Post on 16-Dec-2015
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The Production Possibility The Production Possibility FrontierFrontier
• A model used to highlight and clarify scarcityscarcity, and issues such as
efficiencyefficiency,, tradeoffstradeoffs,,
opportunityopportunity costcost and growthgrowth, which are associated with scarcity
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PPF: EfficiencyEfficiency (Micro Focus Def’n)
• resources must be allocated to the production of goods & services that people want the most “getting the best mix”
allocative efficiencyallocative efficiency
production must be carried on in the least costly way
productive efficiencyproductive efficiency
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P.P.F. AssumptionsP.P.F. Assumptions
• All resources (land, labour, capital, other) are used
• Productive efficiency is achieved
• Given point in time– Resources are fixed in quantity but can be
shifted around– Technology doesn’t change
• Only 2 goods are produced in this economy
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Production possibilities of pizza & robots with full employment, yr. 2009
Production alternatives
TYPE OF PRODUCT A B C D E
Pizza (in hundred thousands) 0 1 2 3 4
Robots (in thousands) 10 9 7 4 0
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PPF DiagramIn
du
stri
al R
ob
ots
(10
00’s
)
Pizzas (100, 000’s)
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8
9
10A
B
C
D
E
Any point within the frontier isproductively inefficient
I
Any point on the frontier is Productively Efficient.It may or may not be Allocatively Efficient
6
PPF Highlights– The PPF is “bowed out”:
• the opportunity cost (how much of one good is sacrificed to produce one of the other good) depends on how much of each the economy is producing
• as more pizzas are produced the opportunity cost of pizzas in terms of robots
increases
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Production possibilities of pizza & robots with full employment, yr. 2006
Production alternatives
TYPE OF PRODUCT A B C D E
Pizza (in hundred thousands) 0 1 2 34
Robots (in thousands) 10 9 7 4 0
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PPF DiagramIn
dust
rial R
obot
s (1
000s
)
Pizzas (100, 000s)
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8
9
10A
B
C
D
E
The opportunity cost of increasingPizza production from 2 to 3 is3,000 robots
The opportunity cost of increasing Pizza production from 3 to 4 4,000 robots
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PPF Highlights• This is the
–Law of increasing relative cost
• not all resources are equally productive in producing all things - resources are not perfect substitutes for each other;
• that is, some resources have comparative advantage over other resources
• Therefore opportunity costs increase for each additional good produced
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PPF DiagramIn
du
stri
al R
ob
ots
(10
00’s
)
Pizzas (100, 000’s)
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8
9
10A
B
C
D
E
Any point within the frontier isproductively inefficient
I
Any point on the frontier is Productively Efficient.It may or may not be Allocatively Efficient
The more specialized the inputs,the more bowed out the frontier
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Change Assumptions– increase quantity &/or quality of
resources growth » PPF shifts to the right
– improve technology growth» PPF shifts to the right
– decrease quantity &/or quality of resources negative growth
» PPF shifts to the left– technology decrease decrease negative
growth» PPF shifts to the left
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GrowthIn
dust
rial R
obot
s (1
000s
)
Pizzas (100, 000s)
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8
9
10
Growth occurs when the Production Possibility Curve shifts to the right
Old PPF
New PPF
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Growth – Capital and Consumption Goods
Consumption Goods-good produced primarily for
consumption-bread, Xbox 360’s, TV shows-do not cause growthCapital Goods-goods that can be used to produce more
goods-factories, universities, robots
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PPF Highlights– Economic Growth results from
• 1.) technological change and
• 2.) capital accumulation (resource base)
– The opportunity cost of faster economic growth is a decrease in current consumption
NOTICE the affect of present choices on future growth.
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GrowthIn
dust
rial R
obot
s (1
000s
)
Pizzas (100, 000s)
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8
9
10
Growth depends on the choices made today, a sacrifice of current consumption results in more capital today and “growth” in the future
PPF, yr. 2009
PPF, yr. 1998
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Comparative Advantage:Specialization and Trade
• Specialization and trade, and therefore markets that facilitate trade, make society better off by increasing the productivity of scarce resources
• Comparative Advantage is the basis for the gains from specialization and trade
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Theory of Comparative Advantage:• Production Possibilities :
– Carl and Mike: retired neighbours: hobbies are making wine and beer
Carl’s ProductionPossibilities
Mike’s ProductionPossibilitiesA B C
A B C
Wine (btls) 0 30 100
Beer (btls.) 1,000 700 0
0 40 80
80 40 0
PPF’s for 1 month using same equipment and time..
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Absolute Advantage
• When a producer with of set of inputs can produce more output than another with the same inputs, the first producer has an absolute advantage in production of the output.
• Carl has an absolute advantage in the production of both wine and beer.
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Carl’s Proposition
• “Since we are both being pressured to produce more, lets each of us do what we do best and trade. This will give each of us more than we now have without either of us working any harder.”
• Notice that voluntary trade does not take place unless both parties benefit.
