Unit 1: Resource Allocation

Production possibility: It is the potential number of goods that can be produced with the given capital. 

For example, I have $10 in total. And the price of the product is $2. With the given amount, I can buy 5 products in total with the given amount. 

Production Possibility Curve

It is the potential production capacity that an economy can run with the given resources. 

GxGy
400
3010
2020
1030
040

In the following table, the concept of constant opportunity cost can be seen. Here, the Gx and Gy represent the available resources we have to run the economy. So, when selecting the quantity for the given goods, one must give up on a certain number of goods from X and Y in order to maximize potential production quantity. 

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When representing in a graph, we get the following figure. 

Graph

The line AE represents production possibility curve, because of constant opportunity cost between Good X and Good Y. 

Efficiency Point: The point at C, Gx and Gy produces equal number of goods (20x and 20y)

Reallocation of Resources: When increasing the resources of Good X from 20 to 30, then production unit from Good Y will decrease, as the production has been switched. This is called reallocation of resources. 

Point of Inefficiency: In the diagram, the point X lies in between the production possibility curve (PPC), which means that the output produced is not at full potential. This diminishes the production capacity and efficiency of the resources i.e. here Product A and Product B. 

Production Efficiency: All the points in the straight line AE, where the resources is utilized and the potential level of output is at maximum. 

Good X and Good Y

Good XGood Y
100
91
72
43
04

Table: Production possibility (increasing opportunity cost)

In the following table, when increasing the production of Good Y, there is incremental change in Good X. This means that, with increasing the cost of producing Good Y is more than cost of producing Good X. This is also known as Increasing opportunity cost.

While presenting this example in a graph, the PPC is concave to the origin. 

Shift in Production Possibility Curve

Shift occurs when there is increased/decreased in the quantity/quality of resources. 

The cause of such shifts are mentioned below:

  1. Change in worker’s active population (retirement age).
  2. Increasing the training of the worker’s to increase the quality of output. 
  3. Uncontrollable factors (natural disasters, nation conflict)
  4. Change in working population due to immigration and emigration. 

Diagram

  • Effects of PPC in Labor productivity

Labor Productivity = Total output produced/ Number of workers

Factors affecting Labor Productivity:

  1. Climatic Condition
  2. Technological advancement
  3. Labor division
  • In an economy when industrial goods and agricultural goods are available. The productivity of industrial workers is increased however, the productivity of agricultural goods remains same. The effect of this, is shown in the figure below. 

Diagram

  • In an economy, there are two goods produced (Product X and Product Y). Product X is more labor intensive than product Y. However, working hours for labors is reduced by the law. The following diagram shows the effect of this in a nation’s PPC. 

Diagram

  • In an economy, when there is higher resource endowment, then the PPC of an economy is higher as compared to an economy with lower resources endowment. 

Diagram

  • In an economy, consumer and capital goods are produced. When the production of capital goods are increased by converting the production of consumer goods, lets see the following diagram. 

Diagram

When there is increased production of capital goods, there will be reduction of consumption.However, in the long run there will be increased production of capital and consumer good in the long run. Therefore, in the above diagram there is an outward shift in the economy. 

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