Presentation on theme: "Economic Models: Production Possibilities Frontier"— Presentation transcript:
1Economic Models: Production Possibilities Frontier Illustrating Opportunity Cost, Trade-offs and the cost of idle resources
2Efficiency / inefficiency and unemployment Today’s AgendaScarcityA simple two-good model of productionProduction possibilities frontiersUse PPFs to illustrate various conceptsSlope of the PPFExamplesEfficiency / inefficiency and unemploymentOpportunity costEconomic GrowthConcave PPFLinear PPF3/25/20172
4Production Possibilities Frontier Economic ModelUsed to show opportunity cost and trade-offsProduction Possibilities Frontier:Represents all the different combinations of goods and/or services an economy can produce at maximum efficiency.It’s called the Production possibilities Frontier because the graph charts the POSSIBLE outcomes of PRODUCTS.When all productive resources are fully employed.
5Let’s examine guns and butter Remember, in society the amounts of guns and butter a society has is indirectly proportional.What does this mean?Right, as the AMOUNT of one Product goes UP, the AMOUNT of the other Product goes DOWN
7Identifying Possible Alternatives Classic example has two goodsGuns (representing military needs)Butter (representing civilian needs)Economy produces only two goods, but has many alternatives!The Economy Could…Use all of its resources to produce 100 units of butter and 30 units of guns (point A)......or it could move resources to more gun production (point B)...Because the economy has so many options, this is why it is called a “Production Possibilities” frontier!
9Fully Employed Resources Points (A, B) represent maximum outputs if all resources are fully employed.Ex. Suppose the economy wanted to move to point C, which is more guns and more butter.What happens?This is why the graph is called a production possibilities “frontier” because it shows the maximum amount of goods and/or services that can be produced.
10Cost of Idle ResourcesIf not all resources are being employed, then it is impossible for an economy to reach is full potential (capacity).Ex.<Strike>A point inside the curve (such as point D) could also be the result of other unused resourcesUndeveloped LandFactories that are not being used
11So if the point is on the arch or on the line it tells you what? If the point is inside the arch that means what?If the point is outside of the graph that means what?
12Attainable and Unattainable All points on or inside the frontier are attainablePoint A is attainable, so is point B. In fact B is better!Point C is unattainableProductionPossibilities frontier3,000CBQuantity ofComputersProducedAQuantity ofCars Produced1,00015123/25/201712
13Opportunity CostThe Production Possibilities Frontier also displays opportunity cost and trade-offs.Ex. Economy wants to move from point A to point B on graph. The opportunity cost of producing the additional 50 units of guns is......the 90 units of butter given up.
15The slope determines the opportunity cost of producing good X in terms of good Y Remember Opportunity cost, is the cost of the THING THAT YOUR ARE GIVING UP!!
16Illustrating Concepts Using a Production Possibility Frontier ScarcityEfficiency, Inefficiency and UnemploymentOpportunity CostEconomic Growth21163/25/201716
17Scarcity All points on or inside the frontier are attainable Points A and B are attainableAt point C more cars and computers are being produced than at A or BBut point C is unattainable. Why?ScarcityProduction possibilities are bounded3,000CBQuantity ofComputersProducedAQuantity ofCars Produced1,00015173/25/201717
18Opportunity Cost Start at B1—800 cars and 1500 computers Say we want to increase the number computers to 2000At point B2 we are producing 2000 computers, but only 600 cars. To increase computer-production by 500, we must give up car-production by 200The negative slope of the PPF implies that whenever we increase production of one good……we must give up some of the other good3,000Not Possible!B2C2,000B11,500Quantity ofComputersProducedQuantity ofCars Produced6008001,00015183/25/201718
19Economic Growth—Long Run Over time an economy can growMore labor and capitalTechnological progressWhat happens to the PPF?Shifts outward!Previously unattainable levels of production……now become attainable4,0003,000Quantity ofComputersProducedQuantity ofCars Produced1,0001,50015193/25/201719
20Why Does the PPF Bow Outward? PPF does not necessarily have to be concave!But it is reasonable assumption. Why?Because not all resources are equally suited at producing the same goodComputer manufacturers make poor car makers and vice versaIf more and more resources were diverted into the production of cars say, then even computer manufacturers would find themselves on the automobile assembly line. But their productivity would be low!15203/25/201720
21Illustrating the Point Suppose we go from A to B. Production of cars is virtually unaffected, but production of computers falls by 750!Computer manufacturers are lousy at making carsPPF is steepSuppose we go from C to D. Production of computers is virtually unaffected, but production of cars decreases by 250!Car makers are lousy at making computersPPF is flatAs we move up the PPF its slope decreasesDC3,000Quantity ofComputersProducedA750BQuantity ofCars Produced2501,00015213/25/201721
22Linear PPFs The slope of the PPF…. …measures the opportunity cost of producing good X (in this case cars) in terms of good Y (in this case computers)If the PPF is linear, then the opportunity cost of producing X in terms of Y is constant at all levels of productionThis is unrealistic, but linear PPFs are easier to deal with3,000Slope = DY/DXSlope at A…Quantity ofComputersProducedADYequals Slope at BBDXQuantity ofCars Produced1,00015223/25/201722
23Measuring the Opportunity Cost What is the opportunity cost of producing cars?Pick any two points on the PPF…As we move from A to B…DY = andDX = 600Slope = -1800/600 = -3O/C of 1 car is 3 computers3,000Slope = DY/DXA2,400DYQuantity ofComputersProducedB600DX2008001,000Quantity ofCars Produced15233/25/201723
24SummaryA PPF shows all combinations of goods and services that can be produced given available resources and technologyThe PPF is used to illustrate concepts such as scarcity and opportunity costThe slope of the PPF measures the o/c of producing good X in terms of good YThe curvature of the PPF reflects increasing opportunity cost when substituting one type of production for another15243/25/201724