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Mike’s Production Possibilities/ Opportunity Costs
1000–
900–
825–
800–
700–
600–
500–
400–
300–
200–175–80–40–
Bottles of beer
A•C
In a month Mike can produce either 80 bottles of wine or 80 bottles of beer
Opp cost of 80 wine is 80 beer Opp cost of 1 wine is 1 beer
Opp cost of 80 beer is 80 wine Opp cost of 1 beer is…………
Bottles of wine
| | | | | | | | | | | 0 10 20 30 40 45 50 60 70 80 90 100
••B Consumption choice before trade
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Carl’s Production Possibilities/ Opportunity Costs
1000–
900–
800–
700–
600–
500–
400–
300–
200–
100–
0
Bottles of beer
A•
C•
Opp cost 100 wine is 1000 beer Opp Cost 1 wine is 10 beer
Opp cost of 1000 beer is 100 wine Opp Cost 1 beer is…………..
Bottles of wine
| | | | | | | | | | | 10 20 30 35 40 50 60 70 80 90 100
•B Consumption choice before trade
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Opportunity Cost Table
Opportunity cost of 1 beer
Opportunity cost of 1 wine
Carl 1/10 wine 10 beer
Mike 1 wine 1 beer
Comparative Advantage
• When producer A has a lower opportunity cost of producing good A compared to another producer, then producer A is said to have a comparative advantage in the production of good A.
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Comparative Advantage: Specialization
• Carl has a “comparative advantage” (lowest opportunity cost producer) in the production of beer and therefore specializes in beer production.
• Mike has a “comparative advantage” in the production of wine and therefore specializes in wine production
• As long as opportunity costs differ, there is comparative advantage
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Comparative Advantage: SpecializationComparative Advantage: Specialization
Theory of Comparative Theory of Comparative AdvantageAdvantage
• if specialization takes place according to comparative advantage (the lowest opportunity cost producer) and then trade takes place…. both parties can benefit: that is, move outside their current PPF’s.
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Carl & Mike Before Specialization & Trade
Carl Produces & Consumes
Mike Produces & Consumes
Total Consumption+ =
Wine (btls.)
Beer (btls.)
30
700
40
40
70
740
Carl & Mike After Specialization, but Before Trade
Mike Produces & Can Consume+ =
Wine (btls.)
Beer (btls.) 0
1,000
80
0
80
1,000
Carl Produces & Can Consume
Total Production & Consumption
Total Gains
+10
+260
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• Carl proposes, after specialization, that he trade Mike 175 beer for 35 wine.
Carl gets wine for a reduced sacrifice–35 wine for 175 beer instead of 350 beer, the opportunity cost before trade
Mike gets beer for a reduced sacrifice–175 beer for 35 wine instead of 175 wine, the opportunity cost before trade
(terms of trade: 5 beer for 1 wine)
Trade: The Benefits of Specialization
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Terms of Trade: 1 Wine for 5 Beer• Since voluntary trade requires that both
parties benefit from the trade.• Before trade:
• Carl: 1 wine “trades” for 10 beer
• Mike: 1 wine trades for 1 beer
After trade 1 wine “trades” for 5 beer
•The Terms of Trade are between the personal ones that exist before trade, thus producing gains for both parties participating in the trade
Carl is better off as he now only has to give up 5 beer for a wine
Mike is better off as he now only has to give up 1/5 wine for a beer
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Trade Between Carl & Mike
1 Wine trades for 5 Beeror
1 Beer trades for 1/5 Wine
Mike (specializes
in wine)
Carl (specializes
in beer)
175 Bottles of Beer To
Trades away
35 Bottles of Wine Trades a
wayTo
Before trade Mike gave up 1 wine to get 1 beer, after trade1/5 wineBefore trade Carl gave up 10 beer to get a wine, after trade 5 beer
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Carl & Mike After Specialization & Trade
Carl
Mike
ProducesTradesFor (+)Away (-)
ConsumesAfterTrade
Produced & ConsumedBefore Trade
GainsfromTrade
Wine (btls.) Beer (btls.)
01,000
+35-175
35825
30700
+5+125
ProducesTradesFor (+)Away (-)
ConsumesAfterTrade
Produced & ConsumedBefore Trade
GainsfromTrade
Wine (btls.)Beer (btls.)
800
-35+175
45175
4040
+5+135
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Mike’s Production Possibilities After Trade
1000–
900–
825–
800–
700–
600–
500–
400–
300–
200–175–80–40–
Bottles of beer
A•C
Bottles of wine
| | | | | | | | | | | 0 10 20 30 40 45 50 60 70 80 90 100
••
B•
D Consumption after trade
Mike produces 80 wine and then trades 35 wine for 175 leaving him with 45 wineand 175 beer, point D
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Carl’s Production Possibilities/ Opportunity Costs, After Trade
1000–
900–
825–800–
700–
600–
500–
400–
300–
200–
100–
0
Bottles of beer
A•
C•
Bottles of wine
| | | | | | | | | | | 10 20 30 35 40 50 60 70 80 90 100
•B
D• Consumption after trade
Carl produces 1000 beer and trades 175 beerto Mike for 35 wine, leaving him with 825 beerand 35 beer, point D
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Gains from Specialization• Specialization produces gains for both
traders, even when one trader enjoys an absolute advantage in both endeavors.
• Specialization– Uses differences in individual skills– Breaks tasks into simple steps which
multiplies the productivity of workers by deepening skills via practice