Confronting Scarcity: Choices In Production

Read this chapter to learn about the factors of production and the way they are combined in production. Use the production possibilities curve to represent the alternative combinations of goods and services that an economy can produce. Make sure to understand how the curve represents efficient, inefficient, and unattainable levels of production. Pay attention to how economic growth can be represented by shifts in the curve. Also in this chapter, learn about how economic systems compare.

3. Applications of the Production Possibilities Model

Economic Growth

An increase in the physical quantity or in the quality of factors of production available to an economy or a technological gain will allow the economy to produce more goods and services; it will shift the economy's production possibilities curve outward. The process through which an economy achieves an outward shift in its production possibilities curve is called economic growth. An outward shift in a production possibilities curve is illustrated in Figure 2.10 "Economic Growth and the Production Possibilities Curve". In Panel (a), a point such as N is not attainable; it lies outside the production possibilities curve. Growth shifts the curve outward, as in Panel (b), making previously unattainable levels of production possible.

Figure 2.10 Economic Growth and the Production Possibilities Curve

An economy capable of producing two goods, A and B, is initially operating at point M on production possibilities curve OMR in Panel (a). Given this production possibilities curve, the economy could not produce a combination such as shown by point N, which lies outside the curve. An increase in the factors of production available to the economy would shift the curve outward to SNT, allowing the choice of a point such as N, at which more of both goods will be produced.

The Sources of Economic Growth

Economic growth implies an outward shift in an economy's production possibilities curve. Recall that when we draw such a curve, we assume that the quantity and quality of the economy's factors of production and its technology are unchanged. Changing these will shift the curve. Anything that increases the quantity or quality of the factors of production available to the economy or that improves the technology available to the economy contributes to economic growth.

Consider, for example, the dramatic gains in human capital that have occurred in the United States since the beginning of the past century. In 1900, about 3.5% of U.S. workers had completed a high school education. By 2009, that percentage rose almost to 92. Fewer than 1% of the workers in 1900 had graduated from college; as late as 1940 only 3.5% had graduated from college. By 2009, over 32% had graduated from college. In addition to being better educated, today's workers have received more and better training on the job. They bring far more economically useful knowledge and skills to their work than did workers a century ago.

Moreover, the technological changes that have occurred within the past 100 years have greatly reduced the time and effort required to produce most goods and services. Automated production has become commonplace. Innovations in transportation (automobiles, trucks, and airplanes) have made the movement of goods and people cheaper and faster. A dizzying array of new materials is available for manufacturing. And the development of modern information technology - including computers, software, and communications equipment - that seemed to proceed at breathtaking pace especially during the final years of the last century and continuing to the present has transformed the way we live and work.

Look again at the technological changes of the last few years described in the Case in Point on advances in technology. Those examples of technological progress through applications of computer technology - from new ways of mapping oil deposits to new methods of milking cows - helped propel the United States and other economies to dramatic gains in the ability to produce goods and services. They have helped shift the countries' production possibilities curve outward. They have helped fuel economic growth.

Table 2.1 "Sources of U.S. Economic Growth, 1960–2007" summarizes the factors that have contributed to U.S. economic growth since 1960. When looking at the period of 1960–2007 as a whole we see that about 65% of economic growth stems from increases in quantities of capital and labor and about 35% from increases in qualities of the factors of production and improvements in technology or innovation. Looking at the three shorter subperiods (1960–1995, 1995-2000, and 2000-2007), we see that the share attributed to quantity increases declined (from 68% to 56% and then 50%), while the share attributed to improvement in the qualities of the factors of production and to technological improvement grew (from 32% to 44% and then to 50%).

Table 2.1 Sources of U.S. Economic Growth, 1960–2007

Period Percentage Contribution to Growth Period Growth Rate
Years 1960–2007   3.45%
Increase in quantity of labor 0.74%  
Increase in quantity of capital 1.48%  
Increase in quality of labor 0.23%  
Increase in quality of capital 0.58%  
Improved technology 0.41%  
Years 1960–1995   3.42%
Increase in quantity of labor 0.80%  
Increase in quantity of capital 1.55%  
Increase in quality of labor 0.24%  
Increase in quality of capital 0.56%  
Improved technology 0.28%  
Years 1995–2000   4.52%
Increase in quantity of labor 1.09%  
Increase in quantity of capital 1.43%  
Increase in quality of labor 0.20%  
Increase in quality of capital 0.89%  
Improved technology 0.90%  
Years 2000–2007   2.78%
Increase in quantity of labor 0.17%  
Increase in quantity of capital 1.21%  
Increase in quality of labor 0.22%  
Increase in quality of capital 0.46%  
Improved technology 0.72%  

Total output for the period shown increased nearly fivefold. The chart shows the percentage of growth accounted for by increases in the quantity of labor and of capital and by increases in the quality of labor and of capital and improvements in technology.

Another way of looking at these data is to note that while the contribution of improved technology has increased over time (from 8% for the 1960–1995 period, to 20% for the 1995–2000 period, and 26% for the 2000–2007 period), most growth comes from more and better-quality factors of production. The study by economists Dale Jorgenson, Mun Ho, and Jon Samuels, on which the data shown in Table 2.1 "Sources of U.S. Economic Growth, 1960–2007" are derived, concludes that "the great preponderance of economic growth in the U.S. involves the replication of existing technologies through investment in equipment and software and expansion of the labour force. Replication generates economic growth with no increase in productivity. Productivity growth is the key economic indicator of innovation…Although innovation contributes only a modest portion of growth, this is vital to long-term gains in the American standard of living".

Waiting for Growth

One key to growth is, in effect, the willingness to wait, to postpone current consumption in order to enhance future productive capability. When Stone Age people fashioned the first tools, they were spending time building capital rather than engaging in consumption. They delayed current consumption to enhance their future consumption; the tools they made would make them more productive in the future.

Resources society could have used to produce consumer goods are being used to produce new capital goods and new knowledge for production instead - all to enhance future production. An even more important source of growth in many nations has been increased human capital. Increases in human capital often require the postponement of consumption. If you are a college student, you are engaged in precisely this effort. You are devoting time to study that could have been spent working, earning income, and thus engaging in a higher level of consumption. If you are like most students, you are making this choice to postpone consumption because you expect it will allow you to earn more income, and thus enjoy greater consumption, in the future.

Think of an economy as being able to produce two goods, capital and consumer goods (those destined for immediate use by consumers). By focusing on the production of consumer goods, the people in the economy will be able to enjoy a higher standard of living today. If they reduce their consumption - and their standard of living - today to enhance their ability to produce goods and services in the future, they will be able to shift their production possibilities curve outward. That may allow them to produce even more consumer goods. A decision for greater growth typically involves the sacrifice of present consumption.