Production_possibility_frontier

In economics, a production possibilities frontier (PPF) or “transformation curve” is a graph that shows the different quantities of two goods that an economy (or agent) could efficiently produce with limited productive resources. Points along the curve describe the trade-off between the two goods, that is, the opportunity cost. Opportunity cost here measures how much an additional unit of one good costs in units forgone of the other good. The curve illustrates that increasing production of one good reduces maximum production of the other good as resources are transferred away from the other good.

Productive efficiency, opportunity cost, and allocative efficiency

The production possibilities curve shows the maximum feasible (obtainable) amount of one commodity for any given amount of another commodity, as of the society\'s technology and the amount of factors of production available. The concept is used to show the options open to a firm, individual, household, or economy for a 2-good world. In microeconomics, the 2-good case readily generalizes to the n-good case. In macroeconomics, it illustrates the production possibilities available to a nation or economy (corresponding roughly to macroeconomic notions of potential output at a given point on the curve) for broad categories of output. All points on a production possibilities curve are points of maximum productive efficiency or minimum productive inefficiency: allocated such that it is impossible to increase the output of one commodity without reducing the output of the other. That is, there must be a sacrifice, an opportunity cost (given by the slope of the curve in absolute value), for increasing the production of a good by one unit. Conversely, points inside the frontier are feasible but productively inefficient.

Point A in the diagram for example, shows that F_A of food and C_A of computers can be produced when production is run efficiently. So can F_B of food and C_B of computers (point B).

For a firm, a point on the curve is productively efficient but, given market demand, could be less profitable than another point on the curve. Equilibrium for the firm with given resources is at the most profitable and productively efficient point on the PPF.

There is a parallel for an economy as well. It may have productive efficiency but not allocative efficiency. Markets and other institutions of social decision-making (such as government, tradition, and community democracy) may lead to the wrong combination of goods being produced (and the wrong mix of resources allocated) compared to what individuals would prefer, given what is feasible on the PPF.

The marginal rate of transformation

The slope of the production possibilities frontier (PPF) at any given point is called the marginal rate of transformation (MRT). It describes numerically the rate at which one good can be transformed into the other. It is also called the (marginal) "opportunity cost” of a commodity, that is, it is the opportunity cost of X in terms of Y at the margin. It measures how much of good Y is given up for one more unit of good X or vice versa. The shape of PPF is commonly drawn as concave downward to represent increasing opportunity cost with increased output of a good. Thus, MRT increases in absolute size as one moves from the top left of the PPF to the bottom right of the PPF.

Marginal Rate of Transformation

If, for example, the (absolute) slope at point "BB" in the diagram is equal to 2, then, in order to produce one more computer, 2 units of food production must be sacrificed. If at "AA" for example, the marginal opportunity cost of computers in terms of food is equal to 0.25, then, the sacrifice of one unit of food could produce 4 computers.

The marginal rate of transformation can be expressed in terms of either commodity. The marginal opportunity costs of computers in terms of food is simply the reciprocal of the marginal opportunity cost of food in terms of computers.

See also

• Production, costs, and pricing
• Production theory basics
• Production function

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