Production Possibilities Curve (Frontier).ppt

Production Possibilities,When faced with SCARCITY of resources,decisions have to be made about how to use those resources,Trade-offsOpportunity Costs,Trade-Offs,This is the decision making process that is occurring in your mind right now!Am I going to pay attention to what Mr.Hayward is saying,or am I going to daydream?Am I going to come to class or go buy a lottery ticket?Am I going to stay in school or go find a full time job?Each and every decision you make has a cost!Not necessarily a cost in dollar terms,but a cost in that you must give up something in order to get more of something else.,Opportunity Cost,The“price you pay”for each decision you make is called the OPPORTUNITY COST.Opportunity cost is vital to the understanding of economics.“The amount of a product or service that must be forgone(given up)in order to obtain more of the next best alternative product or service”,The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production Possibilities Curve,The PPC shows the relationship between two goods:1.Capital Goods(Investment Goods)Goods that satisfy our wants INDIRECTLY and promote future growth or“happiness”Delayed gratification.2.Consumer GoodsGoods that satisfy our wants DIRECTLY.Instant Gratification,Lesson 1 Act 1,Production Possibilities Curve(Frontier),Constructing the PPC.Horizontal axis is labeled“Consumer Goods”Vertical axis is labeled“Capital Goods”,Consumer Goods,Capital Goods,Production Possibilities Curve(Frontier),If this economy allocated ALL of its productive resources to the production of Capital Goods it could produce 100 Capital Goods,Consumer Goods,Capital Goods,0,100,Production Possibilities Curve(Frontier),If this economy allocated ALL of its productive resources to the production of Consumer Goods it could produce 1000 Consumer Goods,Consumer Goods,Capital Goods,0,100,1000,Production Possibilities Curve(Frontier),Connect the two points.This line represents an economys Production Possibilities of Capital and Consumer goods.,Consumer Goods,Capital Goods,0,100,1000,Production Possibilities Curve(Frontier),Notice the line is straight.It has a constant slope.Lets calculate the ratios between Capital and Consumer goods.This gives us our“opportunity costs”of producing capital and consumer goods.,Consumer Goods,Capital Goods,0,100,1000,Production Possibilities Curve(Frontier),An economy that produces ALL capital goods and no consumer goods is a boring place to be.People want to have fun,and consumer goods make life worth living,Consumer Goods,Capital Goods,0,100,1000,Production Possibilities Curve(Frontier),In order to get some consumer goods,the economy must give up the production of some quantity of capital goods.Remember ALL resources are limited!,Consumer Goods,Capital Goods,0,100,1000,Production Possibilities Curve(Frontier),Lets number our axis and connect the points.Each point represents production possibilities for this economy.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),At point“A”we give up the production of 10 capital goods in order to obtain 100 units of consumer goods.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),What is the opportunity cost of producing at point“A”?In terms of Consumer Goods100 Consumer Goods=10 Capital Goods.1 Consumer Good=10 Capital Goods/1001 Consumer Good=.10 Capital Goods Each Consumer Good“costs”one tenth of a Capital Good.If the economy wants 1 consumer good,it must give up the production of.10 of a capital good.“This is the opportunity cost of consumer goods”.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),What is the opportunity cost of producing at point“A”?In terms of Capital Goods10 Capital Goods=100 Consumer Goods.1 Capital Good=100 Consumer Goods/101 Capital Good=10 Consumer Goods Each Capital Good“costs”ten Consumer Goods.If the economy wants 1 Capital good it must give up the production of 10 Consumer goods.“This is the opportunity cost of capital goods”.