Economics: PPF and Technology and Resource Changes

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04/08/2012

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In the last lesson we introduced the production possibilities frontier, a tool that describes what an economy can produce given its resources and its technology. In this lesson we're going to take a dynamic look at production possibilities. We'll ask what happens to the productive capacity of an economy when there's some kind of change in its environment. Perhaps its resources increase or decrease. Perhaps technology changes in some particular way. What then happens to the combination of goods and services that that economy can produce?
Let's take another look at the production possibilities frontier. Remember, it's a downward sloping line representing the fact that if you want to produce more rice, you've got to produce less wheat. The movement of resources from the production of one good to the other is necessary and creates a kind of opportunity cost, that is, the opportunity cost of increasing rice production is reduced wheat production. We draw this line when we know the economy's resource endowment and its technological possibility. That is, what the economy is capable of doing with the resources that it has. Suppose now we change one of those constraints. Suppose we change the technological possibilities in the economy, or suppose we change the resource endowments. In that case, the production possibilities curve will shift. A movement along the production possibilities frontier represents a change in the economy's choice of which combination of goods to produce. If an economy decides that it wants to produce a lot of wheat and a little rice, it will be at a point on the production possibilities frontier up here. If the economy wants to produce a lot of rice and a little wheat, they'll be down at a point like this. If the economy wants a balanced output of wheat and rice, they'll be at a point like this. Whenever the economy changes the combination of wheat and rice that it produces, it moves along the existing production possibilities curve.
Suppose now that we change one of those things that we hold constant when we draw the curve. Suppose we change resources or technology. Anytime you change something that was held constant when you drew the curve, you have to redraw the curve. Anytime you change a variable that's not represented on one of the axes, well, you've got to redraw the curve to represent new production possibilities. Let's start and suppose that we have general technological progress in the economy. Suppose there's an agricultural revolution and this economy discovers new and more productive ways to make both rice and wheat with their given resources. In that case, the production possibilities curve will shift outward. The curve shifts outward, representing the fact that after technical progress, it's now possible to produce more wheat for a given amount of rice than before. Before when we were producing 20 bushels of rice, we could only produce 78 bushels of wheat. Now, after technological progress, we're able to produce maybe as many as 85 or 90 bushels of wheat when we produce 20 bushels of rice. For every quantity of rice produced, we can now make more wheat than before. For every quantity of wheat produced, we can now make more rice than before. Technical progress allows us to expand our production possibilities. We can now make more than before with our given quantity of scarce resources.
Suppose now that we have general migration of labor into the economy, and that this labor is well suited for either working in the production of rice or wheat. A migration into the economy of agricultural labor would also shift the production possibilities curve outwards. Now with more workers to employ in the production of wheat and rice, we can make more wheat and rice than before. For any quantity of rice we produce, we can now produce a larger quantity of wheat than before. For any quantity of wheat that we produce, we can now produce a larger quantity of rice than before. An increase in labor allows us to expand our production possibilities in this economy.
Suppose now that we have a different kind of change. Let's suppose that a change occurs that increases this economy's productivity in the wheat industry but not in the rice industry. Suppose a new fertilizer is discovered that increased the productivity of wheat farms, but doesn't do anything for rice farms. How would we show that change in this picture? Production possibilities would change in such a way that there would be an increase in wheat production, but no change in potential rice production. That is, if the economy continued to devote all of its resources to the production of rice, it would only be able to produce 100 bushels of rice, just like before. But if the economy devoted all of its resources to the production of wheat, it might be able to produce 120 bushels of wheat with this new fertilizer. The new fertilizer increases the productivity of wheat without changing the productivity of rice. So we get a skewed shift in the production possibilities curve, one that is slanted in the direction of increases wheat production without changing the productivity of rice.
Let's consider another possibility. Suppose the climate of our economy changes. With the change in climate of our economy, let's suppose that the ground is wetter most of the year. It rains more often; the ground gets soaked and saturated. What's that going to do to the productivity of our economy? What's that going to do to our production possibilities? Well, let's suppose that this extra wetness hurts the production of wheat and helps the production of rice. We would then show the shift in the production possibilities curve looking something like this. The amount of rice that could be produced with this increased wetness will be larger, maybe at 420 bushels of rice a year. The amount of wheat that could be produced would shrink, maybe down to 60 bushels a year. With this change in the climate there is a reduction in the productivity of this economy for making wheat, and an increase in its productivity in making rice.
One final thing. Let's suppose we have a large out-migration of labor; that a lot of people leave this economy to go to work somewhere else. Or suppose an earthquake occurs and wipes out a lot of the capital stock, a lot of the tools and equipment that are used. In that case, the production possibilities frontier would actually shift inwards. There would be a reduction in the productivity of this economy. It could produce less of everything. So that producing 20 bushels of rice might leave you only enough resources to make, say, 55 bushels of wheat instead of the previous 78. So it's possible sometimes that the production possibilities curve would actually shift inward representing a reduction in the economy's productivity.
So, a quick summary then. Things that increase the productivity of the economy: an increase in the stock of resources, an improvement in technology. Those things shift the production possibilities curve outwards. Those things that reduce productivity, such as a loss of labor or capital, or an unfavorable change in the climate, shift the production possibilities curve inwards. And sometimes changes in the economy will affect the two different sectors in different ways. They might actually cause one sector to become more productive, and the other sector to become less productive.
I'd like to end with a question, and this is a question that came up during your quiz in the last lecture. Look at this production possibilities curve. Of all of these choices, which is the one that our economy prefers? Which combination of wheat and rice is going to make consumers the happiest? The answer is--we have no idea. There's no representation in this picture for consumer preferences. Unless you know something about consumer preferences, you're not able to say which of these feasible points is the most desirable. If our economy likes a lot of wheat, this point up here might be the best one. If our economy likes a lot of rice, this point might be the best one. If our economy like a nice balanced mix, then this point might be the best one. The point I'm trying to make is this. The production possibilities curve tells you about the supply side of an economy. It tells you about what this economy is able to produce given its limited quantity of resources, given the technology know-how that the economy possesses, given the peculiarities of the resources--some being well suited for the production of wheat, some being well suited for the production of rice. But this diagram tells you nothing about which of the points is the most desirable. In order to tell which of these points is best we would have to bring in something from the demand side of the economy, knowledge about what pleases consumers. So the blue line here is purely a statement about engineering--what our economy is able to make. And the important concept from this lesson is the concept of efficiency--doing the best you can with the resources that you have and the know-how that you possess. That is, each point on the blue curve is efficient because it represents the maximum amount of wheat that our economy can produce when it produces a given quantity of rice. The blue line represents doing the best we can with what we have, and that's the definition of efficiency.
Introduction to Economic Thinking
Production Possibilities
Understanding How a Change in Technology or Resources Affects the PPF Page [2 of 2]