When we study how a country can best increase its standard of living, we must look at its production behavior.
In order to produce, a country must use its resources, including land, labor, capital, and raw materials. A production possibilities curve represents production combinations that can be produced with a given amount of resources.
Let’s say that a very small hypothetical country uses 100 acres of land, 20 machines, and 50 workers, and is able to produce two products: guns and roses. You can think of “guns” as representing the category of military products. “Roses” represents all consumer products. This country has some choices (possibilities) regarding how it uses its resources. It can produce 500 units of guns and 350 units of roses (point C on the graph below). However, it can also, with the same resources, produce 400 units of guns and 500 units of roses (point B). Or it can produce 300 units of guns and 580 units of roses (point A). Numerous other combinations (for example, points D, E, G or points in-between), are possible.
A production possibilities curve represents outcome or production combinations that can be produced with a given amount of resources.
Points on the Curve and Trade-offs
If an economy is operating at a point on the production possibilities curve, it is operating at full employment. All resources are used, and they are utilized as efficiently as possible (points E, C, B, A, and D). If a country does not use its resources efficiently, it experiences unemployment and is operating inside the production possibilities curve (point G).
Any point on the curve (full employment) illustrates an output combination that is the maximum that can be produced with the existing resources and technology. It follows that output cannot increase if resources and technology remain constant. When economists discuss the concept of scarcity, they mean that resources are limited and that at any given point in time, production is limited. If an economy is producing on the curve and the curve does not shift, increasing the production of one good or a category of goods always occurs at the expense (opportunity cost or trade-off) of the production of another good or category of goods.
A point inside the curve, for example 300 guns and 350 roses (point G), represents an output combination that is produced using fewer than the available resources (unemployment), or with all the resources, but with the resources used inefficiently (underemployment).
Point F is a production combination that cannot be achieved with the existing resources. Over time, the economy may grow and realize greater production capacities to produce, and we may get to point F in the future. This will be discussed in the next section.
Increasing Costs and the Concave Shape of the Production Possibilities Curve
The production possibilities curve graphed above bows outward (it is concave). This is because the production of the last 100 units of output (for example, the production change from 500 units of guns to 600 units of guns) requires more of a trade-off of roses than the production of the first 100 units of output. In any economy, the production of the first few units is usually easier and cheaper, because the resources to produce these products are more readily available. For example, a country that has no orange production and then chooses to produce 100 oranges per year will find it relatively easy to plant trees in areas that are conducive to growing oranges. However, if total production of bushels of oranges is at one million per year, and we want to produce another 100 oranges, it is more difficult and more costly, because not as much good land is available to grow additional oranges. Thus the production of the first 100 oranges costs less in terms of opportunity cost (cost relative to other goods) than the production of the 100 oranges after one million oranges have been produced already.
For a video explanation of the Production Possibilities Curve, please watch the following: