1. The Production Possibility Frontier
A model used to highlight and clarify scarcity, and issues such as efficiency, tradeoffs, opportunity cost and growth, which are associated with scarcity

2. PPF: Efficiency (Micro Focus Def’n)
resources must be allocated to the production of goods & services that people want the most “getting the best mix”
allocative efficiency
production must be carried on in the least costly way
productive efficiency

3. P.P.F. Assumptions
All resources (land, labour, capital, other) are used
Productive efficiency is achieved
Given point in time
Resources are fixed in quantity but can be shifted around
Technology doesn’t change
Only 2 goods are produced in this economy

4. Pizza (in hundred thousands) 0 1 2 3 4
Production possibilities of pizza & robots with full employment, yr. 2009
Production alternatives
TYPE OF PRODUCT A B C D E
Pizza (in hundred thousands)
Robots (in thousands)

5. PPF Diagram Industrial Robots (1000’s) Pizzas (100, 000’s) A 10 B 9
Any point on the frontier is Productively Efficient.
It may or may not be Allocatively Efficient 8 C 7 6
Industrial Robots (1000’s) 5 D 4 I 3
Any point within the frontier is
productively inefficient 2 E 1 1 2 3 4 5 6 7 8
Pizzas (100, 000’s)

6. PPF Highlights increases The PPF is “bowed out”:
the opportunity cost (how much of one good is sacrificed to produce one of the other good) depends on how much of each the economy is producing
as more pizzas are produced the opportunity cost of pizzas in terms of robots
increases

7. Pizza (in hundred thousands) 0 1 2 3 4
Production possibilities of pizza & robots with full employment, yr. 2006
Production alternatives
TYPE OF PRODUCT A B C D E
Pizza (in hundred thousands)
Robots (in thousands)

8. PPF Diagram Industrial Robots (1000s) Pizzas (100, 000s) A 10 B 9
The opportunity cost of increasing
Pizza production from 2 to 3 is
3,000 robots 8 C 7 6
Industrial Robots (1000s) 5
The opportunity cost of increasing Pizza production from 3 to 4
4,000 robots D 4 3 2 E 1 1 2 3 4 5 6 7 8
Pizzas (100, 000s)

9. PPF Highlights Law of increasing relative cost
This is the
Law of increasing relative cost
not all resources are equally productive in producing all things - resources are not perfect substitutes for each other;
that is, some resources have comparative advantage over other resources
Therefore opportunity costs increase for each additional good produced

10. PPF Diagram Industrial Robots (1000’s) Pizzas (100, 000’s) A 10
Any point on the frontier is Productively Efficient.
It may or may not be Allocatively Efficient B 9 8 C 7 6
Industrial Robots (1000’s)
The more specialized the inputs, the more bowed out the frontier 5 D 4 I 3
Any point within the frontier is
productively inefficient 2 E 1 1 2 3 4 5 6 7 8
Pizzas (100, 000’s)

11. Change Assumptions
increase quantity &/or quality of resources  growth
PPF shifts to the right
improve technology  growth
decrease quantity &/or quality of resources  negative growth
PPF shifts to the left
technology decrease  negative growth

12. Growth 10
New PPF 9
Growth occurs when the Production Possibility Curve shifts to the right
Old PPF 8 7 6
Industrial Robots (1000s) 5 4 3 2 1 1 2 3 4 5 6 7 8
Pizzas (100, 000s)

13. Growth – Capital and Consumption Goods
-good produced primarily for consumption
-bread, Xbox 360’s, TV shows
-do not cause growth
Capital Goods
-goods that can be used to produce more goods
-factories, universities, robots

14. PPF Highlights Economic Growth results from
1.) technological change and
2.) capital accumulation (resource base)
The opportunity cost of faster economic growth is a decrease in current consumption
NOTICE the affect of present choices on future growth.

15. Growth
Growth depends on the choices made today, a sacrifice of current consumption results in more capital today and “growth” in the future 10 9
PPF, yr. 1998 8 7 6
Industrial Robots (1000s) 5 4 3 2
PPF, yr. 2009 1 1 2 3 4 5 6 7 8
Pizzas (100, 000s)

16. Comparative Advantage: Specialization and Trade
Specialization and trade, and therefore markets that facilitate trade, make society better off by increasing the productivity of scarce resources
Comparative Advantage is the basis for the gains from specialization and trade

17. Theory of Comparative Advantage:
Production Possibilities :
Carl and Mike: retired neighbours: hobbies are making wine and beer
PPF’s for 1 month using same equipment and time..
Carl’s Production
Possibilities
Mike’s Production
A B C
Wine (btls)
Beer (btls.) ,

18. Absolute Advantage
When a producer with of set of inputs can produce more output than another with the same inputs, the first producer has an absolute advantage in production of the output.
Carl has an absolute advantage in the production of both wine and beer.

19. Carl’s Proposition
“Since we are both being pressured to produce more, lets each of us do what we do best and trade. This will give each of us more than we now have without either of us working any harder.”
Notice that voluntary trade does not take place unless both parties benefit.

