Production Possibilities Curve/Frontier Model

Bik

es

Computers

14

12

10

8

6

4

2

0

0 2 4 6 8 10

A

B

C

D

E

G

Inefficient

Unattainable (given current resources)

Efficient

A B C D E F

14 12 9 5 0 0

0 2 4 6 8 10

Bikes

Computers

F

Each point

represents a specific

combination of goods that

can be

produced given full

employment of resources.

Production Possibilities Table

PRODUCTION POSSIBILITIES CURVE/FRONTIERA production possibilities curve (PPC) is a model that graphically demonstrates efficiency, opportunity costs, and economic growth.

Key Assumptions

•Only two goods can be produced

•Full employment of resources

•In the short-run, resources and technology are fixed

3

TWO TYPES OF EFFICIENCY

Productive Efficiency

•Full employment of resources, no missed opportunities

•This is any point ON the PPC

Allocative Efficiency

•The products being produced are the ones most desired by society

•This optimal point on the PPC depends on what consumers want

Bik

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Computers

14

12

10

8

6

4

2

0

0 2 4 6 8 10

A

B

C

D

F

E

G

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Productively efficient combinations are A through D

Allocative efficient combinations depend on the

wants of society

What if this represents a country with no electricity?

WHICH POINTS ARE PRODUCTIVELY EFFICIENT?WHICH ARE ALLOCATIVELY EFFICIENT?

Size 20

running shoes

Size 10 running shoes

A Yes and no. It is productively efficient

but mostly likely not the combination

society would need.

IS COMBINATION “A” EFFICIENT?

2 Bikes

2.The opportunity cost of moving from b to d is…

4.The opportunity cost of moving from f to c is…

3.The opportunity cost of moving from d to b is…

7 Bikes

4 Computers

0 Computers

5.What can you say about point G?

Unattainable

1. The opportunity cost of moving from a to b is…

Opportunity CostThe slope of the PPC is equal to the opportunity cost.

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PIZZA 0 1 2 3 4

CALZONES 4 3 2 1 0

• List the opportunity cost of moving from a-b, b-c, c-d, and d-e.

• Constant Opportunity Costs- resources are easily adaptable for producing either

good.• Result is a straight line PPC (not common)

A B C D E

8

Constant Opportunity Cost

Blue Jeans 20 19 16 10 0

Fire Engines 0 1 2 3 4

• List the opportunity cost of moving from a-b, b-c, c-d, and d-e.

• Increasing Opportunity Costs- as more of one good is produced, it's opportunity cost rises because well-suited inputs are used up and less adaptable input must be used instead.

• Result is a bowed out (concave to the origin) PPC

A B C D E

Constant vs. Increasing Opportunity Cost

Corn

Wheat

Cactus

Pineapples

Identify which good will have a straight line PPC

and which will be bowed out?

PER UNIT OPPORTUNITY COST

1 Bike

2.The PER UNIT opportunity cost of moving from b to c is…

4.The PER UNIT opportunity cost of moving from d to e is…

3.The PER UNIT opportunity cost of moving from c to d is…

1.5 (3/2) Bikes

2 Bikes

2.5 (5/2) Bikes

= Opportunity Cost

Units Gained

1. The PER UNIT opportunity cost of moving from a to b is…

How much each marginal unit costs

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PPC AND ECONOMIC GROWTH Economic growth is when an

economy can produce more of both goods (the PPC shifts

outward).

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13

Key Assumptions Revisited

•Only two goods can be produced

•Full employment of resources

BUT in the long-run, resources and technology change.

How can a country move beyond their current PPC and achieve

economic growth?

3 Shifters of the PPC1. Change in resource quantity or quality

2. Change in technology

3. Change in trade

Ro

bo

ts

Pizzas14

What happens if there is an

increase in the labor force?

Ro

bo

ts

Pizzas

An increase in the labor

force will shift the PPC outward.

Ro

bo

ts

Pizzas

What if there is a technology

improvement in pizza ovens?