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),What is the practical application of this model?Absolute and Comparative Advantage.Forms the basis for International Trade.Who can produce“Absolutely”more relative to another country.Who can produce at a lower opportunity cost relative to another country.In other words,who has the Comparative Advantage.We will examine this later!,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Comparative and Absolute Advantage,“Do what you do best and trade for the rest”This was the whole point of the summer reading“The Choice:A Fable of Free Trade and Protectionism”Comparative Advantage is the“Round-about way”To produce goods and services,Comparative Advantage,Basic Premise:I could be a teacher AND grow my own food.You could be a farmer AND home-school your children.I have a college degree and a knack for teaching Economics but I tend to kill most things I grow.You have a green thumb and can grow anything,but you hate economics.What are we to do?,Comparative Advantage,We should specialize in what we do best and trade with each other.To determine what we are best at doing,we need to consider our opportunity costs.We want to specialize in the activity that is least costly to us in terms of opportunity costs.,Assume Country“A”utilizes ALL of its productive resources(Productive Efficiency)to produce either Cloth or Wine.If it allocates all its resources to the production of Cloth it can produce 10 yards or Cloth.If it allocates all its resources to the production of Wine it can produce 15 gallons Wine,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,Assume Country“B”utilizes ALL of its productive resources(Productive Efficiency)to produce either Cloth or Wine.If it allocates all its resources to the production of Cloth it can produce 20 yards or Cloth.If it allocates all its resources to the production of Wine it can produce 20 gallons Wine,10,15,20,20,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Which country has the ABSOLUTE ADVANTAGE in the production of Cloth?(Who can“absolutely”produce more Cloth?)Which country has the ABSOLUTE ADVANTAGE in the production of Wine?(Who can“absolutely”produce more WIne?),Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Which Country has the Comparative Advantage in the production of Cloth?(Who can produce at the LOWEST OPPORTUNITY COST,or in other words,who gives up the LEAST in terms of production of the other GOOD.,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Lowest Opportunity Cost determines Comparative Advantage,Cloth Opportunity Cost Wine Opportunity CostCountry“A”10 10Cloths=15Wines 15 15Wines=10Cloths or or 1Cloth=15cloths/10 1Wine=10Cloths/15 or or 1Cloth=1.5Wines 1Wine=.67ClothsCountry“B”20 20Cloths=20Wines 20 20WInes=20Cloths or or 1Cloth=20Wines/20 1Wine=20Cloths/20 or or 1Cloth=1Wine 1Wine=1Cloth,Who has the Comparative Advantage in the Production of Cloth?,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Lowest Opportunity Cost determines Comparative Advantage,Cloth Opportunity Cost Wine Opportunity CostCountry“A”10 10Cloths=15Wines 15 15Wines=10Cloths or or 1Cloth=15cloths/10 1Wine=10Cloths/15 or or 1Cloth=1.5Wines 1Wine=.67ClothsCountry“B”20 20Cloths=20Wines 20 20WIne=20Cloths or or 1Cloth=20Wines/20 1Wine=20Cloths/20 or or 1Cloth=1Wine 1Wine=1Cloth,Who has the Comparative Advantage in the Production of Wine?,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Bottom Line Country“B”has to give up 1 Cloth when they produce1 Wine,but Country“A”has to give up 1.5 Cloths to produce 1 Wine.Country“B”has to give up less relative to country“A”to produce Cloth.Country“B”should specialize in the production of Cloth.Country“A”has to give up.67 Wine when they produce 1 Cloth,but Country“B”has to give up 1 Wine to produce 1 Cloth.Country“A”has to give up less relative to country“B”to produce Wine.Country“A”should specialize in the production of Wine.,Lowest Opportunity Cost determines Comparative Advantage,Comparative Advantage,Who should export Cloth?Who should import Cloth?Who should export Wine?Who should import Wine?,Comparative Advantage“Terms of Trade”,We have established that nations should produce the good/service that they have the comparative advantage in.How do we then trade?We have to determine what are acceptable“terms of trade”Simply what is the price,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Lowest Opportunity Cost determines Comparative Advantage,Cloth Opportunity Cost Wine Opportunity CostCountry“A”10 1Cloth=1.5 Wines 15 1 Wine=.67 Cloths Country“B”20 1Cloth=1 Wine 20 1 Wine=1 Cloth,Country“A”specializes and produces 15 WinesCountry“B”specializes and produces 20 ClothsIf country“A”wants some cloth they must give up some wineIf country“B”wants some wine they must give up some clothWhat are acceptable terms of trade to close this deal!,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Lowest Opportunity Cost determines Comparative Advantage,Cloth Opportunity Cost Wine Opportunity CostCountry“A”10 1Cloth=1.5 Wines 15 1 Wine=.67 Cloths Country“B”20 1Cloth=1 Wine 20 1 Wine=1 Cloth,Lets say“A”trades 2 wines