Production Possibilities

Production Possibilities

This concept illustrates the choices a society makes in using its resources. To apply the concept of production possibilities, we will consider a hypothetical economy and make some assumptions or ground rules to describe it.

Assumptions

The economy will always employ its productive resources fully in the most efficient manner.
The supply of all resources is fixed in both quantity and quality
Technology does not change during the period of time being considered
The economy produces only two products. Steel and coffee

Since resources are limited in supply, and if fully employed, any increase in the production of steel will shift resources away from the production of coffee. Or, if the production of coffee is increased, steel production will decrease. Resources can be made available only by shifting them from one type of production to the other. Table 1 shows the alternative production possibilities for this economy which produces only steel and coffee.

Table 1

Production Possibilities of

Steel and coffee

Per month/per tons

Possibility (production Alternatives)	Steel	Coffee
A	16	0
B	15	1
C	13	2
D	10	3
E	6	4
F	0	5

Table 1 shows that six alternatives are possible. By selecting alternative A, society can have 16 tons of steel but no production of coffee. Alternative B indicates that if one fewer ton of steel is built, one ton of coffee may be produced. Alternative E shows that if six tons of steel are built, society can have four tons of coffee.

Figure 1 is the graph of the data from table 1. it is called production possibilities curves. If instead of using only six alternatives, (A thru F), we showed all possible combinations, we would have a series of points that make up the Production Possibilities Curve.

The law of increasing Costs

In table 1 you may note that as the number of steel increases by one at each possibility, the number of coffee decreases by an increasing amount. we can compute the opportunity cost by following the given formula:

Opportunity cost = quantity2 - quantity1

Wherein:

Quantity 1 is the original product produced

Quantity 2 is the new product produced

Table 2

Possibility	STEEL	Opportunity cost	COFFEE	Opportunity cost
A	16		0
B	15	1	1	1
C	13	2	2	1
D	10	3	3	1
E	6	4	4	1
F	0	6	5	1

A greater sacrifice of steel is necessary each time coffee increase by one ( see table 2). The opportunity cost of the first ton of coffee is one ton of steel. The opportunity cost of increasing from one ton of coffee to two tons of steel. in other words, the resources used for producing steel and coffee cannot be traded on a one-for-one basis at all levels of output. They are not perfectly substitutable. Instead, the opportunity cost in terms of steel increased more and more each time that one ton of coffee was produced. This imperfect substitution of resources reflects the Law of Increasing Costs.

The Law of Increasing Cost states that to obtain equal additional amounts of one product, increasing amounts of another product must be sacrificed.

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