Ro

bo

ts

Pizzas

A technology improvement in

pizza ovens will only increase the production of pizzas.

Panama Mexico capital goods > consumer goods

Consumer goods

Cap

ital

Go

od

s

Current

PPC

Future

PPC

Consumer goodsC

ap

ital

Go

od

s

Future

PPC

Current

PPC

18

Countries that produce more capital goods will have

more growth in the future.

CONSUMER GOODS- CREATED FOR DIRECT CONSUMPTION

CAPITAL GOODS- GOODS THAT ARE USED TO PRODUCE OTHER GOODS

PPC Practice

Pizza and Robots

1. New robot making technology

2. Decrease in the demand for pizza

3. Mad cow disease kills 85% of cows

Consumer goods and Capital Goods

4. BP Oil Spill

5. Faster computer hardware

6. The unemployment rate is 10%

7. Post-secondary education rates rise

WHAT HAPPENS TO THE PPC WHEN THE FOLLOWING EVENTS OCCUR?

New robot making technology

Ro

bo

ts

Pizzas

An outward shift only

for robots.

Decrease in the demand for pizza

Ro

bo

ts

Pizzas

The curve doesn’t shift!

A change in demand

will only change the

combination of goods

produced.

Mad cow disease kills 85% of cows

Ro

bo

ts

Pizzas

An inward shift only for

pizzas.

BP Oil Spill

Ca

pit

al G

oo

ds

Consumer Goods

A decrease in resources

will decrease production

possibilities for both

goods.

Faster computer hardware

Ca

pit

al G

oo

ds

Consumer Goods

The quality of a resource

improves allowing the

nation to produce more

of both goods.

The unemployment rate is 10%

Ca

pit

al G

oo

ds

Consumer Goods

The curve doesn’t shift!

Less than full

employment of the labor

force is a point in the

inside of the PPC.

Post-secondary education rates rise

Ca

pit

al G

oo

ds

Consumer Goods

The quality of labor improved

resulting in an outward shift.

Absolute advantage: the ability of an individual/firm/nation to produce a good/service more efficiently than others.

Comparative advantage: the ability of an individual/firm/nation to produce a good/service at a lower opportunity cost.

PPC: ECONOMIC GROWTH AND TRADE

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� The "output method" provides data on the amount of output that can be

produced with a given amount of an input.

� To find the opportunity cost of producing corn, the Q of sunscreen

goes over the Q of corn.

Output Questions:

OOO=

Output: Other goes Over

DETERMINING COMPARATIVE ADVANTAGE OUTPUT METHOD

If Mexico produces corn, the

opportunity cost is

150 = 1

300 2

For every bushel of corn Mexico produces, it gives up

the production of 0.5 gallon

of sunscreen.

30

Both/Neither

Canada

Japan

Canada

Output Questions:

OOO=

Output: Other goes Over

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� The "input method" provides data on the amount of resources needed to

produce one unit of output.� To find the opportunity cost of

producing a TV, the amount of resources it takes to produce a computer goes

under the amount of resources that it takes to produce a TV.

DETERMINING COMPARATIVE ADVANTAGE (INPUT METHOD)

Input Questions:

IOU=

Input: Other goes Under

1 TV 1 Computer

Redland 18 hours 6 hours

Blueland 16 hours 4 hours

If Redland produces a TV,

the opportunity cost is

18 = 3

6

For every TV Redland produces, it gives up the

production of 3 computers.

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Both/Neither

U.S. – only took 2 hours to produce a bushel of corn

France

U.S.

Input Questions:

IOU=

Input: Other goes Under

Input or Output Question?Number caught per day

Deer Antelope

Henry 4 6

John 24 12

Months to produce one

Car Plane

Canada 8 10

Japan 15 12

Acres to produce 100 bushels

Corn Rice

Henry 9 3

John 8 2

OOO

IOU

IOU

Number caught per day

Deer Antelope

Henry 4 6

John 24 12

Months to produce one

Car Plane

Canada 8 10

Japan 15 12

Acres to produce 100 bushels

Corn Rice

Henry 9 3

John 8 2

OOO

IOU

IOU

Absolute Advantage?

