Politics & Society

Economics 101: What Is the Production Possibility Frontier? Learn How the Production Possibility Frontier Can Be Useful in Business

Written by MasterClass

Aug 7, 2019 • 5 min read

The production possibility frontier is an economic model and visual representation of the ideal production balance between two commodities given finite resources. It shows businesses and national economies the optimal production levels of two distinct capital goods competing for the same resources in production, and the opportunity cost associated with either decision. Over time, the movement of the production possibility frontier indicates if a business or economy is growing or shrinking.

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What Is the Production Possibility Frontier?

In business and economics, the production possibility frontier (PPF)—also called the production possibility curve (PPC) or the transformation curve—visualizes the different possible quantities of two different goods that may be produced when there is limited availability of a certain resource that both need to be produced.

The production possibility frontier assumes that production is operating at a maximum amount of productive efficiency. It also assumes that the production of any one commodity will only increase if the production of another commodity decreases because of finite resources. It measures and visualizes the level of efficiency at which two different commodities can be produced together. In private companies, managers utilize this data to understand the precise combination of commodities that can and should be produced to provide the greatest boost to a company’s profits.

Every economic decision is a trade-off—any business, and any economy for that matter, only has so many resources available and using them for one purpose over another always represents a trade-off. It shows the comparative advantage of each possibility and represents how resources should ideally be allocated. These resources can include (but are not limited to):

  • Land
  • Natural resources
  • Fuel
  • Factory capacity
  • Labor

The PPF, for all of its utility, does come with limitations, however:

  • It assumes that technology is a constant, meaning that it does not consider how different technologies can make the production of certain products more efficient than others.
  • This is not always the case, and this leads to confusion occasionally when two products compete for the same resource but one of them can be produced at a lesser cost due to technological applications.
  • It also does not apply when a company is producing three or more products that compete for the same resources. A binary system, the PPF is limited to a side-by-side illustration and cannot break into more complicated models.

What Is the Purpose of the PPF?

In macroeconomics, the PPF shows the point in which a country’s economy is at its most efficient, producing consumer goods and services by optimally allocating resources. It considers production factors and determines the best combinations of goods. It is one of the most important economic concepts guiding production and resource allocation.

If a country such as the United States is in this optimal state, it means they have the ideal amount of resources being used efficiently: there are just enough wheat fields and cow pastures, just enough car factories and auto sales centers, and just enough accountants and lawyers offering tax and legal services.

But if the economy is not producing the amounts indicated by the PPF, it means resources are being mismanaged. Falling short of the production possibility frontier suggests that an economy is not stable and will ultimately dwindle.

In the end, the production possibilities frontier teaches us that there are always production limits, meaning that in order to be efficient, those running an economy must decide what combination of goods and services can (and should) be produced.

Production Possibility Curve illustration

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How Is the PPF Interpreted?

A PPF graph appears as an arc (not a straight line) with one commodity on the X-axis and the other commodity on the Y. Each point along the arc represents the most efficient number of each commodity that should be produced with the available resources. The slope of the production possibility frontier shows the ideal combinations (there are always more than one) of production.

It is important to understand the concept of opportunity costs when interpreting a PPF. Opportunity cost, in economics, represents the cost of making one production choice over another.

There are constant opportunity costs and often times increasing opportunity costs, which are accounted for and visualized in the PPF.

  • Let’s say a publisher can produce 200 magazines and 100 books a day, or it if shifts its priorities and focus, it can produce 500 magazines and 25 books in a day.
  • The leadership at this fictitious publication house will have to decide which item is required at higher urgency.
  • According to the PPF, the opportunity cost of producing an additional 300 magazines/day is 75 books.

When reading a PPF, the points along the arc represent different optimal production levels of each commodity. If the actual production levels do not fall along the curve on point a, point b, point c, or point d but instead fall below its arc, it means the production levels are not optimal. If an aspired-to production level is plotted above the curve, this level is not attainable given the resources available.

Since a PPF is dynamic, not static—it is shifting depending on available resources—we can also interpret its changes over time.

  • When the PPF curve moves outwards (outward shift), we can infer there has been growth in an economy. This can result from an increase in resources. It can also represent improved technology.
  • When the PPF curve moves inwards (inward shift) it suggests the economy is shrinking. This is likely due to a poor allocation of resources and a suboptimal production capability. It can also result from technological deficiencies.

Since scarcity forces economic decisions that will favor one product at the expense of another, the slope of the PPF will always be negative—increasing production of product A will, by necessity, decrease the production of product B.

How Can the PPF Be Used in Business?

A PPF shows businesses a way to make sense of their production possibilities by charting out the opportunity cost of resource allocation, suggesting how to reach optimal allocative efficiency. With scarce resources, it tells us which products to prioritize and at what ratio, showing the maximum possible combinations of goods and services

But, for all of its utility, it is important to remember that the PPF is still a theoretical construct, not an actual representation of reality. It is important to remember that an economy only costs on the PPF curve theoretically; in real life, businesses and economies are in a constant battle to arrive at and then maintain optimal production capacity.

Learn more about economics and society in Paul Krugman’s MasterClass.