A production possibilities curve is crucial for keeping track of your business. It allows you to analyse its productivity accurately.
This allows you to identify problems and recognize any potential improvements. Regarding production, several graphical representations allow you to balance the products you produce.
It is generally a good idea to use multiple graphs to have a clear overview of your various products. Today, we will discuss the production possibilities curve, which allows you to compare two products that share common resources to balance the amount of each.
It measures the efficiency of your current operation regarding the available resources and the amount of two products produced. Ensuring that your operation is working efficiently means utilizing all your resources.
Naturally, this means that you maximize your output (and profits) while minimizing unused resources which might otherwise go to waste. Now, to begin, let us understand the production possibilities curve.
For business leaders making strategic decisions about growth and resource allocation, the production possibilities curve (PPC) provides a valuable economic model. The PPC visually depicts the maximum possible output combinations for two goods or services, given current resources and technology constraints.
The curve illustrates the trade-offs involved when shifting between different output levels. This demonstrates the opportunity costs and efficiency loss from underutilized resources. Points inside the curve represent idle or inefficient production capabilities.
By analyzing their position on the PPC relative to resource constraints, small and medium enterprises can gain useful insights for expansion planning, investing in technology improvements, and optimizing the output mix between different goods.
While the PPC has limitations in accounting for real-world complexities, it provides SMEs with a straightforward visualization for making informed decisions about production levels, resource allocation, and growth strategies.
This guide will walk through constructing a basic production possibilities curve, practical applications for business decision-making, and analyzing trade-offs depicted in the model.
Table of Contents
What is a Production Possibilities Curve?
The definition of a production possibilities curve is a graphical representation combining two products that share common resources in your operation.
It shows the maximum amount of output possible for both products, which you can then compare to your actual output to ensure that no inefficiencies are occurring. To understand the production possibilities curve, you must consider the opportunity cost.
According to the concept of scarcity, your business only has a limited amount of resources that must be utilized to create your outputs. To allocate resources to one production, it must be removed from another.
Likewise, Buying too much material while not outputting all of it into a sellable product is considered a waste of money that could otherwise be used on something else. It is important to know which of your products to prioritize over another one.
For a growing company, that is an incredible loss. Now, let us identify how a production possibilities curve is constructed:
- Each axis has the quantity of one of the common products,
- A table of supposed quantities your operation can produce is sketched onto the graph.
What are Production Resources?
Resources are anything which is needed to make your products. Naturally, on the one hand, this includes raw materials, packaging and any other physical goods you might need to create the product itself.
The trickier thing is intangible resources.
An intangible resource is something which you need to create your products which you can’t hold in your hands.
- Production capacity,
- Equipment and tools,
- Logistics to bring your products to market.
For example, you might have all of the raw materials in the world but not enough machinery to combine them into a final product.
What are Production Possibility Outputs?
Outputs are much simpler to get your head around. That is, this is the quantity of your products you can create. Again, when you create simple physical products, this is pretty self-explanatory.
If you have a service business or create digital products, things get slightly trickier.
In this case, the output might be measured by the number of clients or customers you can provide with a service. Alternatively, it might be measured in terms of the hours of labour you can provide for a project.
Your outputs might also include research and development time or internal investment.
Look at the following table to understand the construction of the curve. For simplicity’s sake, let’s assume that your business’s only resource is labour, with a maximum of six workers.
In other words, if you throw all of your resources at one product, you’ll have maximum output for this and no output for your other products.
Constructing a production possibilities curve:
- Identify the two goods or services to compare – e.g. furniture and electronics production.
- Collect data on total resources – capital, labour, technology, etc.
- Determine current maximum production levels for each good based on full utilization of resources.
- Plot the production quantity of one good on the X-axis
- Plot the production quantity of the other good on the Y-axis
- Indicate current production levels on the axes
- Draw a curve through points showing maximum output combinations.
- The curve’s downward slope shows a tradeoff between the output of the two goods.
- The convex shape reflects the scarcity of resources and efficiency.
- Points inside the curve indicate idle resources/inefficiency.
- Points on the curve represent the full utilization of resources.
The final curve visually depicts production output limits based on current constraints. SMEs can use this to identify opportunities for expansion or improvement.
The Pareto Efficiency Principle
A concept that was named after the Italian economist Vilfredo Pareto. It states that any point under this curve is inefficient as you are not utilising your resources to their full potential.
On the other hand, points lying above that curve are impossible as they utilize more resources than your business has. Based on these findings, if your points lie above the curve, it is likely that there was an error in the report.