Comparative Advantage?Number caught per day

Deer Antelope

Henry 4 6

John 24 12

Months to produce one

Car Plane

Canada 8 10

Japan 15 12

Acres to produce 100 bushels

Corn Rice

Henry 9 3

John 8 2

OOO

IOU

IOU

Comparative Advantage?Number caught per day

Deer Antelope

Henry 4 (1D=3/2A) 6 (1A =2/3D)

John 24 (1D=1/2A) 12(1A=2D)

Months to produce one

Car Plane

Canada 8 10

Japan 15 12

Acres to produce 100 bushels

Corn Rice

Henry 9 3

John 8 2

OOO

IOU

IOU

Comparative Advantage?Number caught per day

Deer Antelope

Henry 4 (1D=3/2A) 6

John 24 (1D=1/2A) 12

Months to produce one

Car Plane

Canada 8 (1C=4/5P) 10 (1P=5/4C)

Japan 15(1C=5/4P) 12 (P=4/5C)

Acres to produce 100 bushels

Corn Rice

Henry 9 3

John 8 2

IOU

Comparative Advantage?Number caught per day

Deer Antelope

Henry 4 (1D=3/2A) 6

John 24 (1D=1/2A) 12

Months to produce one

Car Plane

Canada 8 (1C=4/5P) 10

Japan 15(1C=5/4P) 12

Acres to produce 100 bushels

Corn Rice

Henry 9 (1C=3R) 3 (1R = 1/3C)

John 8 (1C=4R) 2 (1R = 1/4C)

IOU

•First- Identify if it is a output or input question •Second-Identify who has the ABSOLUTE ADVANTAGE

•Third-Identify who has a COMPARATIVE ADVANTAGE

1. Sara gives 2 haircuts or 1 perm per hour. Megan gives 3 haircuts or 2 perms per hour.

2. Justin fixes 4 flats or 8 brakes per day. Tim fixes 1 flats or 5 brakes per day.

3. Hannah takes 30 minutes to wash dishes and 1 hour to vacuum the house. Kevin takes 15 minutes to wash dishes and 45 minutes to vacuum.

4. Americans produce 50 computers or 50 TVs per hour. Chinese produce 30 computers or 40 TVs per hour.

COMPARATIVE ADVANTAGE PRACTICE

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1.Output.

Absolute: Megan in both.

Comparative: Sarah in haircuts and Megan in perms.

2.Output

Absolute: Justin in flats. Tim and Justin share in breaks.

Comparative: Justin in flats and Tim in breaks.

3.Input

Absolute: Kevin in both.

Comparative: Kevin in dishes. Hannah in vacuuming.

4.Output.

Absolute: Americans in both.

Comparative: Americans in computers and Chinese in T.V.s

ANSWERS

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THEORY OF COMPARATIVE ADVANTAGEA nation should specialize in the production of a good for which it has a lower opportunity cost and trade to obtain those goods for which its opportunity cost is higher.

Which country will produce pineapples? Radios?

Kenya

India

Pineapples Radios

30

40

10

40

(1P = 1/3R)

(1P = 1R)

(1R = 3P)

(1R = 1P)

1. Which nation has an absolute advantage in producing corn?

2. Which nation has an absolute advantage in producing sunscreen?

3. Which nation has a comparative advantage in producing corn?

4. Which nation has a comparative advantage in producing sunscreen?

5. Should Mexico specialize in corn or sunscreen?

6. Should France specialize in corn or sunscreen?

PRACTICE = 1/2 = 2

= 3/4 = 4/3

Country A Country B

Wheat 200 (1 = ½) 100 (1 = 1.5)

Textiles 100 (1 = 2) 150 (1 = 2/3)

TERMS OF TRADE

= 1/2 = 2

= 3/4 = 4/3

150

300

200

Mexico will produce

corn and import sunscreen from

France. France will

produce sunscreen and import corn from

Mexico

Select the good/service with the easier numbers. For this example, the opportunity cost of producing sunscreen

has one fraction while the opportunity cost of corn has two fractions, making sunscreen the easier good to use

when determining the terms of trade.

