Production Possibility Curve

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SHAPE OF PRODUCTION POSSIBILITY CURVE:
Shape 1: Concave
Good Y
A

P

Q

0

Good X
B

The slope of the production possibility curve is the Marginal Rate of Transformation (MRT) which indicates the rate at which one good is being transformed into another, not physically, but by transferring resources from one good to another good. As we move along the production possibility curve through points P and Q downwards, slope or steepness of each tangent through these points increases. Thus, the production possibility curve takes a concave shape, indicating increasing opportunity cost, that is, the economy is willing to give up more Y for an additional unit of X. There is increasing opportunity cost because of diminishing returns.
Note: slope of PPC = MRTYX = change in Y = change in X

opportunity cost of producing an additional unit of X in terms of Y.

Shape 2: Convex
Good Y
A

P

Q
0

Good X

B
As we move downwards from P to Q, the steepness of each gradient falls, i.e, the gradient becomes flatter. In other words, the slope of the production possibility curve diminishes as we move downwards. This means that the MRTYX keeps falling, and thus, the opportunity cost is decreasing
(increasing returns). The economy is now willing to give up less units of Y for the same additional unit of X.

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Shape 3: Linear
Good Y
A
P

Q

0

B

Good X

Here the slope of the production possibility curve remains constant. The MRTYX is constant or unchanged as we moved downwards the curve from left to right. Thus, the production possibility curve becomes linear or straight line. The opportunity cost also remains constant (constant returns). This means that the economy is willing to give up the same amount of Y for the same additional unit of X.

SHIFT OF THE PRODUCTION POSSIBILITY CURVE:
Good Y
A1
A

c a b

0

Good X
B

B1

If the economy’s capacity to produce goods is increasing, the production possibility curve will be moving outwards over time. This indicates that economic growth has taken place. Economic growth shifts the boundary outward and makes it possible to produce more of all goods. Before growth points a and b were on the production possibility curve and point c was unattainable. After growth, point c is attainable. FACTORS RESPONSIBLE FOR THE SHIFT:
1. Improvement in the state of technology
2. Increase in the labour force and labour productivity

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3. Increase in capital stock (investment)
4. Discovery of new resources.

PRODUCTION POSSIBILITY CURVE AND EXCHANGE (through international trade): Good Y
A
20

P (10X, 20Y)

16

Q (20X, 16Y)

0

Good X
10

20 B

In an open economy, suppose a country produces at point P along the production possibility curve AB. In other words, with the available amount of resources, it produces 10 units of X and 20 units of Y. Combination Q cannot be produced due to scarcity of resources unless there is economic growth.
However, even without economic growth, consumption at point Q could be attained only through exchange, that is, only if the country engages itself in international trade. To attain combination Q, the country has to export 4Y and import 10X.

ECONOMIC SYSTEMS:
The central problem of every economic society is to allocate resources in deciding what, how, and for whom to produce. These three questions are dealt with in different ways in each and every

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economy. They are dealt with depending on the economic and political frameworks of that country.
Broadly speaking, the economic systems are classified into 3 categories namely:
1. The market economy or laissez-faire system or capitalist economy.
2. The command or planned economy
3. The mixed economy.

MARKET ECONOMY:
In a market economy resource allocation is carried out by private individuals only. All factors of production
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