20. Mike’s Production Possibilities/ Opportunity Costs
Bottles of beer
In a month Mike can produce either bottles of wine or 80 bottles of beer
Opp cost of 80 wine is 80 beer Opp cost of 1 wine is 1 beer
Opp cost of 80 beer is 80 wine Opp cost of 1 beer is…………
1000–
900–
825–
800–
700–
600–
500–
400–
300–
200–
175–
80–
40– • A B
Consumption choice before trade • C •
| | | | | | | | | | |
Bottles of wine

21. Carl’s Production Possibilities/ Opportunity Costs
Bottles of beer
Opp cost 100 wine is 1000 beer Opp Cost 1 wine is 10 beer
Opp cost of 1000 beer is 100 wine Opp Cost 1 beer is………….. • A
1000–
900–
800–
700–
600–
500–
400–
300–
200–
100– B
Consumption choice before trade • C •
| | | | | | | | | | |
Bottles of wine

22. Opportunity Cost Table
Comparative Advantage
When producer A has a lower opportunity cost of producing good A compared to another producer, then producer A is said to have a comparative advantage in the production of good A.
Opportunity Cost Table
Opportunity cost of 1 beer
Opportunity cost of 1 wine
Carl
1/10 wine
10 beer
Mike
1 wine
1 beer

23. Comparative Advantage: Specialization
Carl has a “comparative advantage” (lowest opportunity cost producer) in the production of beer and therefore specializes in beer production.
Mike has a “comparative advantage” in the production of wine and therefore specializes in wine production
As long as opportunity costs differ, there is comparative advantage

24. Comparative Advantage: Specialization
Theory of Comparative Advantage
if specialization takes place according to comparative advantage (the lowest opportunity cost producer) and then trade takes place…. both parties can benefit: that is, move outside their current PPF’s.

25. Carl & Mike Before Specialization & Trade
Carl Produces & Consumes
Mike Produces & Consumes
Total Consumption + =
Wine (btls.)
Beer (btls.) 30
700 40 70
740
Carl & Mike After Specialization, but Before Trade
Mike Produces & Can Consume + =
Wine (btls.)
Beer (btls.)
1,000 80
Carl Produces & Can Consume
Total Production & Consumption
Total Gains
+10
+260

26. (terms of trade: 5 beer for 1 wine)
Trade: The Benefits of Specialization
Carl proposes, after specialization, that he trade Mike 175 beer for 35 wine.
(terms of trade: 5 beer for 1 wine)
Carl gets wine for a reduced sacrifice
35 wine for 175 beer instead of 350 beer, the opportunity cost before trade
Mike gets beer for a reduced sacrifice
175 beer for 35 wine instead of 175 wine, the opportunity cost before trade

27. Terms of Trade: 1 Wine for 5 Beer
Since voluntary trade requires that both parties benefit from the trade.
Before trade:
Carl: 1 wine “trades” for 10 beer
Mike: 1 wine trades for 1 beer
Carl is better off as he now only has to give up 5 beer for a wine
After trade 1 wine “trades” for 5 beer
Mike is better off as he now only has to give up 1/5 wine for a beer
The Terms of Trade are between the personal ones that exist before trade, thus producing gains for both parties participating in the trade

28. Trade Between Carl & Mike
175 Bottles of Beer To
Trades away
1 Wine trades for 5 Beer or
1 Beer trades for 1/5 Wine
Mike (specializes in wine)
Carl (specializes in beer)
35 Bottles of Wine
Trades away To
Before trade Mike gave up 1 wine to get 1 beer, after trade1/5 wine
Before trade Carl gave up 10 beer to get a wine, after trade 5 beer

29. Carl & Mike After Specialization & Trade
Trades
For (+)
Away (-)
Consumes
After
Trade
Produced & Consumed
Before Trade
Gains
from
Trade
Produces
Wine (btls.) Beer (btls.)
1,000
+35
-175 35
825 30
700 +5
+125
Mike
Trades
For (+)
Away (-)
Consumes
After
Trade
Produced & Consumed
Before Trade
Gains
from
Trade
Produces
Wine (btls.)
Beer (btls.) 80
-35
+175 45
175 40 +5
+135

30. Mike’s Production Possibilities After Trade
Bottles of beer
1000–
900–
825–
800–
700–
600–
500–
400–
300–
200–
175–
80–
40–
Mike produces 80 wine and then trades
35 wine for 175 leaving him with 45 wine
and 175 beer, point D • D
Consumption after trade • A B • C •
| | | | | | | | | | |
Bottles of wine

31. Carl’s Production Possibilities/ Opportunity Costs, After Trade
Bottles of beer
Carl produces 1000 beer and trades 175 beer
to Mike for 35 wine, leaving him with 825 beer
and 35 beer, point D • A
1000–
900–
825–
800–
700–
600–
500–
400–
300–
200–
100– D •
Consumption after trade B • C •
| | | | | | | | | | |
Bottles of wine

32. Gains from Specialization
Specialization produces gains for both traders, even when one trader enjoys an absolute advantage in both endeavors.
Specialization
Uses differences in individual skills
Breaks tasks into simple steps which multiplies the productivity of workers by deepening skills via practice