Chapter 2: Production Possibility Curve/Frontier Model

Chapter 2: Production Possibility Curve/Frontier Model

What is the Production Possibilities Frontier/Curve? A production possibilities curve (PPC) is a model that graphically demonstrates opportunity costs, efficiency, and economic growth. Key Assumptions Only two goods can be produced Full employment of resources In the short-run, resources and technology are fixed (Ceteris Paribus) 4

Production Possibilities Table A B C D E f Each point represents a specific combination of goods that can be produced given full employment of resources. Bikes Computers 14 12 9 5 0 0 0 2 4 6 8 1 Bikes 14 12 10 8 6 4 2 0 A B C Inefficient/ Unemployment D G 0 2 4 6 8 10 Impossible/Unattainable (given current resources) E Computers Efficient

The Production Possibilities Curve and Efficiency 6

Two Types of Efficiency Productive Efficiency- There are no missed opportunities; maximum output with the least waste. This is any point ON the Production Possibilities Curve Allocative Efficiency- The products being produced are the ones most desired by society. This optimal point on the PPC depends on the desires of society. 7

Which points are productively efficient? Which are allocatively efficient? 14 12 A B G Productively Efficient combinations are A through D Bikes 10 8 6 4 2 0 E F C D Allocative Efficient combinations depend on the wants of society (What if this represents a country with no electricity?) 0 2 4 6 8 10 Computers 8

Is combination A efficient? Yes and No. It is productively efficient but it is not the combination society wants Size 20 running shoes A Size 10 running shoes

Opportunity Cost The slope of the PPC is equal to the opportunity cost. 1. The opportunity cost of moving from a to b is 2 Bikes 2.The opportunity cost of moving from b to d is 7 Bikes 3.The opportunity cost of moving from d to b is 4 Computer 4.The opportunity cost of moving from f to c is 0 Computers 5.What can you say about point G? Unattainable 10

A B C D E CALZONES 4 3 2 1 0 PIZZA 0 1 2 3 4 List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e. Constant Opportunity Cost- Resources are easily adaptable for producing either good. Result is a straight line PPC (not common) 11

A B C D E PIZZA 20 19 16 10 0 ROBOTS 0 1 2 3 4 List the Opportunity Cost of moving from a-b, b-c, c-d, and d-e. Law of Increasing Opportunity Cost- As more of one good is produced, it's opportunity cost typically rises because well-suited inputs are used up and less adaptable input must be used instead. Result is a bowed out (Concave) PPC

Constant vs. Increasing Opportunity Cost Identify which product would have a straight line PPC and which would be bowed out? Corn Cactus Wheat Pineapples

PER UNIT Opportunity Cost How much each marginal unit costs Example: 1. The PER UNIT opportunity cost of moving from a to b is 1 Bike 2.The PER UNIT opportunity cost of moving from b to c is 1.5 (3/2) Bikes 3.The PER UNIT opportunity cost of moving from c to d is 2 Bikes 4.The PER UNIT opportunity cost of moving from d to e is 2.5 (5/2) Bikes = Opportunity Cost Units Gained NOTICE: Increasing Opportunity Costs 14

Absolute and Comparative Advantage 15

Absolute and Comparative Advantage Absolute Advantage The producer that can produce the most output OR requires the least amount of inputs (resources) Comparative Advantage The producer with the lowest opportunity cost. Countries should trade if they have a relatively lower opportunity cost. They should specialize in the good that is cheaper for them to produce. 16

Both Output Questions: OOO= Output: Other goes Over Canada CDs Japan Canada Beef 17

Ronald McDonald can produce 20 pizzas or 200 burgers Papa John can produce 100 pizzas or 200 burgers 1. What is Ronald s opportunity cost for one pizza in terms of burgers given up? 2. What is Ronald s opportunity cost for one burger in terms of pizza given up? 1 burger costs 1/10 pizza 3. What is Papa John s opportunity cost for one pizza in terms of burgers given up? 1 pizza costs 2 burgers 4. What is Papa John s opportunity cost for one burger in terms of pizza given up? 20/200 = 1 pizza cost 10 burgers 1 burger costs 1/2 pizza 18

Both Input Questions: IOU= Input: Other goes Under U.S. only took 2 hours to produce a bushel of corn France U.S. 20

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?

soybeans coffee Brazil 20 mins (1S = 1/3C) 60 mins (1C =3S) Peru 50 mins (1S = 2/3C 75 mins (1C = 1.5S) 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.

International Trade Why do people trade? 23

Why do people trade? 1. Assume people didn t trade. What things would you have to go without? Everything you don t produce yourself! (Clothes, car, cell phone, bananas, heath care, etc) The Point: Everyone specializes in the production of goods and services and trades it to others 2. What would life be like if cities couldn t trade with cities or states couldn t trade with states? Limiting trade would reduce people s choices and make people worse off. The Point: More access to trade means more choices and a higher standard of living. 24

Kenya India Pineapples Radios 30 10 (1P costs 1/3R) (1R costs 3P) (1P costs 1R) (1R costs 1P) 40 40 Kenya wants Radios If the terms of trade for 1 radio is greater than 3 pineapples then Kenya is worse off and should make radios on their own. India wants Pineapples If the terms of trade for 1 radio is less than 1 pineapple then India is worse off and should make pineapples on their own. FOR BOTH PARTIES TO GAIN FROM THE TRADE, THE TERMS OF TRADE MUST LIE BETWEEN THE TWO OPPORTUNITY COSTS.

Kenya India Pineapples Radios 30 10 (1P costs 1/3R) (1R costs 3 P) 40 40 (1P costs 1R) (1R costs 1P) Trading 1 radio for 2 pineapples will benefit both If Kenya produces radios by themselves, they give up 3 Pineapples for each radio. If they can trade 2 pineapples for each radio they are better off. If India produces pineapples by themselves, they give up 1 pineapple for one radio. If they can get 2 pineapples for one radio they are better off. The countries trade at a lower opportunity cost than if they made the products themselves!

Benefits of Specialization and Trade 27

Wheat Sugar USA Brazil 45 30 30 (1W costs 1S) (1S costs 1W) 10 20 (1W costs 2S) (1S costs 1/2W) Which country has a comparative advantage in wheat? Sugar (tons) 40 1. Which country should EXPORT Sugar? 35 2. Which country should EXPORT 30 Wheat? 30 3. Which country should IMPORT 25 Wheat? 4. What 25 should the terms of trade be? 20 20 15 Sugar (tons) 15 10 5 10 15 20 25 30 5 10 15 20 Wheat (tons) Wheat (tons) 28

Sugar (tons) 45 40 35 30 25 20 15 International Trade Trade: 1 Wheat for 1.5 Sugar USA Brazil TRADE SHIFTS THE PPC! AFTER TRADE Sugar (tons) 30 25 20 15 AFTER TRADE 10 5 0 10 5 0 5 10 15 20 25 30 5 10 15 20 Wheat (tons) Wheat (tons) 29

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.

soybeans coffee 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. 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