If an economy is operating on its production possibility frontier are there any unemployed

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Have you been to a frontier lately? Whether you realize it or not, the economy has a frontier—it has an outer limit of economic production. In this episode of the Economic Lowdown Video Series, economic education specialist Scott Wolla explains how the production possibilities frontier (PPF) illustrates some very important economic concepts.

Segment 2 of The Production Possibilities Frontier uses the production possibilities frontier to explain key economic ideas such as why an economy might have underemployed resources but later expand, and how changes in productivity can lead to economic growth.

Watch other segments of this episode:

More episodes:

• The Economic Lowdown Podcast Series
• The Economic Lowdown Video Series

Transcript:

Below is the full transcript of this video presentation. It has not been edited for readability, and there may be slight differences between the text and the video.

In the previous segment we learned that scarcity forces people to make a choice, and when people choose, there is an opportunity cost.

Opportunity cost is the value of the next-best alternative when a decision is made; it's what is given up. The opportunity cost of producing 1 more widget is the lost opportunity to produce 2 gadgets.

So, the PPF can be used to illustrate two very important economic concepts—scarcity and opportunity cost.

Now, let's move beyond the basics and see how the PPF graph illustrates some bigger economic ideas.

This space right here, on the inside of the frontier, helps illustrate our next lesson.

Lesson 3: A point inside the frontier represents underemployment; movement back toward the frontier reflects economic expansion.

The frontier represents maximum production with the available resources, but it isn't just the points along the line that are production possibilities. Econ Isle could alternatively produce at any point inside the frontier. So, while it could produce 4 gadgets and 4 widgets, it might produce only 2 gadgets and 2 widgets. In this case, Econ Isle would not be fully employed, or put differently, resources in Econ Isle would be underemployed. In fact, any point inside the frontier represents underemployment, which is a failure to reach full employment. Why would an economy produce below its potential? Well, it could be in a recession, which is a significant decline in general economic activity extending over a period of time.

During a recession, Econ Isle's production will likely decline, resulting in workers losing jobs and leaving other resources—machines and factories—underutilized as well. When economic activity picks up again, production levels would likely move back toward the frontier. That is, the economy would move toward full employment. The shift from a recession toward the frontier is sometimes called an economic expansion.

So far, we've talked about Econ Isle's possibilities up to its frontier, but the frontier line itself can shift. Two primary changes can cause the frontier to shift: a change in productive resources and technological change.

Remember that the frontier reflects the available resources. The frontier will shift as the economy acquires or loses productive resources. For example, if the labor force grows and other resources levels stay the same, the frontier will shift outward. Or, if an economy diverts resources to produce more capital goods, which means they are using economic resources to make other resources, the frontier will shift outward.

Technological change is an advance in overall knowledge in a specific area. The gains achieved through technological change tend to be gains through increased productivity—or an increase in economic output per input. In fact, productivity is measured as the ratio of output per worker per unit of time. Take Fred, for example.

Imagine Fred can produce 2 widgets per hour, but then his productivity improves and he can produce 3 widgets per hour. Notice that there is still only 1 Fred, and we are still measuring his production per hour, but his output has increased.

Two factors can increase worker productivity over time: investment in physical capital, things such as computer software and tools, and human capital.  Human capital is the knowledge and skills that people obtain through education, experience, and training.

Imagine Fred's hand tools were replaced with new power tools. All of a sudden Fred would be able to produce more output in the same amount of time. His increase in productivity would be due to investment in physical capital.

And then when Fred learns to use the new power tools more effectively, he'll likely increase his productivity even more! This increase in productivity would be due to investment in human capital.

Increasing the productivity of workers allows for more production without an increase in resources.

And improvements in productivity will shift the frontier outward, which illustrates our fourth lesson.

Lesson 4: An outward shift of the frontier reflects economic growth.

Fred increased his productivity by learning how to use new tools. Increasing the productivity of workers allows for more production without an increase in resources. And improvements in productivity will shift the frontier outward, which reflects economic growth.

For Econ Isle, an outward shift can mean that it can produce both more gadgets and more widgets. Notice that I said the economy could produce more of both goods. Remember that when the PPF is static, producing more gadgets means producing fewer widgets—there is an opportunity cost. But when the frontier shifts outward, it is possible to produce more of both goods. Economists call this economic growth—a sustained rise over time in a nation's production of goods and services. Economic growth is important because it allows more people to have more of what they want over time.

Be sure to watch Part 3 of this series to learn our final lesson, and wrap up this episode.

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The production possibility frontier (PPF) is a curve on a graph that illustrates the possible quantities that can be produced of two products if both depend upon the same finite resource for their manufacture. The PPF is also referred to as the production possibility curve.

PPF also plays a crucial role in economics. For example, it can demonstrate that a nation's economy has reached the highest level of efficiency possible.

• When producing goods, opportunity cost is what is given up when you take resources from one product to produce another. The maximum amount that can be produced is illustrated by a curve on a graph.
• The production possibility frontier (PPF) is above the curve, illustrating impossible scenarios given the available resources.
• The PPF demonstrates that the production of one commodity may increase only if the production of the other commodity decreases.
• The PPF is a decision-making tool for managers deciding on the optimum product mix for the company.

