What is the 'Production Possibility Frontier - PPF'
The production possibility frontier (PPF) is a curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors. The PPF assumes that all inputs are used efficiently.
Factors such as labor, capital and technology, among others, will affect the resources available, which will dictate where the production possibility frontier lies. The PPF is also known as the production possibility curve or the transformation curve.
BREAKING DOWN 'Production Possibility Frontier - PPF'
The PPF indicates the production possibilities of two commodities when resources are fixed. This means that the production of one commodity can only increase when the production of the other commodity is reduced, due to the availability of resources. Therefore, the PPF measures the efficiency in which two commodities can be produced together, helping managers and leaders decide what mix of commodities are most beneficial. The PPF assumes that technology is constant, resources are used efficiently, and that there is normally only a choice between two commodities.
Understanding and Interpreting the PPF
The PPF drives home the idea that opportunity costs normally come up when an economic organization with limited resources must decide between two alternatives. The PPF is depicted graphically as an arc, with one commodity on the X axis and the other commodity on the Y access. At each point on the arc, there is an efficient number of the two commodities that can be produced with available resources. Therefore, it's up to the organization to look at the PPF and decide what number of each commodity should be produced to maximize the overall benefit to the economy.
If, for example, a government organization is deciding between the production mix of textbooks and computers, and it can produce either 40 textbooks and 7 computers or 70 text books and 3 computers, it's up to that organization to determine what it needs more. In this example, the opportunity cost of producing an additional 30 textbooks is 4 computers.
Understanding the Pareto Efficiency
The Pareto Efficiency is a concept named after Italian economist Vilfredo Pareto that measures the efficiency of the commodity allocation on the PPF. The Pareto Efficiency states that any point within the PPF curve is considered inefficient because the total output of commodities is below the output capacity. Conversely, any point outside the PPF curve is considered to be impossible because it represents a mix of commodities that will take more resources to produce than can be obtained.
Therefore, any mix of two commodities, given limited resources, is only efficient when it lies on the PPF curve, with one commodity on the X axis and one commodity on the Y axis. Achieving the Pareto Efficiency means that an economy is operating at maximum potential and lies directly on the PPF.