Econ 201 Modelling the Market Production Possibilities Frontier (PPF) Curve One Individual’s or Countries Production Capabilities

How People Make Decisions Principle 1: People face trade-offs Making decisions Trade off one goal against another Principle 2: The cost of something is what you give up to get it - each decision has an opportunity cost Because people face trade-offs when making choices – you have to give something up to get something Principle 3: Rational people think at the margin Rational decision maker – take action only if Marginal benefits > Marginal costs Marginal Benefits – change (or increase) in total benefits from choice Marginal Costs – change/increase in costs from choice (opportunity costs of “not chosen”)

Production Possibilities Frontier - Choice between producing 2 goods Combinations of outputs that a society can produce if all of its resources are being used efficiently Assumptions of this model Technology fixed Resources fixed Simplified two-good analysis Lecture notes: The assumptions of the model help preserve ceteris paribus. Our two goods are pizzas and wings.

Production Possibilities Frontier Image: Animated Figure 2.1 Lecture notes: Let’s begin by imagining a society that produces only two goods—pizzas and wings. This may not seem very realistic, since the entire economy is comprised of millions of different goods and services, but the benefit of this approach is that it allows us to understand the trade-offs in the production process without making the analysis too complicated. The figure shows the production possibilities frontier for our two-product society. It is important to remember that the number of people and the total resources of this two-product society are fixed. If the economy uses all of its resources to produce pizzas, it can produce 100 pizzas and zero wings. If it uses all of its resources to produce wings, it can make 300 wings and zero pizzas. These outcomes can be found by locating points A and B on the production possibilities frontier. It is unlikely that the society will choose either of these extreme outcomes because it is human nature to enjoy variety. At any combination of wings and pizzas along the production possibilities frontier, the society is using all its resources to be productive. These points are considered efficient because society is producing the largest possible output from its resources. But what about point F, and all the other points located in the purple shaded region? These points represent an outcome inside the production possibilities frontier and are, therefore, inefficient. Whenever society is producing along the production possibilities frontier, the only way to get more of one good is to accept less of the other

Production Possibilities Frontier - Choice between producing 2 goods Combinations of outputs that a individual/society can produce if all of its resources are being used efficiently Lecture notes: The assumptions of the model help preserve ceteris paribus. Our two goods are pizzas and wings.

Why Trade – PPF Model of Trade DEFINITION of 'Production Possibility Frontier - PPF' A curve depicting all maximum output possibilities for two or more goods given a set of inputs (resources, labor, etc.). The PPF assumes that all inputs are used efficiently. A production-possibility frontier is a budget constraint presented by the limitation of available factors of production.

Production Possibilities Frontier Pizzas Chicken W Cost of +1 CW Cost of +1 Pizza 100 -3 70 90 -0.33 50 150 300 Can’t Produce Technology Constraint Image: Animated Figure 2.1 Lecture notes: Let’s begin by imagining a society that produces only two goods—pizzas and wings. This may not seem very realistic, since the entire economy is comprised of millions of different goods and services, but the benefit of this approach is that it allows us to understand the trade-offs in the production process without making the analysis too complicated. The figure shows the production possibilities frontier for our two-product society. It is important to remember that the number of people and the total resources of this two-product society are fixed. If the economy uses all of its resources to produce pizzas, it can produce 100 pizzas and zero wings. If it uses all of its resources to produce wings, it can make 300 wings and zero pizzas. These outcomes can be found by locating points A and B on the production possibilities frontier. It is unlikely that the society will choose either of these extreme outcomes because it is human nature to enjoy variety. At any combination of wings and pizzas along the production possibilities frontier, the society is using all its resources to be productive. These points are considered efficient because society is producing the largest possible output from its resources. But what about point F, and all the other points located in the purple shaded region? These points represent an outcome inside the production possibilities frontier and are, therefore, inefficient. Whenever society is producing along the production possibilities frontier, the only way to get more of one good is to accept less of the other Economically Inefficient

PPF – Non-linear function The production--possibility frontier (PPF) is an expository figure for representing scarcity, cost, and efficiency.

How People Interact Principle 5: Trade can make everyone better off Specialization Allows each person/country to specialize in the activities he/she does best People/countries can buy a greater variety of goods and services at lower cost

A Parable for the Modern Economy Two goods: meat and potatoes Two people: rancher and farmer If rancher produces only meat And farmer produces only potatoes Both gain from trade If both rancher and farmer produce both meat and potatoes They still gain from specialization and trade

The production possibilities frontier (a) 1 The production possibilities frontier (a) (a) Production Opportunities Minutes needed to Make 1 ounce of: Amount produced in 8 hours Meat Potatoes Farmer Rancher 60 min/oz 20 min/oz 15 min/oz 10 min/oz 8 oz 24 oz 32 oz 48 oz Panel (a) shows the production opportunities available to the farmer and the rancher.

The production possibilities frontier (b, c) 1 The production possibilities frontier (b, c) (b) The farmer’s production possibilities frontier (c) The rancher’s production possibilities frontier Meat (oz) 4 8 Meat (oz) 12 24 If there is no trade, the rancher chooses this production and consumption. If there is no trade, the farmer chooses this production and consumption. B A Potatoes (oz) 16 32 Potatoes (oz) 24 48 Panel (b) shows the combinations of meat and potatoes that the farmer can produce. Panel (c) shows the combinations of meat and potatoes that the rancher can produce. Both production possibilities frontiers are derived assuming that the farmer and rancher each work 8 hours per day. If there is no trade, each person’s production possibilities frontier is also his or her consumption possibilities frontier

The opportunity cost of meat and potatoes 1 The opportunity cost of meat and potatoes Opportunity cost of: 1 oz of Meat 1 oz of Potatoes Farmer Rancher 4 oz potatoes 2 oz potatoes ¼ oz meat ½ oz meat

A Parable for the Modern Economy Specialization and trade Farmer – specialize in growing potatoes More time growing potatoes Less time raising cattle Rancher – specialize in raising cattle More time raising cattle Less time growing potatoes Trade Willing to trade: 3 oz of meat for 1 oz potatoes Final trade -5 oz of meat for 15 oz of potatoes Both gain from specialization and trade

Farmer’s Gains From Trade   Potatoes Meat No Trade With 32 28 29 1 24 26 2 20 23 3 16 4 12 17 5 8 14 6 11 7

Rancher’s Gains From Trade

Greg’s Final Solution (text) 2 Greg’s Final Solution (text) (a) The farmer’s production and consumption (b) The rancher’s production and consumption Meat (oz) 4 8 Meat (oz) 12 24 Farmer's production and consumption without trade Rancher’s production with trade Rancher’s production and consumption without trade Farmer's consumption with trade 18 12 13 B* A* 27 Rancher’s consumption with trade B 5 Farmer's production with trade 17 A Potatoes (oz) 16 32 Potatoes (oz) 24 48 Farmer and Rancher agree to trade 5 oz of Meat for 15 oz of Potatoes (3:1) Start at corners (specialization)