A decrease in investment expenditure will not lead to an inward shift in the production possibility curve.

Introduction

The production possibility curve (PPC) shows all the possible combinations of two goods that can be produced in the economy when resources are fully and efficiently employed, given the state of technology, assuming the economy can only produce the two goods. An increase in the production capacity in the economy will lead to an outward shift in the PPC resulting in a decrease in scarcity, and vice versa. When the PPC shifts outwards, some of the points which were previously unattainable will become attainable. The production capacity in the economy may increase due to an increase in the quantity or the quality of the factors of production in the economy. For example, education and training which will lead to greater human capital will increase the skills and knowledge of labour and hence the production capacity in the economy. Research and development which will lead to technological advancement will increase the efficiency of capital and hence the production capacity in the economy.

Many students think that a decrease in investment expenditure will lead to an inward shift in the production possibility curve. Mr. Edmund Quek will provide a more detailed explanation in economics tuition on this economic misconception.

Exposition

As explained above, the PPC depends on the production capacity in the economy which in turn depends on the quantity and the quality of the factors of production in the economy. Investment expenditure is the expenditure made by firms on goods produced not for their present use but for their use in the future. In economics, investment is comprised of business fixed investment (i.e. new factories and machinery), residential investment (i.e. new houses, apartments and condominiums) and inventory investment (i.e. the change in the value of unsold goods). When investment expenditure falls, firms produce less capital goods (i.e. factories and machinery). When this happens, the quantity of capital in the economy will increase at a slower rate. Therefore, the production capacity in the economy will increase at a slower rate which will lead to a less rapid outward shift in the PPC. As a decrease in investment will not lead to a decrease in the production capacity in the economy, it will not lead to an inward shift in the PPC. Rather, it will cause the PPC to shift outwards at a slower rate as firms are still producing new capital. For the same reason why a decrease in investment expenditure will not lead to an inward shift in the production possibility curve, a decrease in investment expenditure will not lead to a leftward shift in the aggregate supply curve. Capital, however, is subject to wear and tear when it is employed in the production of goods and services. Therefore, if the amount of new capital falls below the level necessary to replace the amount of worn-out capital, the PPC will shift inwards.

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