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ii) P.P.F. graph: Figure 1 illustrates the
Production Possibility curve. It is strictly based on the
information given by the schedule. The units of X have been measured
along the horizontal (x) axis and those of Y along the vertical
(y) axis. The six points ’a’ to ’f’ are then the result of mapping
out the values of varying combinations of the two goods in the schedule.
On joining these points we obtain a continuous curve which is known
as the P.P.F. curve, since each point on the P.P.F.
represents maximum producible units of X and Y with the given
quantities of resources. It is also known as a transformation
curve since the resources are transformed into varying units
of the two goods. Note that all points on the P.P.F. are efficient,
in the sense, all available resources have been utilized fully and
efficiently. Any point such as ’g’ inside the curve is inefficient
and hence not desirable (though possible). At such a point, units
of one or both the goods are produced in smaller quantities than
what is otherwise possible. Hence the resources are either utilized
inefficiently or wastefully. On the other hand, any point outside
the curve such as H is not attainable (though desirable) with the
given amount of resources. Hence the only points, both desirable
and possible, occur along the P.P.F. curve. The curve slopes downwards
and bulges outwards. Such a shape satisfies the two properties (the
Y units diminishing as the X units increase, and an increasing rate
of sacrificing Y units) manifested by the P.P.F. Schedule. Such
a curve is called strictly concave to the point of origin.
(D) Substitution and Opportunity cost: The
production possibility frontier hints at the principle of substitution.
Resources in a given scenario are always limited or scarce. With
the given quantity of resources, either 5 units of X or 20 units
of Y can be produced. But these resources can be alternatively used
either to produce X or Y or any combination of the two goods. Again
with limited resources, every additional unit of X requires sacrificing
the production of some units of Y. Therefore units of X are substituted
for those of Y. The resource thus released from the production
of Y units and utilized in the production of X is called opportunity
cost of producing X units. The principle of opportunity cost
is stated exactly in the same manner. It is the cost equivalent
to the amount of a product that would have been otherwise produced,
or the amount of resources which could have been otherwise used
in the next best productive activity. The opportunity cost
is the real cost of production and is a theoretical concept. It
differs from the market or money cost of production.
The underlying principle of substitution was introduced
and made widely applicable by Alfred Marshall in a variety
of economic activities. In the present example it applies to goods
produced with limited resources. But it can be generalized in various
ways. Though resources are scarce, each unit of a resource is capable
of being alternatively used. When it is used in some productive
activity, some other activity for which this resource unit could
have been used will have to be forgone. That is the opportunity
cost or the cost of the highest valued alternative of that
particular choice. For example, a small piece of land is capable
of serving the following three purposes. Also given the respective
revenue that each purpose would yield.
i) Cultivation of wheat - $80
ii) Cultivation of cotton - $120
iii) Construction purposes - $150
When a piece of land is actually used for the (B)
purpose, though it can yield $120 its opportunity cost is $80, since
it is the next best alternative forgone. Similarly when it is used
for the purpose (C), though its actual yield is $150 its opportunity
cost is $120. The difference, if any, between actual yield and opportunity
cost is called economic rent. Thus when land is used for
(B) or (C) purposes, the amount of economic rent is $40 (120-80)
and $30 (150-120) respectively. If the land is used in the (A) capacity
then both - the amount of yield and opportunity cost are identical
and there is no economic rent.
(E) Errors or Pitfalls: In modern times,
economics is no doubt being developed on a positive scientific basis.
But unlike other physical sciences, economics suffers from a certain
weakness. It is after all a science based on human behavior which
is not predictable. This makes economic analysis less accurate.
There are a variety of other empirical and technical
reasons that contribute to its inaccuracy. Most of the economic
theories are tailor-made to suit competitive market conditions.
But the markets in reality are likely to consist of imperfections.
The knowledge of the economic agents, the mobility of resources,
the availability of information, future uncertainties, changes in
tastes and technical conditions are some of the causes of imperfection
in the market system. A technical error arises out of the statistical
and theoretical tools employed. In algebraic and geometric methods
the degree of precision depends on the degree of correlation
between the two variables: the stronger the correlation, the
greater the predictive value of any change. But sometimes, the correlation
coefficient may lead one to false predictions. In that case, it
is called a spurious correlation. Economic realities are
sometimes not amenable enough to be able to fit into the technical
requirements of mathematical or statistical precision.
Two specific pitfalls that one can encounter in
economic analysis are fallacy of composition and false-cause
fallacy. The first one refers to the assumption that if one
company will gain from a particular policy, other related companies
will gain as well. However, this may not always be the case. The
second one refers to a condition when two events are positively
correlated or appear simultaneously. In such a case, they may be
assumed to have a causal relation as well. However, this is again
a false assumption: one needs to look at other related components
as well.
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