Production Possibilities
Curve/Frontier Model
PRODUCTION POSSIBILITIES CURVE/FRONTIER
A 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
Production
Possibilities Table
14
Bikes
Computers
B
12
2
C
9
4
Unattainable
A
(given current resources)
B
12
G
Bikes
Each point
represents a
specific
combination
of goods that
can be
produced
given full
employment
of resources.
A
14
0
C
10
8
F
Efficient
D
6
Inefficient
4
2
E
0
0
2
4
6
8
10
Computers
D
5
6
E
0
8
F
0
10
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
WHICH POINTS ARE PRODUCTIVELY EFFICIENT?
WHICH ARE ALLOCATIVELY EFFICIENT?
14
B
12
Bikes
Productively efficient
combinations are A through D
A
G
Allocative efficient
combinations depend on the
wants of society
10
8
C
E
6
What if this represents a
country with no electricity?
4
F
2
D
0
0
2
4
6
8
10
Computers
6
IS COMBINATION “A” EFFICIENT?
Size 20
running
shoes
A
Yes and no. It is productively efficient
but mostly likely not the combination
society would need.
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 Computers
4.The opportunity cost of moving from f to c is…
0 Computers
5.What can you say about point G?
Unattainable
8
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 Costs- resources
are easily adaptable for producing either
good.
• Result is a straight line PPC (not common)
Constant Opportunity Cost
9
A
B
C
D
E
Blue Jeans
20
19
16
10
0
Fire Engine
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 origin) PPC
Constant vs. Increasing Opportunity Cost
Identify which good would have a straight line PPC
and which would be bowed out?
Cactus
Corn
Wheat
Pineapples
PER UNIT OPPORTUNITY COST
How much each = Opportunity Cost
Units Gained
marginal unit costs
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
12
PPC AND ECONOMIC GROWTH
Economic growth is when an
economy can produce more of
everything (the PPC shifts
outward).
13
Key Assumptions Revisited
•Only two goods can be produced
•Full employment of resources
•In the long-run, are resources and technology are
fixed?
How can a country move beyond their current PPC and achieve
economic growth?
3 Shifters of the PPC
1. Change in resource quantity or quality
2. Change in technology
3. Change in trade
14
Robots
What happens if there is an
increase in the labor force?
Pizzas
15
Robots
What happens if there is an
increase in the labor force?
Pizzas
Robots
What if there is a technology
improvement in pizza ovens
Pizzas
Robots
What if there is a technology
improvement in pizza ovens
Pizzas
CAPITAL GOODS AND FUTURE GROWTH
Countries that produce more capital goods will have
more growth in the future.
Panama
Mexico
•Consumer Goodscreated for direct
consumption
•Capital Goods- goods
that are used to
produce other goods
capital goods > consumer goods
Future
PPC
Future
PPC
Consumer goods
Capital Goods
Capital Goods
Current
PPC
Current
PPC
Consumer goods
19
PPC Practice
DRAW A PPC SHOWING CHANGES FOR EACH OF THE
FOLLOWING:
Pizza and Robots (3)
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)
4. BP Oil Spill
5. Faster computer hardware
6. The unemployment rate is 10%
7. Post-secondary education rates rise
New robot making technology
Robots
A shift only for Robots
Pizzas
Decrease in the demand for pizza
Robots
The curve doesn’t shift!
A change in demand
doesn’t shift the curve
Pizzas
Robots
Mad cow disease kills 85% of cows
A shift inward only for
Pizza
Pizzas
Capital Goods
BP Oil Spill
Decrease in resources
decrease production
possibilities for both
Consumer Goods
Capital Goods
Faster computer hardware
Quality of a resource
improves shifting the
curve outward
Consumer Goods
Capital Goods
The unemployment rate is 10%
The curve doesn’t shift!
Unemployment is just a
point inside the curve
Consumer Goods
Capital Goods
Post-secondary education rates rise
The quality of labor improved
curve shifts outward.
Consumer Goods
PPC: ECONOMIC GROWTH AND TRADE
Absolute advantage: when a country uses fewer resources to produce a
given unit of output than the other country it can produce more output
than the other country
Comparative advantage: when a country can produce its output at a
lower opportunity cost.
DETERMINING COMPARATIVE ADVANTAGE
OUTPUT METHOD
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
If Mexico produces corn, the
opportunity cost is
150 =
300
1
2
For every bushel of corn
Mexico produces, it gives up
the production of 0.5 gallon
of sunscreen.
30
Output Questions:
OOO=
Output: Other goes Over
Both/Neither
Canada
Japan
Canada
31
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
20/200 = 1 pizza cost 10 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?
1 burger costs 1/2 pizza
DETERMINING COMPARATIVE ADVANTAGE
(INPUT METHOD)
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.
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.
