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

Bik

es

Computers

14

12

10

8

6

4

2

0

0 2 4 6 8 10

A

B

C

D

E

G

Inefficient/ Unemployment

Impossible/Unattainable (given current resources)

Efficient

Production “Possibilities” Table A B C D E f

14 12 9 5 0 0

0 2 4 6 8 10

Bikes

Computers

Each point represents a specific combination

of goods that can be produced given full

employment of resources.

The Production Possibilities

Curve and Efficiency

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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.

Two Types of Efficiency

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Bik

es

Computers

14

12

10

8

6

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2

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0 2 4 6 8 10

A

B

C

D

F

E

Which points are productively efficient?

Which are allocatively efficient?

G

8

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?)

Size 20 running

shoes

Size 10 running shoes

A

Is combination “A” efficient?Yes and No. It is productively efficient but it is not the

combination society wants

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 Computer

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 Cost- Resources are easily

adaptable for producing either good.

• Result is a straight line PPC (not common)

A B C D E

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PIZZA 20 19 16 10 0ROBOTS 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

A B C D E

Constant vs. Increasing Opportunity Cost

Corn

Wheat

Cactus

Pineapples

Identify which product would have a straight line

PPC and which would be bowed out?

1 Bike2.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 CostUnits Gained

1. The PER UNIT opportunity cost

of moving from a to b is…

Example:

PER UNIT Opportunity CostHow much each marginal

unit costs

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.

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Countries should trade if they have a relatively lower opportunity cost.

They should specialize in the good that is “cheaper” for them to produce.

Output Questions:

OOO=

Output: Other goes Over

17

Both

Canada

Japan

Canada

CDs

Beef

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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?

3. What is Papa John’s opportunity cost for one pizza in

terms of burgers given up?

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 1/10 pizza

1 pizza costs 2 burgers

1 burger costs 1/2 pizza

Input Questions:

IOU=

Input: Other goes Under

20

Both

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

France

U.S.

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?

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.

soybeans coffee

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

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

International TradeWhy do people trade?

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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

40 40

(1P costs 1/3R) (1R costs 3P)

(1P costs 1R) (1R costs 1P)

Kenya wants RadiosIf the terms of trade for 1 radio is greater than 3 pineapples then Kenyais worse off and should make radios on their own.

India wants PineapplesIf 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.

Trading 1 radio for 2 pineapples will benefit bothIf 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!

Kenya

India

Pineapples Radios

30 10

40 40

(1P costs 1/3R) (1R costs 3 P)

(1P costs 1R) (1R costs 1P)

Benefits of

Specialization and

Trade

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Su

gar

(to

ns)

Su

gar

(to

ns)

45

40

35

30

25

20

15

30

25

20

15

10

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)

Which country has a comparative advantage in wheat?

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

gar

(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

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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