1. COMM 113 Economies and Markets The Production Possibilities Frontier Tuesday February 28

2. Learning objectives for the lecture
At the completion of this lecture, students will be able to:
Define the production possibilities frontier (ppf) and use it to identify opportunity costs.
Distinguish between inefficient, efficient and unattainable states.
Explain how investment in new technologies affects the ppf and consumption possibilities over time.
Reading:
Chapter 2 of McTaggart

3. Our first economic model
Recall that one of the tenets of economics is:
Scarcity leads to trade-offs…
Having more of one thing means having less of another
… which in turn leads to opportunity costs
The opportunity cost of something is the value of the next-best alternative that must be given up to get it
We want to build a model that explains the impacts and implications of trade-offs and opportunity costs in an economic setting
We will look at the choices made with respect to what is produced within an economy by modelling a Production Possibility Frontier (PPF)

4. Core simplifying assumptions of our PPF model
Recall that economic models make simplifying assumptions in order to focus attention on the things that really matter
In our model of economic production we will assume:
There are only two different consumption goods {milk and dresses} that can be produced
There is only one factor of production {labour} within an economy, and it is able to be used in the production of either good
We have a choice where to use it
The availability of factors of production, and the production technology that transforms factors of production into consumption goods, within an economy is limited at any point in time
Scarcity, constraints
The impact of changes in the quantity of factors and/or production technology can be examined in our model, so don’t get too worried about this assumption

5. Why are we assuming what we are assuming?
Two goods
This allows me to draw the production possibilities frontier in two-dimensional space (ie we can plot the quantity of milk produced on one axis and the quantity of dresses produced on the other axis)
If I was a better artist I could draw a 3D graph, and if I wanted more goods I could drop the graph and just use algebra to model the problem
Two goods are enough to highlight the nature of the choices and trade-offs that must be made, so there is no need to make things more complicated
Transferability of the factor of production
Without this assumption, we will have no ability to operationalise our choices about how much of each good to produce
Note that how effective or productive the factor is in the production of each type of good is determined by the production technology
So some factors might be particularly productive making milk and particularly unproductive at making dresses
Or factors might be equally productive in their different uses

6. The PPF in words
The PPF is the boundary between those combinations of our two goods that CAN be produced given our resources and those that CANNOT be produced
The nature of the PPF is determined by 1) how much of the factor of production we have, and 2) the production technology
Changes in either of these will affect what can and cannot be produced
The PPF allows us to make some very insightful observations about the way an economy works and what choices should be made
The PPF, on its own, does not allow us to say exactly what combination of goods the economy should be producing

7. Our PPF - a few more assumptions
Let us add a few additional assumptions so that we can draw a picture of a specific PPF:
The productivity of a unit of labour in a particular industry does not change in relation to the total amount of labour employed in that industry
In other words assume constant marginal productivity of labour
Let us assume that one hour of labour always produces either one litre of milk or half a dress
We have 100 hours of labour
So we can produce 100 litres of milk, or 50 dresses, or some specific combinations of both
The slope of our PPF will be -2

8. Our PPF illustrated

9. Economic efficiency

10. Economic growth

11. General purpose technologies

12. A second PPF in words
Assume now that labour becomes less productive in a particular industry as the amount of labour used in that industry increases
In other words, assume diminishing marginal productivity of labour
This might be because of crowding or, think of it as if workers are, themselves, specialised and as the economy always moves the most productive workers to the new industry first
Diminishing marginal productivity implies that as we become more specialised in the production of one good or the other, we become less efficient in the production of that good
This means that the PPF will become concave (ie it will bow inwards as we near either axis)

13. A PPF with diminishing marginal productivity

14. The opportunity cost of production
In our PPF model, when we are on the PPF the opportunity cost of more production of one good is less production of the other good
The opportunity cost of the good on the x-axis is the slope of the PPF
In our first constant marginal productivity example the cost of an additional dress was 2 L of milk (slope -2) and the cost of an additional L of milk was ½ a dress (inverse of the slope)
In our second diminishing marginal productivity example the opportunity cost of a dress increases as we produce additional dresses (the PPF becomes increasingly steep)

15. The slope of a PPF as opportunity cost