Factors shifting the production possibilities curve

As its name suggests, the production possibilities curve provides a summary of the production options open to any company. At any given moment, the PPC confronts society with a trade-off. The only way to produce and consume more nuts is to produce and consume less coffee. In the long term, however, it is often possible to increase the production of all goods.

This is what is meant by economic growth. As Figure 1 shows, economic growth is an outward shift in the production possibilities curve.

It can result from an increase in the quantity of productive resources available, or from improvements in knowledge or technology that make existing resources more productive.

FIGURE 1 Economic growth: a shift away from the PPC.
Increases in productive resources (such as labour and capital goods) or improvements in knowledge and technology lead to an outward shift in the PPC. These are the main drivers of economic growth.

Factors shifting the production possibilities curve

What increases the quantity of productive resources in an economy?

One factor is investment in new plants and equipment. When workers have more and better equipment at their disposal, their productivity increases, often dramatically.

This is certainly an important factor in explaining the differences in living standards between rich and poor countries. According to one study, for example, the value of capital investment per worker in the United States is around 30,000 dollars, while in Nepal the corresponding figure is less than 1,000 dollars.

Such large differences in capital per worker do not all occur at the same time. They are the consequence of decades, even centuries, of differences in savings and investment rates.

Over time, even small differences in investment rates can translate into extremely large differences in the amount of capital goods available to each worker.

Differences of this kind are often self-reinforcing: not only do higher savings and investment rates lead to higher incomes, but the resulting higher income levels also make it easier to allocate additional resources to savings and investment.

Over time, therefore, even small initial productivity advantages arising from specialisation can translate into very large income differentials.

Population growth also leads to an outward shift in an economy’s PPC curve and is therefore often listed as one of the sources of economic growth.

But because population growth also generates more mouths to feed, it cannot in itself raise a country’s standard of living. Indeed, it can even lead to a lower standard of living if existing population densities have already begun to exert pressure on available land, water and other scarce resources.

Perhaps the most important source of economic growth is improved knowledge and technology. As economists have long recognised, such improvements often lead to higher output through increased specialisation. Technological improvements often occur spontaneously, but more often than not they are the direct or indirect result of increased education.

The real gains from specialisation are often much more spectacular than those from the example. One reason is that specialisation not only capitalises on pre-existing differences in individual skills, but also deepens those skills through practice and experience.

In addition, it eliminates many of the changeover and start-up costs incurred by individuals as they move back and forth between numerous tasks. These gains apply not only to people, but also to the tools and equipment they use.

Breaking down a task into simple steps, each of which can be carried out by a different machine, greatly multiplies the productivity of individual workers.

Even in simple contexts, these factors can combine to multiply productivity by hundreds or even thousands. Adam Smith, the Scottish philosopher remembered today as the founder of modern economics, was the first to recognise the enormity of the gains made possible by the division and specialisation of labour.

Consider, for example, his description of work in an eighteenth-century Scottish pin factory:

One man pulls the thread, another straightens it, a third cuts it, a fourth pricks it, a fifth grinds it at the top to receive the head; making the head requires two or three separate operations … I saw a small factory of this kind where only ten men were employed … [who] could, when they practised, make between them about twelve pounds of pins a day. There are more than four thousand medium-sized pins in a pound.

These ten people could therefore make between them more than forty-eight thousand pins a day. Therefore, each person, making one tenth of forty-eight thousand pins, could be considered to be making four thousand eight hundred pins a day.

But if they had all worked separately and independently, and without any of them having been instructed in that particular trade, they would certainly not each have been able to make twenty, perhaps not one pin a day.

The productivity gains resulting from specialisation are often prodigious. They are the most important explanation for why societies that do not rely heavily on specialisation and trade quickly become relics.

Why have some countries been slow to specialise?

You may be asking yourself: “If specialisation is such a good thing, why don’t people in poor countries like Nepal specialise? If so, you’re in good company.

Adam Smith spent many years trying to answer precisely the same question. In the end, his explanation was that population density is an important precondition for specialisation. Smith, ever the economic naturalist, observed that work tended to be much more specialised in the great cities of England in the eighteenth century than in the rural uplands of Scotland :

‘In the solitary houses and very small villages which are scattered over a country as desolate as the Highlands of Scotland, every farmer must be butcher, baker, and brewer for his own family……’ A country carpenter… is not only a carpenter, but also a joiner, a cabinetmaker and even a woodcarver, as well as a wheelwright, a cartwright and a cartwright.

In contrast, each of these same tasks was carried out by a different specialist in the major English and Scottish towns of Smith’s day. Scottish highlanders would also have specialised if they had had the chance, but the markets in which they participated were simply too small and fragmented.

Of course, high population density alone does not guarantee that specialisation will result in rapid economic growth. But especially before the advent of modern shipping and electronic communications technology, low population density was a definite barrier to gains from specialisation.

Nepal remains one of the most remote and isolated countries on the planet. As recently as the mid-1960s, its average population density was less than 30 people per square mile (compared, for example, with more than 1,000 people per square mile in New Jersey). Specialisation was still limited by Nepal’s rugged terrain.

Exchanging goods and services with people from other villages was difficult, as the nearest village could in most cases only be reached after trekking for hours or even days on treacherous Himalayan trails. More than any other factor, this extreme isolation explains Nepal’s long-standing failure to benefit from widespread specialisation.

Population density is by no means the only important factor influencing the degree of specialisation. Specialisation can be severely hampered, for example, by laws and customs that restrict the freedom of individuals to transact freely with each other.

The Communist governments of North Korea and the former East Germany severely restricted trade, which explains why these countries achieved much lower levels of specialisation than South Korea and the former West Germany, whose governments were much more favourable to trade.

Is it possible to have too much specialisation?

Of course, just because specialisation increases productivity doesn’t mean that more specialisation is always better than less, because specialisation also entails costs.

For example, most people seem to enjoy variety in the work they do, but variety tends to be one of the first casualties as workplace tasks become more and more narrowly specialised.

Can specialisation go too far?

Indeed, one of Karl Marx’s central themes was that the fragmentation of tasks in the workplace often imposes a heavy psychological toll on workers. He wrote

All means for the development of production . . mutilate the worker into a fragment of man, degrade him to the level of an appendage of a machine, destroy every vestige of charm in his work and turn it into hated toil.

Charlie Chaplin’s 1936 film Modern Times paints a vivid picture of the psychological costs of repetitive factory work. As an assembler, Chaplin’s only task, day after day, is to tighten the nuts on two bolts that pass in front of him on the assembly line. Finally, he slams and staggers out of the factory, keys in hand, tightening every nut-shaped protrusion he comes across.

Are the additional goods made possible by specialisation simply too expensive? We must certainly acknowledge at least the possibility that specialisation has gone too far. Yet specialisation does not necessarily imply rigidly segmented and repetitive work.

And it is important to recognise that not specialising also entails costs. Those who don’t specialise have to accept low wages or work extremely long hours.

Ultimately, we can expect to meet life’s financial obligations as quickly as possible – freeing up more time to do everything we want – if we focus at least a significant proportion of our efforts on tasks where we have a comparative advantage.

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