Microeconomics Unit 1 Class 12

The production possibilities (PP) curve is a graphical medium of highlighting the central problem of ‘what to produce’. To decide what to produce and in what quantities, it is first necessary to know what is obtainable. The PP curve shows the options that are obtainable, or simply the production possibilities. What is obtainable is based on the following assumptions: 1. The resources available are fixed. 2. The technology remains unchanged. 3. The resources are fully employed. 4. The resources are efficiently employed. 5. The resources are not equally efficient in production of all products.

Thus if resources are transferred from production of one good to another, the cost increases. In other words marginal opportunity cost increases. The last assumption needs explanation because it determines the shape of the PP curve. If this assumption changes, the shape changes. Efficiency in production means productivity i. e. output per unit of an input. Let the input be worker. Suppose an economy produces only two goods X and Y. Suppose a worker is employed in production of X because he is best suited for it. The economy decides to reduce production of X and increase that of Y.

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The worker is transferred to Y. He is not that efficient in production of Y as he was in X. His productivity in Y will be low, and so cost of production high. The implication is clear. If the resources are transferred from one use to another, the less and less efficient resources will be transferred leading to rise in the marginal opportunity cost which is technically termed as marginal rate of transformation (MRT). What is MRT? Marginal Rate of Transformation (MRT) To simplify, let us assume that only two goods are produced in an economy.

Let these two goods be guns and butter, the famous example given by Samuelson. The guns symbolize defense goods and butter, the civilian goods. The example, therefore, symbolizes the problem of choice between civilian goods and war goods. In fact it is a problem of choice before all the countries of the world. Suppose if all the resources are engaged in the production of guns, there will be a maximum amount of guns that can be produced per year. Let it be 15 units (one unit may be taken as equal to 1000, or one lakh and so on).

At the other extreme suppose all the resources are employed in production of butter only. Let the maximum amount of butter that can be produced is 5 units. These are the two extreme possibilities. In between there are others if the resources are partly used for the production of guns and partly for production of butter. Given the extremes and the in-between possibilities, a schedule can be prepared. It can be called a production possibilities schedule. Let the schedule be:2 Production Possibilities Schedule Possibilities Guns Butter MRT = Guns (units) (units) Butter

A 15 0 – B 14 1 1G : IB C 12 2 2G : IB D 9 3 3G : IB E 5 4 4G : IB F 0 5 5G : IB In the table the possibility A is one extreme. The society devotes all the resources to guns and nothing to butter. Suppose the society wants one unit of butter. Since resources are limited and fully and efficiently employed, to produce one unit of butter some of the resources engaged in production of guns have to be transferred to the production of butter. Let the resources worth one unit of gun are enough to produce one unit of butter. This gives us the second possibility with MRT = 1G/IB.

Now suppose that the society wants another unit of butter. This requires transfer of more resources from the production of guns. Now we require transfer of resources worth 2 units of guns to produce one more unit of butter. The MRT rises to 2G/IB. MRT rises because now less efficient resources are being transferred. In this way MRT goes on rising. We can now define MRT in general terms. MRT is the ratio of units of one good sacrificed to produce one more unit of the other good. MRT = Units of one good sacrificed____ = Guns More units of the other good produced Butter

Or, MRT is the rate at which the quantity of output of one good is sacrificed to produce on more unit of the other good. Production Possibility Curve By converting the schedule into a diagram, we can get the PP curve. Refer to the figure I which is based on the PP schedule. Butter’s production is shown on the x-axis and that of guns on the y-axis. We can measure MRT on the PP curve. For example MRT between the possibilities C and D is equal to CG/GD. Between D and E it is equal to DH/HE, and so on. 3 Diagrammatically, the slope of the PP curve is a measure of the MRT.

Since the slope of a concave curve increases as we move downwards along the curve, the MRT rises as we move downwards along the curve. Characteristics A typical PP curve has two characteristics: (1) Downward sloping from left to right It implies that in order to produce more units of one good, some units of the other good must be sacrificed (because of limited resources). (2) Concave to the origin A concave downward sloping curve has an increasing slope. The slope is the same as MRT. So, concavity implies increasing MRT, an assumption on which the PP curve is based.

Can PP curve be a straight line. Yes, if we assume that MRT is constant, i. e. slope is constant. When the slope is constant the curve must be a straight line. But when is MRT constant? It is constant if we assume that all the resources are equally efficient in production of all goods. Note that a typical PP curve is taken to be a concave curve because it is based on a more realistic assumption that all resources are not equally efficient in production of all goods. Does production take place only on the PP curve? Yes and no, both. Yes, if the given resources are fully and fficiently utilized. No, if the resources are underutilized or inefficiently utilized or both. Refer to the figure 3. On point F, and for that matter on any point on the PP curve AB, the resources are fully and efficiently employed. On point U, below the PP curve or any other point but below the PP curve, the resources are either underutilized or inefficiently utilised or both. Any point below the PP curve thus highlights the problem of unemployment and inefficiency in the economy. 4 Can the PP curve shift? Yes, if resources increase. More labor, more capital goods, etter technology, all mean more production of both the goods. A PP curve is based on the assumption that resources remain unchanged. If resources increase, the assumption is broken, and the existing PP curve is no longer valid. With increased resources there is a new PP curve to the right of the existing PP curve. It can also shift, to the left if the resources decrease. It is a rare possibility but sometimes it may happen due to fall in population, due to destruction of capital stock caused by large scale natural calamities, war, etc.

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