Production Possibility Frontiers

1. Production Possibility Frontiers Holmes Econ 10

2. What is a PPF? Production Possibility Frontier (PPF) is a representation of all possible combinations of two goods that our given resources can produce. We only graph the “biggest” combinations, so we look at the frontier of the combinations.

3. Guns Butter Example (classical school) If we choose to produce 50 pounds of Butter, then we can make 100 Guns. (50,100) (100,75) (150,20)

4. Why is it bowed out? Some resources are more suitable in the production of one of the goods (how can we use cows in our production of guns?) Suppose we are making as many guns as we can. We wish to make one pound of butter. We take one cow, one worker, and one butter churn. How much does our production of guns fall? Not much. Thus, the opportunity cost of the first pound of butter is rather low. Guns 0 B, 120 G 1 B, 119.8 G Butter

5. Guns Butter Why is it bowed out? …but as we get further out and are trying to make the last pound of butter, then we take all the gunpowder and steel and somehow use this to produce more butter. These resources add little to our production of butter but decrease our production of guns dramatically. Thus, the opportunity cost of the last pound of butter is rather high. 199 B, 5 G 200 B, 0 G

6. What does this imply? Our first pound of butter cost .2 guns Our last pounds of butter cost 5 guns. What happens to our cost of one unit? Does this agree with anything else we have done this semester? Note we say nothing about the relative attractiveness of combinations; we are just saying what we could achieve.

7. A more tangible example Suppose we have two types of people in our economy. We have 10 Carlas: these people are really good at dancing-they produce 15 Quality Dance Routines per hour. We also have 10 Joshs: these people can kick field goals: 20 per hour. Unfortunately, Carla can only make 1 FG/hour and Josh can make 2 QDR’s per hour. What kinds of combinations can they produce?

8. Graph of ALL combinations All J make FG All C make DR 210 All make FG Field Goals 0 0 170 Quality Dance Routines All C make FG All J make DR 10 Joshs and 10 Carlas All make QDR

9. But we only care about the frontier

10. Suppose we add another type of person Let’s suppose there are now 5 Marks. Marks can make 5 FG/hr and 5 QDR/hr.

11. Carlas do DR Marks do DR Joshs do DR

12. Economy A: 3 FG/DR Economy B: 1 FG/4DR Two economies If each splits their workforce: A makes 30 FG, 10DR B makes 10 FG, 40 DR = 40 FG, 50 DR If each makes what they are best at: A makes 60 FG B makes 80 DR =60 FG, 80 DR Can trade at 1 FG = 1 DR

13. Suppose instead... Economy A: 3 FG/ 1DR per person Economy B: 4 FG / 2DR per person B is better at both. Now what? Split: A: 18 FG 14 DR B: 40 FG 20 DR 58 FG 34 DR

14. Suppose instead... Economy A: 3 FG/ 1DR per person Economy B: 4 FG / 2DR per person Specialize: A gives up 3 FG/DR, B gives up 2 FG/DR, so B should make DR We say that A has a comparative advantage in FG, B has a CA in DR. A: 60 FG. B: 40 DR.

15. Trade Trade: A buys DR at 1 DR = 2.5 FG A likes: 1 DR costs 3 FG B likes: 1 DR costs 2 FG Better off than was originally!

16. Moral Even “superior” economies can benefit from trade. In our last example, B could do both better. Yet trading with A was still better than trying to do it by themselves. Practice Problem: Suppose that some high-powered lawyer can write 5 lawsuits per hour and type 3 letters per hour. Her paralegal can write 1 lawsuit per hour and type 2 letters per hour. Why doesn’t the lawyer type her own letters?