outside the production possibility frontier are not possible using existing resources and technology.
If an economy is producing at a point within the production possibility curve, point Y, it is not producing at the most efficient level in order to maximize output. The economy is satisfying fewer needs and wants than it could be. Causes include unemployed or underemployed resources and inefficient use of resources.
At point Y, this economy is producing 100 computers and 400 CD players, but if the decision was made to produce 100 computers it should be producing 600 CD players, or if it decided to produce 400 CD players it should produce 200 computers. Production at a point inside the frontier indicates that the economy has fewer goods than it could produce.
(2) The Dynamic Production Possibility Model:
The dynamic production possibility model allows for changes that occur in an economy’s level of resources over time. We can therefore alter some of our earlier assumptions:
(i) The quantity of resources will change over time.
(ii) We continue with the assumption that only two goods are produced.
(iii) The resources can be used interchangeably to produce either good, but may be more efficient in producing one or the other.
(iv) The economy uses all the resources; there are no resources are leftover.
(v) Resources are used at maximum efficiency, with no wastage or idle capacity.
For example, populations increase, new resources are discovered, new and better technology is applied to production. The quantity and quality of resources in every economy changes over time. When this occurs, the production possibility curve will shift as shown in the below diagram:
Diagram – Dynamic Production Possibility Frontier in a Two Output Economy:
When the quantity and/or quality of resources increase over time, the economy can produce more goods and the entire curve shifts outwards. However, the opposite is also true. Over time resources are used up, or perhaps the birth rate falls; the available resources are reduced and the curve shifts inwards, indicating that fewer goods and services can be produced.
Note that a change in resources or technique of production may affect the production of one product only. In this case, the production possibility frontier shifts on one axis only as shown in the below diagram:
Diagram: Changes in the Production Possibility Frontier in a Two Output Economy:
Production possibility theory illustrates that increasing levels of output enable greater levels of consumption and satisfaction of consumers’ needs and wants.