Alternative Production Possibilities Models

The principle of economic scarcity and choice can be illustrated through use of a production
possibilities model. The production possibilities model illustrates the range of choices available
to an economy with a given level of technology and a fixed stock of resources, or inputs. If we
simplify things in terms of a production possibilities choice between two outputs, or goods, we
can portray the range of choices in a first quadrant two-dimensional space.

A production possibilities schedule illustrates the range of output choices available to a

society with a given stock of resources and level of technology at a given point in time. If we
map the production possibilities schedule, we derive the production possibilities frontier.
Any point inside a given production possibilities curve, or frontier, represents unemployment
or underemployment of resources. Any point outside the production possibilities frontier is an
unattainable point with the present level of technology and stock of resources. Any movement
along the frontier will, by definition, involve a sacrifice of one type of output in order to gain an
additional unit of the alternative good. This sacrifice is known as the opportunity cost. The
opportunity cost is thus measured as the slope of the production possibilities frontier for one
good, and the reciprocal of the slope for the alternative good. Opportunity cost is a fundamental
tool in all economic analysis, and is central to the principle of economic efficiency.

Production Possibilities Schedule - Model A

A B C D E F
K 25 24 21 16 9 0
C 0 1 2 3 4 5

Calculation of the Opportunity Cost:

dc/dk= 1.00 3.00 5.00 7.00 9.00
dk/dc= 1.00 0.33 0.20 0.14 0.11

Static Production Possibilities Model A

A B C D E F
30 0.00 1.00 2.00 3.00 4.00 5.00
T-0 25.00 24.00 21.00 16.00 9.00 0.00
T-1 25.00 24.00 21.00 16.00 9.00 0.00
25 T-2 25.00 24.00 21.00 16.00 9.00 0.00
T-3 25.00 24.00 21.00 16.00 9.00 0.00 B - Infeasible zone

20 Technical Change Rate: 0

15

10 A - unemployment, or
underemployment zone

0 Page 1
0 1 2 3 4 5
 10 A - unemployment, or
underemployment zone

0
0 1 2 3 4 5

We can calculate the opportunity cost of production in terms of the change in one type of good
in comparison to the change in the alternative type of good. In model A, we see that each extra
unit of good C involves a larger opportunity cost as measured in terms of good K given up. This
also holds true if we reverse our measure and track the opportunity cost of each additional unit
of good K in comparison to the quantity of good C given up.

Choice in the basic production possibilities model represents alternative combinations of the two
outputs. If we stipulate that one of the two outputs represents capital goods, while the other point
represents consumer goods, we also can illustrate what will happen with the production possibilities
frontier over time. As long as a society chooses to place relative emphasis on the production of
capital goods, since they add to the economy's stock of inputs, this will tend to expand the production
possibilities frontier outward at a faster rate. It is for this reason that, in general, countries that have
higher rates of saving and investment tend to grow faster than countries that have lower rates.
We also note that high rates of saving and investment do not just produce physical capital goods.
They also produce more efficient capital goods that can use fewer natural resources, the one input
that is ultimately fixed in quanitity. These changes in efficiency thus represent a second way in which
economic growth can occur, that is, through technical change. Thus, an economy can grow either
by an increase in the stock of its inputs, or by improved efficiency in the stock of existing inputs.
Both types of change are essential and intertwined in all processes of economic growth.

A B C D E F G H I J K
K 61 60 58 55 Economic
51 46Growth
40 33 25 16 0
K 25
K - Capital Goods 24 21 16 9 0
70
C 0 1 2 3 4 5 6 7 8 9 10

60 Economic Growth Expands the Range

of Production Choice for all Goods
50

40

30

20

10

0
1 2 3 4 5 6 7 8 9 10 11
C - Consumer Goods

Why do we portray convex production possibilities frontiers? It is not just to derive increasing
opportunity costs. We need an explanation for these rising opportunity costs. The simple answer

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is that in most economies, resources are specialized and are allocated to their specialized uses.
When we withdraw resources from one type of production into another, initially the opportunity
cost will be relatively small since the resources we shift first will be those that can be substituted
most easily in another kind of production. Gradually, as we shift more and more resources from
one kind of production into another, we wind up using more specialized resources, with the
result that each extra unit of resource contributes a smaller and smaller increment to additional
production of the alternative type of output.

Are there alternative types of production possibilities models? The short answer is "yes",
except that any alternative model that moves away from a given degree of convexity will, by
definition, involve a lesser degree of specialization. Consider, for example, a straight-line
production possibilities model, illustrated below as model-B. In this case, we still have positive
opportunity costs, but they are constant (as is the slope and its reciprocal) as we move from one
type of production to another along the production possibilities frontier. While it is possible to
have an economy with a straight-line production possibilities frontier, we note that it portrays
an economy in which there is no specialization, and thus, that resources are equally efficient
in either of the alternative types of production, even if the opportunity costs differ for each good
(i.e., the slope of the production possibilities frontier has a value other than negative one).