Using the sunscreen column, we can see that

• France will import corn and will not be willing to accept less than 1.33 bushels of corn since 1 sunscreen = 1.33

corn.

• Mexico produces corn and will not be willing to give up more than 2 bushels of corn since 1 sunscreen = 2 corn.• Therefore the exchange for corn must be between 1.333 and 2 bushels of corn to benefit both countries.

• An acceptable terms of trade would be 1 sunscreen for 1.5 bushels of corn.

- rate of exchange of one product for another when two countries trade.

The differences in opportunity costs define the limits of a trade in which both parties will benefit. The acceptable terms of trade must lie in the range of opportunity costs.

= 1/2 = 2

= 3/4 = 4/3

150

300

200

Would an exchange of 1 sunscreen for 1.5 corn benefit both countries?If Mexico were to exchange all its corn for sunscreen, it would have 200 gallons of

sunscreen (300/1.5). If France were to exchange all of its sunscreen for corn, it would have 225 bushels of corn (150 x 1.5). This terms of trade benefit both countries and increase

both their PPCs.

Mexico will produce corn and import sunscreen from France.

France will produce sunscreen and import corn from Mexico

Su

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ns)

Su

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(to

ns)

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5 10 15 20 25 30 5 10 15 20Wheat (tons) Wheat (tons)

USA

Brazil

Wheat Sugar

30 30

10 20

(1W costs 1S) (1S costs 1W)

(1W costs 2S) (1S costs 1/2W)

1. Which country should EXPORT Sugar?

2. Which country should EXPORT Wheat?

3. Which country should IMPORT Wheat?

4. What should the terms of trade be?

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Su

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(to

ns)

Su

gar

(to

ns)

45

40

35

30

25

20

15

10

5

0

30

25

20

15

10

5

0

5 10 15 20 25 30 5 10 15 20

AFTER TRADE

AFTER TRADE

Wheat (tons) Wheat (tons)

International Trade

47

USA Brazil

TRADE SHIFTS

THE PPC!

Trade: 1 Wheat for 1.5 Sugar

TERMS OF TRADE PRACTICE Suppose that in a year an American worker can produce 20 computers or 100 shirts, while a Chinese worker can produce 10 computers or 100 shirts.

1. Graph the PPC for the two countries.

2. Suppose that without trade the workers in each country spend half of their time producing each good. How much would they produce of each good? Show this on your graph.

3. Give a terms of trade that would be acceptable to both countries.

Shirts Computers

American 100 (1S = 1/5 C) 20 (1c = 5S)

Chinese 100 (1S = 1/10C) 10 (1C = 10S)

Terms of Trade = 1C: 6-9s

1C = 6S Shirts Computers

American 100 120 20

Chinese 100 10 16.6

1C = 9S Shirts Computers

American 100 180 20

Chinese 100 10 11.1

TERMS OF TRADE PRACTICE A average worker in Brazil can produce an ounce of soybeans in 20 minutes and an ounce of coffee in 60 minutes, while an average worker in Peru can produce an ounce of soybeans in 50 minutes and an ounce of coffee in 75 minutes.

1. Who has absolute advantage?

2. Who has comparative advantage in coffee?

3. If the two countries specialize and trade with each other, who will import coffee?

4. Assume that the two countries trade and that the country importing coffee trades 2 ounces of soybeans for 1 ounce of coffee. Explain why both countries will benefit from this trade.

1. Brazil has absolute advantage in both soybeans and coffee.

2. Peru has comparative advantage in coffee.

3. Brazil will produce soybeans and import coffee.

4.

soybeans coffee

Brazil 20 mins (1S = 1/3C) 60 mins (1C =3S)

Peru 50 mins (1S = 2/3C 75 mins (1C = 1.5S)

2S = 1C soybeans coffee

Brazil 3 1 1.5

Peru 1.5 2 1