with“B”for 4 clothsNow“A”consumes 13 Wines AND 4 ClothsIs this a good deal for“A”?Graph and see!Terms of Trade in this case2 Wines=4 Cloths1 Wine=2 Cloths,13,5,4,7.5,10,10,Lets say“B”trades 4 cloth with“A”for 2 WinesNow“B”consumes 16 cloths AND 2 WinesIs this a good deal for“B”?Graph and see!Terms of Trade in this case4 cloths=2 wines1 cloths=.5 wines,16,2,BAD DEAL FOR COUNTRY“B”NO TRADE!,“A”produces Wine,“B”produces Cloth,Country“A”,Country“B”,Cloth,Wine,Cloth,Wine,10,15,20,20,Lowest Opportunity Cost determines Comparative Advantage,Cloth Opportunity Cost Wine Opportunity CostCountry“A”10 1Cloth=1.5 Wines 15 1 Wine=.67 Cloths Country“B”20 1Cloth=1 Wine 20 1 Wine=1 Cloth,Lets say“A”trades 5 wines with“B”for 4 clothsNow“A”consumes 10 Wines AND 4 ClothsIs this a good deal for“A”?Graph and see!Terms of Trade in this case5 Wines=4 Cloths1 Wine=.8 Cloths,5,7.5,10,10,Lets say“B”trades 4 cloth with“A”for 5 WinesNow“B”consumes 16 cloths AND 5 WinesIs this a good deal for“B”?Graph and see!Terms of Trade in this case4 cloths=5 wines1 cloths=1.25 wines,“A”produces Wine,“B”produces Cloth,10,16,4,5,TRADE should occur!BOTH now Consume beyond Their PPCS!,Production Possibilities Curve(Frontier),This straight line PPC represents“Constant Opportunity Costs”The Trade-off as we move along the PPC are constant,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),What is the practical application of this model?We want to use this model to examine an individual economy more closely.THE PPC IS GOING TO GO THROUGH CHANGES FIRSTYou didnt think it was going to be that easy,did you?,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,.F,.G,.H,.I,Production Possibilities Curve(Frontier),A closer look at an individual economy is going to give different look to the PPC.It is not going to be a straight line.It is going to have a“bowed”look.It is going to be convex from the origin.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,Production Possibilities Curve(Frontier),The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.At Point“A”the economy gives up 10 capital goods in order to get 400 consumer goods.400 Consumer goods=10 Capital goods1 Consumer good=10 Capital goods/4001 Consumer good=.025 Capital good,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS.At Point“B”the economy gives up 10 Capital goods in order to get 200 more Consumer goods.200 Consumer goods=10 Capital goods1 Consumer good=10 Capital goods/2001 Consumer good=.05 Capital good,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),The bowed nature of the PPC is due to INCREASING OPPORTUNITY COSTSNot all resources are adaptable to alternative uses.Resources used for Capital Goods may not be suitable to make Consumer Goods(and Vice Versa)Marsh land suitable for growing rice could not easily be converted for use as a an airport.It would be much more costly than using farmland in Kansas.,Consumer Goods,Capital Goods,0,100,1000,10 20 30 40 50 60 7 0 80 90,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),Lets take a closer look at the PPC.What do the different points on the PPC represent?,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),Each point represents Productive EfficiencyThis means that this economy is allocating ALL of it productive resources in the least costly way,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),There are an infinite number of points on the PPC.Where a society decides to produce is called Allocative EfficiencyThis represents the combination of Capital and Consumer Goods most desired by the society,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),The WHOLE PPC represents“FULL PRODUCTION”Productive EfficiencyFull-Employment of Resources,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,Production Possibilities Curve(Frontier),Do economys always produce on the PPC?No!Often they operate inside their production possibilities,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,E,Production Possibilities Curve(Frontier),Do economys always produce on the PPC?Point“E”represents a point inside the PPC.Notice that this point“E”represents a lower bundle of Capital and Consumer Goods,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.B,.C,.D,.E,Production Possibilities Curve(Frontier),Do economys always produce on the PPC?Point“E”represents a point inside the PPC.The area between point“E”and the PPC represents underutilization of resources or under-employment of resources or unemployment.The economy is being inefficient.,Consumer Goods,0,100,1000,100 200 300 400 500 600 700 800 900,.A,.