What causes production inefficiency? China’s inefficiency problem.

Inefficient production is a production where all the resources are not used efficiently. So let’s say we’re looking at an economy that can produce two goods it can produce food and it can produce steel. If it’s strictly focused on producing food, it would produce a hundred million tons of food whereas if it’s strictly focused on producing steel, it would have 50 million tons of steel and we know that all the different points that are along this production possibilities frontier are efficient in production or that we’ve achieved production efficiency which means that we couldn’t produce an additional unit of one good without decreasing production of the other good.

So for example let’s say that we were at this point which is 90 million tons of food and then that meant 40 million tons of steel. At this point, we got 90 million and 40 million. So what for us to go to 91 million tonnes of food we would have to give up some steel. We couldn’t reach this point (x), we can’t reach it as it’s not feasible.

But you might be wondering what about all the points in the interior. All these points outside the PPF we know are not feasible, they’re not feasible it means we can’t reach them with the current level of resources that we have. What about all the points on the interior? Aren’t these feasible? The answer is yes they are feasible. We could reach any of these points but we don’t want to do that. We want to be on this PPF line because that’s efficient in production.

You might be thinking okay well why do we even care? Well, let’s take this point which corresponds to the 40 million tons of steel and then it corresponds to let’s say 60 million tons of food. You’d say well what’s wrong with this point (60m, 40m)? Well, the point we could reach without giving up any steal is (90m, 40m) because this is ninety million tons of food in 40 million tons of steel so why would we take 60 million tons of food and 40 million tons of steel? Without giving up any steel we could get an additional 30 million tons of food. So obviously this point along the curve (90m, 40m) is better, that’s why all these points along this curve are efficient in production.

Why inefficient production happens?

So you might be wondering then why would we ever end up at this point? How will we ever end up on the interior of the PPF? Because it’s certainly possible and there’s a couple of reasons that an economy could end up with inefficient production and one of the reasons is that resources are being misallocated. All these points in the PPF we’re reaching with the resources that we have in the economy. We’re talking about resources our people their machines and so forth. They’re all the things that we use to produce steel and food. So we have some level of resources and we’re bounded by this PPF curve of how much food and steel we can produce given the current level of resources, if resources are being misallocated somehow if they’re not being used wisely then that means that we could actually not be producing at a point that’s efficient in production. We’ll be at one of these points on the interior which is inefficient.

I want to give you an example of inefficient production and this misallocation you might be wondering. So China in the late 1960s embarked on a program called the Great Leap Forward. One of the things with the Great Leap Forward was that the government wanted to increase production of steel and they set quotas and so a lot of people who were farmers and stuff they had quotas that they needed to meet of the amount of Steel that they could produce.

They needed to get steel and so what they would do in some cases is actually melting down farm equipment so that they could get scrap metal. That then they would melt and say hey we’ve got some steel here. So we got the ability to make steel, basically pig iron. You can look that up if you’re curious about it. They were making pig iron from melting farm equipment, which is a lot of cases the pig iron wasn’t even usable. It was not usable there were problems with the pig iron and so forth and so you could think about this as a misallocation of resources. Because millions of people ended up starving because there wasn’t enough food.
So you can think of it as we’re at a point like (60m, 40m) where it’s inefficient. If they instead of melting down the farm equipment they had instead used it to produce more food maybe they would have been able to have 90 million tons of food instead of 60 million as our example. I don’t know how accurate these numbers are I just picked them out of a hat.
So the idea is that we’re not using the resources in the right way. Each resource we want to use in the best way possible. If we have a bunch of farm equipment the farm equipment is best suited to be producing food, it’s not really well suited for us to melt it down, make pig iron. So that we can try and increase our steel production. That’s a misallocation of resources and it can lead to where we’re actually at an inefficient point of production.
Another thing would be if resources are simply being wasted. When we think about resources being wasted, we come back to what our resources? Well, we’ve got people we’ve got machines we’ve got buildings.

Let’s say, for example, in the United States you have a lot of vacant buildings particularly in urban areas and also metropolitan areas you will have a lot of vacant buildings or vacant lands. Land that’s not being used for agricultural purposes. There’s no food being grown there it’s not being used for commercial purposes they’re just building sitting there due to deindustrialization and so these are resources they’re being wasted.
You could even think of people being wasted, right? If there’s really high unemployment there’s a lot of people who could be doing something but for whatever reason, the economy is not using that, so you end up at some point inside the PPF. Where theoretically based on the resource that you have you actually could get to a point on that PPF without any Opportunity Cost you could actually get more food or vice versa. Because resources are being wasted or they’re not being put to their best use in terms of the misc allocation you can end up with one of the inefficient levels of production.