Under the field of macroeconomics, the production possibility frontier (PPF) represents the point at which an economy is most efficiently producing its goods and services and, therefore, allocating its resources in the best way possible. If the economy is not producing the quantities indicated by the PPF, resources are being managed inefficiently and the production of society will dwindle. The production possibility frontier shows there are limits to production, so an economy, to achieve efficiency, must decide what combination of goods and services can be produced.
Let's turn to the chart below. Imagine an economy that can produce only wine
and cotton. According to the PPF, points A, B and C - all appearing on the
curve - represent the most efficient use of resources by the economy. Point X
represents an inefficient use of resources, while point Y represents the goals
that the economy cannot attain with its present levels of resources.
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As
we can see, in order for this economy to produce more wine, it must give up
some of the resources it uses to produce cotton (point A). If the economy
starts producing more cotton (represented by points B and C), it would have to
divert resources from making wine and, consequently, it will produce less wine
than it is producing at point A. As the chart shows, by moving production from
point A to B, the economy must decrease wine production by a small amount in
comparison to the increase in cotton output. However, if the economy moves from
point B to C, wine output will be significantly reduced while the increase in
cotton will be quite small. Keep in mind that A, B, and C all represent the
most efficient allocation of resources for the economy; the nation must decide
how to achieve the PPF and which combination to use. If more wine is in demand,
the cost of increasing its output is proportional to the cost of decreasing
cotton production.
Point X means that the country's resources are not being used efficiently or,
more specifically, that the country is not producing enough cotton or wine
given the potential of its resources. Point Y, as we mentioned above,
represents an output level that is currently unreachable by this economy.
However, if there was a change in technology while the level of land, labor and
capital remained the same, the time required to pick cotton and grapes would be
reduced. Output would increase, and the PPF would be pushed outwards. A new
curve, on which Y would appear, would represent the new efficient allocation of
resources.
When
the PPF shifts outwards, we know there is growth in an economy. Alternatively,
when the PPF shifts inwards it indicates that the economy is shrinking as a
result of a decline in its most efficient allocation of resources and optimal
production capability. A shrinking economy could be a result of a decrease in
supplies or a deficiency in technology.
An economy can be producing on the PPF curve only in theory. In reality,
economies constantly struggle to reach an optimal production capacity. And
because scarcity forces an economy to forgo one choice for another, the slope
of the PPF will always be negative; if production of product A increases then
production of product B will have to decrease accordingly.