33
Input Questions:
IOU=
Input: Other goes Under
Both/Neither
U.S. – only took 2 hours to produce a bushel of corn
France
U.S.
34
Input or Output Question?
OOO
Number caught per day
Henry
Deer
4
Antelope
6
John
24
12
Months to produce one
Car
IOU
Plane
Canada
8
10
Japan
15
12
IOU
Acres to produce 100 bushels
Henry
Corn
9
Rice
3
John
8
2
Absolute Advantage?
OOO
Number caught per day
Henry
Deer
4
Antelope
6
John
24
12
Months to produce one
Car
IOU
Plane
Canada
8
10
Japan
15
12
Acres to produce 100 bushels
IOU
Henry
Corn
9
Rice
3
John
8
2
Comparative Advantage?
OOO
Number caught per day
Deer
Henry
John
4
24
Antelope
6
12
Months to produce one
Car
Canada
8
10
Japan
15
12
IOU
Plane
Acres to produce 100 bushels
Corn
IOU
Rice
Henry
9
3
John
8
2
Comparative Advantage?
OOO
Number caught per day
Deer
Henry
John
Antelope
4 (1D=3/2A) 6 (1A =2/3D)
24 (1D=1/2A) 12(1A=2D)
IOU
Months to produce one
Car
Canada
Japan
8
15
Plane
10
12
IOU
Acres to produce 100 bushels
Corn
Rice
Henry
9
3
John
8
2
Comparative Advantage?
Number caught per day
Henry
John
Deer
4 (1D=3/2A)
Antelope
6
24 (1D=1/2A) 12
IOU
Months to produce one
Canada
Japan
Car
Plane
8 (1C=4/5P)
15(1C=5/4P)
10 (1P=5/4C)
12 (P=4/5C)
Acres to produce 100 bushels
Corn
Rice
Henry
9
3
John
8
2
Comparative Advantage?
Number caught per day
Deer
Antelope
Henry
John
4 (1D=3/2A)
6
24 (1D=1/2A) 12
Months to produce one
Car
Canada
Japan
8 (1C=4/5P)
15(1C=5/4P)
Plane
10
12
IOU
Acres to produce 100 bushels
Corn
Henry
John
9 (1C=3R)
8 (1C=4R)
Rice
3 (1R = 1/3C)
2 (1R = 1/4C)
COMPARATIVE ADVANTAGE PRACTICE
•First- Identify if it is a output or input question
•Second-Identify who has the ABSOLUTE ADVANTAGE
•Third-Identify who has a COMPARATIVE ADVANTAGE
•Fourth- Identify how they should specialize
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.
41
ANSWERS
1.Output.
3.Input
Absolute: Megan in both
Absolute: Kevin in both.
Comparative: Sarah in haircuts
and Megan in perms.
Comparative: Kevin in dishes.
Hannah in vacuum.
2.Output
Absolute: Justin in flats. Tim and
Justin share in breaks.
Comparative: Justin in flats and
Tim in breaks.
4.Output.
Absolute: Americans in both.
Comparative: American in
computers and China in T.V.s
42
THEORY OF COMPARATIVE ADVANTAGE
A 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.
Pineapples
Kenya
India
Radios
30 (1P = 1/3R)
10
(1R = 3P)
40 (1P = 1R)
40
(1R = 1P)
What should Kenya produce?
What should India produce?
PRACTICE
= 1/2
= 3/4
=2
= 4/3
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?
300
200
= 1/2
= 3/4
=2
= 4/3
Mexico will produce corn and import sunscreen from France.
France will produce sunscreen and import corn from Mexico
150
TERMS OF TRADE
- 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.
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)
Wheat
USA
Sugar
30 (1W costs 1S) 30 (1S costs 1W)
Brazil 10 (1W costs 2S)
20 (1S costs 1/2W)
45
40
Sugar (tons)
Which country should EXPORT Sugar?
35
30
Which country should EXPORT
Wheat?
30
Which
country should IMPORT
Wheat?
25
25
What
should the terms of
trade be?
20
Sugar (tons)
1.
2.
3.
4.
20
15
15
10
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
46
International Trade
Trade: 1 Wheat for 1.5 Sugar
USA
45
Brazil
40
35
AFTER TRADE
30
Sugar (tons)
30
Sugar (tons)
TRADE
SHIFTS
THE PPC!
25
20
15
25
20
15
10
10
5
5
0
0
5
10
15
20
Wheat (tons)
25
30
AFTER TRADE
5
10
15
20
Wheat (tons)
47
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
Chinese
100
10
1C = 9S
Shirts
Computers
American
100
Chinese
100
120
180
20
16.6
20
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
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.
4.
2S = 1C
soybeans
coffee
Brazil
3
1
Peru
1.5
2
1
1.5