What is the Production Possibility Frontier?
In business analysis, the production possibility frontier (PPF) is a curve illustrating the different possible amounts that two separate goods may be produced, when there is a fixed availability of a certain resource that both items require for their manufacture. The PPF, which assumes that production is optimally efficient, is alternatively referred to as the "production possibility curve" or the "transformation curve".
Production Possibility Frontier (PPF)
Understanding the Production Possibility Frontier (PPF)
The PPF operates under the assumption that the production of one commodity may only increase if the production of the other commodity decreases, due to limited available resources. The PPF consequently measures the efficiency in which two commodities can be produced together. This data is of paramount importance to managers seeking to determine the precise proportional mix of goods that most greatly benefits a company's bottom line.
The PPF assumes that technological infrastructure is constant, and underlines the notion that opportunity costs typically arise when an economic organization with limited resources must decide between two products. However, the PPF curve does not apply to companies that produce three or more products vying for the same resource.
Understanding and Interpreting the PPF
The PPF is graphically depicted as an arc, with one commodity represented on the X axis and the other represented on the Y-axis. Each point on the arc shows the most efficient number of the two commodities that can be produced with available resources. For example, if a government organization that produces a mix of textbooks and computers, can produce either 40 textbooks and seven computers, versus 70 textbooks and three computers, it is incumbent on company leadership to analyze which item is required with greater urgency. In this example, the opportunity cost of producing an additional 30 textbooks equals four computers.
Understanding the Pareto Efficiency
The Pareto Efficiency a concept named after Italian economist Vilfredo Pareto 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 deemed impossible because it represents a mix of commodities that will require more resources to produce than are currently obtainable. Therefore, in situations with limited resources, the only the efficient commodity mixes are those lying along the PPF curve, with one commodity on the X-axis the other on the Y-axis.