Production Possibilities Schedule - Model B

A B C D E F
K 25 20 15 10 5 0
C 0 1 2 3 4 5

Calculation of the Opportunity Cost:

dc/dk= 5.00 5.00 5.00 5.00 5.00
dk/dc= 0.20 0.20 0.20 0.20 0.20

A B C D E F
Static Production
C Possibilities
0 1 2Model
3 B 4 5
K 25 20 15 10 5 0
30

25

20

15

10

0
0 1 2 3 4 5

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 5

0
0 1 2 3 4 5

While a straight-line, or constant opportunity cost is possible, let us round out the alternatives
with a third variation, shown below as Model C. In this case, the production possibilities frontier
is convex. With a convex production possibilities frontier, there now are decreasing opportunity
costs. It thus becomes cheaper to shift production from one type of production to another, but it
is equally true for the converse. We can think of this as a "schizophrenic economic model" in that
it is always preferable to be in the opposite position. This clearly is not very realistic because it
violates the logic of economic specialization. Convex production possibilities thus represent only
a theoretical possibility for which there is no empirical foundation.

Production Possibilities Schedule - Model C

A B C D E F
K 25 16 9 4 1 0
C 0 1 2 3 4 5

Calculation of the Opportunity Cost:

dc/dk= 9.00 7.00 5.00 3.00 1.00
dk/dc= 0.11 0.14 0.20 0.33 1.00

A
Static ProductionBPossibilities
C D - Model
E F
C
C 0 1 2 3 4 5
K 25 16 9 4 1 0
30

25

20

15

10

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5
15

10

0
0 1 2 3 4 5

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 Alternative Production Possibilities

The production possibilities model illustrates the principles of scarcity, opportunity costs, and economic growth.
The shape of the production possibilities curve at one moment in time indicates whether the opportunity cost is
increasing, constant, or decreasing. Input specialization indicates that there will be increasing opportunity costs,
and thus the production possibilities curve will be concave, or bow-shaped outward. If resources are perfectly
shiftable because there is no input specialization, then we will have a straight-line production possibilities curve.
If we have a mismatched allocation of inputs, we may have the alternative extreme of decreasing opportunity costs,
in which case it is always better to be in a different position than you actually are.

Static Production Possibilities Model A

30

A B C D E F Increasing opportunity costs =

A B C D E F
25 inputs are specialized and
K 25 24 21 16 9 0 #REF! 1.00 2.00 imperfectly
3.00 4.00 shiftable
5.00
C 0 1 2 3 4 5 T-0 25.00 24.00 21.00 16.00 9.00 0.00
20
Calculation of the Opportunity Cost: T-1 25.00 24.00 21.00 16.00 9.00 0.00
dk/dc= 1.00 3.00 5.00 7.00 9.00 B - Infeasible zone
T-2 25.00 24.00 21.00 16.00 9.00 0.00
15
dc/dk= 1.00 0.33 0.20 0.14 0.11 T-3 25.00 24.00 21.00 16.00 9.00 0.00

A - unemployment, or
10
underemployment
Technical Change zone
Rate: 0

0
0 1 2 3 4 5

Static Production Possibilities Model B

A B C D E F
30 C 0 1 2 3 4 5
A B C D E F K 25 20 15 10 5 0
K 25 20 15 10 5 0 25
Constant opportunity costs =
C 0 1 2 3 4 5 inputs are unspecialized and
Calculation of the Opportunity Cost: perfectly shiftable
20
dk/dc= 5.00 5.00 5.00 5.00 5.00
dc/dk= 0.20 0.20 0.20 0.20 0.20 15

10

0
0 1 2 3 4 5

Static Production Possibilities - Model C

30

A B C D E F
25 C 0 1 2 3 4 5
K 25 16 9 4 1 0
A B C D E F Decreasing opportunity costs =
20 resources may be specialized
K 25 16 9 4 1 0 or unspecialized but are
misallocated to their
15 Page 6 least productive uses

10
 25

Decreasing opportunity costs =

20 resources may be specialized
or unspecialized but are
C 0 1 2 3 4 5 misallocated to their
15 least productive uses
Calculation of the Opportunity Cost:
dk/dc= 9.00 7.00 5.00 3.00 1.00 10
dc/dk= 0.11 0.14 0.20 0.33 1.00
5

0
0 1 2 3 4 5

Achieving Economic Growth

Economic growth can occur in four possible ways. How much growth by each factor
will depend on economic incentives such as savings and investment, technological
innovation, and policies toward resource specialization and international trade.

Economic Growth
K - Capital Goods

70 A B C D E F G H I J K
K 61 60 58 55 51 46 40 33 25 16 0
60
K 25 24 21 16 Economic
9 Growth Expands the Range
0
of Production Choice for all Goods
50
C 0 1 2 3 4 5 6 7 8 9 10

40

30

20

10

0
1 2 3 4 5 6 7 8 9 10 11
C - Consumer Goods

Determinants of Economic Growth

1 An increase in the stock of inputs - land, labor, capital, entrepreneurship

Examples: growth in the labor force, capital stocks, new natural resource discoveries

2 Technological innovation that produces a more efficient use of inputs

Examples: investment in energy conserving machinery and buildings, faster computers

3 Input specialization
Examples: education and training in computers, biotechnology, space exploration; robotics

4 International trade
Examples: WTO commitments to reduce tariffs, quotas, and non-tariff barriers

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