production possibilities frontier. outline i. introduction to gilligan’s island a. production...

Production Possibilities Production Possibilities FrontierFrontier

OutlineOutline

I. Introduction to Gilligan’s IslandA. Production Possibilities Table

B. Production Possibilities Frontier

II. Economic Concepts Illustrated with a PPFA. Opportunity Cost

B. Scarcity

C. Productive Efficiency

D. Growth/Technology Change

Gilligan’s IslandGilligan’s Island

• Recall that in the Gilligan’s TV show there are seven people stranded on a desert island: Gilligan, The Skipper, Maryanne, Ginger, Mr and Mrs. Howell, and the Professor.

• Assume that they only produce two things - huts (from Palm trees) and radios (from coconuts)

Production Possibilities (per Production Possibilities (per month)month)

• If everyone is making huts they can produce 112 huts in one month and implicitly no radios.

• Let’s say they figure that it’s probably a good idea to make some radios. Who do they ask to stop making huts?

Who?Who?

The Professor

• Because he has been trained to do this and is not all skilled in hut production.

• So now the crew can make 7 radios and 98 huts in a month.

• What if they want to make more radios - who do they ask to do it?

Who Next?Who Next?

• Whomever is next best at making radios relative to making huts - let’s say that is Maryanne.

• If Maryanne and the Professor are making radios, then the crew can produce 13 radios and 80 huts in a month.

Three Production PossibilitiesThree Production Possibilities

• At this point we have three production possibilities for the crew. One in which they all make huts, one where all but the Professor make huts, and one where the Professor and Maryanne make radios and the rest make huts.

• Let’s look at this information in a table.

Production Possibilities TableProduction Possibilities Table

• Production Possibilities Table - a table that shows all combinations of goods and services that can be produced given the resources of society and the existing state of technology

Production Possibilities Table Production Possibilities Table (Part I)(Part I)

Huts Radios

112 0

98 7

80 13

[The Whole CrewMakes Huts]

[Professor Makes RadiosThe Rest Make Huts]

[Professor and MaryanneMake Radios, The Rest Make Huts]

The Rest of the CrewThe Rest of the Crew

• Now, let’s consider what would happen if, one by one, the rest of the crew moved into radio production from hut production.

• Remember -- you want to take the people who are best at making radios and not very good at making huts out of hut production and put them in radio production first.

Who Next?Who Next?

• First the Mr. Howell, then Mrs. Howell, then Ginger, then The Skipper, and lastly - of course would be Gilligan, since he is probably the worst at making radios.

• Let’s see how we might include each of these production possibilities in our table.

Production Possibilities Table Production Possibilities Table (Complete)(Complete)

Huts Radios

112 0

98 7

80 13

1860

40 22

22 25

8 27

0 28

Production Possibilities FrontierProduction Possibilities Frontier

• This table let’s us know how much our island economy can produce. Now, let’s try to get a graphical sense of these possibilities.

• To do this we to measure the quantity of each good on the x and y axes.

Production Possibilities FrontierProduction Possibilities Frontier

Quantity of Huts

Quantity of Radios

Production Possibilities FrontierProduction Possibilities Frontier

Huts

Radios0

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Production Possibilities FrontierProduction Possibilities Frontier

Huts

Radios0

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This is the first line inthe table - where thereare no radios and 112huts produced

Production Possibilities FrontierProduction Possibilities Frontier

Huts

Radios0

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This is the second line inthe table - where thereare 7 radios and 98huts produced

Production Possibilities FrontierProduction Possibilities Frontier

Huts

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These are all of the production possibilitiesfrom our table

Production Possibilities FrontierProduction Possibilities Frontier

Huts

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When we connect the pointswe have the “ProductionPossibilities Frontier”

Production Possibilities Frontier Production Possibilities Frontier DefinedDefined

Production Possibilities Frontier (PPF) - graph that shows all combinations of goods and services that can be produced given the resources of society and the existing state of technology

Assumptions made in using a Assumptions made in using a PPFPPF

• There are only 2 goods in the economy

• Everything produced is consumed

• Resources and technology are held constant

Concepts Illustrated by the PPFConcepts Illustrated by the PPF

• Opportunity Cost– Constant– Increasing

• Scarcity

• Productive Efficiency

• Growth

Opportunity CostOpportunity Cost

Opportunity Cost - the next best alternative forgone when a resource is used.

“There is no such thing as a free lunch.”

Opportunity Cost in Gilligan’s Opportunity Cost in Gilligan’s IslandIsland

• When The Professor makes 7 radios, he is using his labor - a resource.

• That labor could have been used to make something else, specifically, it could have made 14 huts.