For example, you may have miscalculated your resources or ignored product loss.
Regarding points below the curve, they show that your business is not working at maximum efficiency, which requires immediate attention. Inefficiency is a direct loss of profits and stunts the growth of your business.
How can you fix this? The answer is often to shift your curve to the left or right.
Shift to the Right
This indicates an increase in the capacity of your business’s output. This could be because of the introduction of a new technology that allows for more production or the purchase of more tools needed to produce.
A shift to the right is always a great thing; it indicates that your company’s production line is growing. In simple terms, a shift to the right results from increased output.
Shift to the Left
This indicates a decrease in the capacity of your business’s output. This could be the result of the loss of some of your resources. It is regarded as a decrease in the output of your business.
Alternatively, this might be a deliberate decrease in your output. For example, you might limit the number of your products on the market before a new product launch.
Production Possibility Curve and Economics
Say, for example, you’re responsible for sales for a car brand in a given country.
By applying the amount of a basic product in the market on the x-axis against the amount of a luxury product on the y-axis, the resulting point on the graph represents the current state of the market.
This information is important for your business as it will allow you to know which type of products to focus on producing. It allows you to know the consumer demand, which is valuable to the success of your business.
If the point is closer to the x-axis, then the demand has shifted towards luxury, indicating that the market is flourishing and there are a lot of potential customers. Similarly, if the point is close to the y-axis, there is a higher demand for basic products.
This indicated that the market’s economy isn’t doing so well, and you should focus on essential products since there is no buying power.
Applications of the Production Possibilities Curve for Business Decision-Making:
Analyzing Expansion Potential:
- The curve shows maximum production levels given current constraints.
- Shifting the curve outwards indicates opportunities to expand output through added resources.
- Weigh costs of obtaining more capital, labor, technology vs. benefits
Assessing Technology Improvements:
- New technologies can increase productivity and shift the curve outwards
- Evaluate ROI from tech investments that would increase output capacity
Planning Production Mix:
- Curve visually shows tradeoffs between producing different goods
- Helps plan optimal production quantity combinations
- Match output mix to customer demand patterns
The PPC provides visualization of current constraints and tradeoffs to help SMEs identify and evaluate opportunities for expansion through added resources or technology.
Limitations of Using The Production Possibilities Curve Model:
- The standard PPC is a static model showing a snapshot in time
- It does not account for dynamic changes and developments over a period
- Fails to model fluctuations in resource availability and technology
- The assumption of fixed land, labour, and capital in the short run may not hold.
- Constraints like resources can change, affecting production possibilities.
- Assumes full efficiency, which may not reflect real-world capacity
- In practice, inefficiencies mean maximum outputs are rarely achieved
- The model provides a theoretical visualization
- Does not quantify costs, revenues, profits from output decisions
While useful for visualizing theoretical maximum outputs, the PPC has limitations in providing actionable data. Business leaders should supplement with quantitative financial modeling.
Production Possibility Curves in Short
The production possibilities curve is a powerful graphical representation of the theoretical output of your production. It considers two conflicting products and allows you to decide on the perfect balance between them.
Furthermore, your actual product may be represented as a point on that graph to allow you to know where your business stands right now regarding efficiency. In addition, the production possibilities curve can give you a general idea of the status of your potential market.
For example, by comparing luxury to essential goods, you can tell how well the market is doing.
This is not the only available statistical tool, but it can prove quite useful.
Production Possibilities Curve FAQ:
Q: What are the main limitations of the production possibilities curve?
A: Key limitations are its static snapshot view, fixed resource assumptions, lack of quantitative insights on costs and revenues.
Q: What data do I need to construct a basic PPC?
A: You need to identify two goods/services to compare, determine current maximum production levels, and understand your resource constraints.
Q: How does technology shift the PPC outward?
A: Improved technology allows increased output with the same resources. Investments can shift the curve and provide expansion opportunities.
Q: Can the PPC help plan which goods a business should produce?
A: Yes, the curve shows tradeoffs between outputs to help plan an optimal production mix matched to demand.
Production Possibilities Curve Conclusion:
While the production possibilities curve has some inherent simplifications, it remains a valuable economic model for SMEs to visualize trade-offs, identify opportunities for output growth and efficient resource allocation.
Using the PPC as a strategic decision-making complement while being mindful of its limitations allows small businesses to maximize available resources. The visualization it provides of current constraints and expansion potential makes the PPC a useful addition to any SME’s planning toolkit.