The PPF is the area on a graph representing production levels that cannot be obtained given the available resources; the curve represents optimal levels. Here are the assumptions involved:

• A company/economy wants to produce two products
• There are limited resources
• Technology and techniques remain constant
• All resources are fully and efficiently used

If a company is deciding how much of each product to produce, it can plot points on a graph representing the number of products made using variables based on amounts of available resources. Keeping in mind that resources are limited, if the desire is to produce more of one product, resources must be taken away from the other.

As resources are taken from one product and allocated to the other, another point can be plotted on the curve. When you plot the points where more of X will be produced by taking resources from Y or vice versa, a curve is generated representing the maximum amount of each product that can be produced as resources are reallocated.

For example, if a non-profit agency provides a mix of textbooks and computers, the curve may show that it can provide either 48 textbooks and six computers or 72 textbooks and two computers. This results in a ratio of about six textbooks to one computer.

The agency's leadership must determine which item is more urgently needed. In this example, the opportunity cost of providing an additional 30 textbooks equals five more computers, so it would only be able to give out one computer with 78 textbooks. If it wanted more computers, it would need to reduce the number of textbooks by six for every computer.

When this is plotted, the area below the curve represents computers and textbooks that are not being used, and the area above the curve represents donations that cannot happen with the available resources. The area above the curve is called the production possibility frontier, and the curve (the line itself) is sometimes called the opportunity cost curve. The entire graph is sometimes referred to as the production possibility curve.

The non-profit could provide 10 textbooks and 10 computers, but this is not using all of its resources. This would be represented by a plot beneath the curve. A plot would be placed above the curve in the frontier area if the company wanted to give more than its resources provided, such as 85 textbooks and no computers or 42 textbooks and 10 computers—it simply can't do it based on available resources.

This technique can be used by economists to determine the set of points at which a country’s economy is most efficiently allocating its resources to produce as many goods as possible. If the production level is on the curve, the country can only produce more of one good if it produces less of some other good.

If the economy is producing less than the quantities indicated by the curve, this signifies that resources are not being used to their full potential. In this case, it is possible to increase the production of some goods without cutting production in other areas.

The production possibility frontier demonstrates that there are limits on production, given that the assumptions hold. Therefore, each economy must decide what combination of goods and services should be produced to attain maximum resource efficiency.

Imagine a national economy that can produce only two things: wine and cotton. If points A, B, and C are plotted on a curve, it represents the economy's most efficient use of resources.

For instance, producing five units of wine and five units of cotton (point B) is just as attainable as producing three units of wine and seven units of cotton. Point X represents an inefficient use of resources, while point Y represents a goal that the economy simply cannot attain with its present levels of resources.

As we can see, for this economy to produce more wine, it must give up some of the resources it is currently using to produce cotton (point A). If the economy starts producing more cotton (represented by points B and C), it would need to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A.

Moreover, 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. But if the economy moves from point B to C, wine output will be reduced by about 50%, while the cotton output only increases by about 75%.

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. For example, if more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production. Markets play an important role in telling the economy what the PPF should look like.

Consider point X in the figure above. If a country is producing at point X, it means its resources are not being used efficiently—that is, the country is not producing enough cotton or wine, given the potential of its resources. On the other hand, point Y, as we mentioned above, represents an unattainable output level.

An economy can only be produced on the PPF curve in theory. Economies constantly struggle to reach an optimal production capacity. Scarcity always forces an economy to forgo some choice in favor of another.

The only way for the curve to move outward to point Y is if there were an improvement in cotton and grape harvesting technology because the available resources—land, labor, and capital—generally remain constant. As output increased, the PPF curve would be pushed outwards. A new curve, represented in the figure on which Y would fall, would show the new optimal allocation of resources.

When the PPF shifts outwards, it implies growth in an economy. When it shifts inwards, the economy is shrinking due to a failure to allocate resources and optimal production capability. A shrinking economy could result from a decrease in supplies or a deficiency in technology.

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 inefficient because the total output of commodities is below the output capacity.

Conversely, any point outside the PPF curve is 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 efficient commodity mixes lie along the PPF curve, with one commodity on the X-axis and the other on the Y-axis.

An economy may be able to produce all of the goods and services it needs to function using the PPF as a guide. However, this may lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trading with other countries are considered.

There are four common assumptions in the model:

1. The economy is assumed to have only two goods that represent the market
2. The supply of resources is fixed or constant
3. Technology and techniques remain constant
4. All resources are efficiently and fully used

The PPF demonstrates whether resources are being used efficiently and fully when everything else remains constant. Thus, the variables can be changed to see how the curve reacts, letting you observe different outcomes.

The simplest method is to use Excel or Google Sheets. Fill two columns with two variable values, highlight the data, and use the chart wizard. Create an XY scatter plot chart and label the X and Y axes.

Because the PPF is a curve based on the data of two variables representing resources between two goods, the data can be manipulated to observe how scarcity, growth, inefficiency, efficiency, and other factors can affect production.

The PPF identifies the options when making a decision. When you decide on one action, you lose the opportunity the other action provides. Thus, there is an opportunity cost; the PPF curve plots this.

The production possibilities curve illustrates the maximum possible output for two products when there are limited resources. It also illustrates the opportunity cost of making decisions about allocating resources.

Businesses and economists use the PPF to consider possible production scenarios by changing resource variables. The PPF allows businesses to learn how variables influence production or decide which products to manufacture. Economists can use it to learn how much of a specific good can be produced in a country while not producing another good to analyze economic efficiency levels and growth.