• Thus the opportunity cost of making the first 7 radios is 14 huts.

Per Unit Opportunity Cost in Per Unit Opportunity Cost in Gilligan’s IslandGilligan’s Island

• If the opportunity cost of making 7 radios is 14 huts, then the opportunity cost of making 1 radio must be 2 huts.

• Most of the time when we are thinking about opportunity cost, it is easier to think of it in “per unit” terms. In other words, ask yourself “what is the opportunity cost of making one unit of a good or service?”

How to Find Per Unit How to Find Per Unit Opportunity CostOpportunity Cost

A simple way to find the per unit opportunity cost is to use the following equation:

Units of Good or Service ForgoneUnits of a Good or Serve Produced

Opportunity Cost of a Good or Service Produced =

Examples of Opportunity Cost on Examples of Opportunity Cost on Gilligan’s IslandGilligan’s Island

• The Professor gave up making 14 huts for 7 radios. The opportunity cost of The Professor making a radio is 14/7 = 2 huts.

• Maryanne gave up making 18 huts to produce 6 radios. The opportunity cost of Maryanne making a radio is 18/6 = 3 huts.

• We can also find the opportunity cost of Maryanne making a hut = 6/18 = 1/3 of a radio.

Amount of Huts Given Up

Opportunity Cost and the PPFOpportunity Cost and the PPF

Huts

Radios0

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Amount ofRadios Gained

Amount of Huts Given Up

Opportunity Cost and the PPFOpportunity Cost and the PPF

Huts

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Amount ofRadios Gained

Opportunity Cost and the PPFOpportunity Cost and the PPF

• We know that the opportunity cost of radios is huts given up divided by radios gained.

• Graphically, that is the same thing as the vertical change divided by the horizontal change (if we ignore the negative sign). In other words, the opportunity cost of making a radio is the slope of the the PPF.

Increasing Opportunity CostsIncreasing Opportunity Costs

If we compute the opportunity cost of making radios for each member of the crew we find the following opportunity costs:

Professor - 2Maryanne - 3

Mister Howell - 4Ginger - 5

Mrs. Howell - 6The Skipper - 7

Gilligan - 8

Increasing Opportunity CostIncreasing Opportunity Cost

• Opportunity Cost increased because we picked people who were best at radios to make radios first. Then we kept choosing the best radio maker from all of the hut makers until we we left with the worst radio maker, Gilligan.

Increasing Opportunity Cost Increasing Opportunity Cost (Cont.)(Cont.)

This is because different parts of our economy are better suited for making different things. When starting to produce something we are going to want to make it as cheaply as possible. In other words - giving up as little as possible of other things. That is why the first person who makes radios is the professor, since he has the lowest opportunity cost of making radios.

Increasing Opportunity Cost Increasing Opportunity Cost (Cont.)(Cont.)

Note that generally as we make more and more of a good, the opportunity cost of making it increases. This is called the “The Law of Increasing Opportunity Cost.”

Constant Opportunity CostConstant Opportunity Cost

• If all of the crew are equally skilled at making huts and radios, then there are Constant Opportunity Costs

• This means that the slope of the PPF is constant.

Constant Opportunity CostConstant Opportunity Cost

Huts

0

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The opportunity cost ofmaking a radio is 6 huts.This is true regardless ofwhat combination of goods is produced.

Radios

ScarcityScarcity

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Since we have scarce resources, i.e. only7 people, we are limited in what we can produce. We cannot make 60 huts and 28 radios.

Productive EfficiencyProductive Efficiency

In order to be productively efficient, our economy must not be able to produce more of one good without producing less of another. In other words, we must be on the PPF. If we are inside of the PPF, we could produce more of one good without producing less of another.

Consider the 3 points on the following graph:

Productive EfficiencyProductive Efficiency

Huts

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A CB

Productive EfficiencyProductive Efficiency

Point A cannot be productively efficient since we can increase production of radios from 7 to 18 while still producing 60 huts.

Productive Efficiency (Cont.)Productive Efficiency (Cont.)

Point B is efficient since if we want to increase production of radios from 18 to 28, we must decrease our hut production from 60 to 0.

Productive Efficiency (Cont.)Productive Efficiency (Cont.)

Point C is unattainable, since no matter how we juggle our resources, we cannot produce that much. It is outside of our PPF.

GrowthGrowth

We all remember the special Gilligan’s Island movie where the Harlem Globetrotters’ (a very cool basketball team) plane crashed on the island. The episode involved a game for control of the world, but that is another story! For our purposes, let’s consider what would happen to our PPF.

Growth (Cont.)Growth (Cont.)

Now we have 10 more people who can produce huts and radios. If we assume that opportunity costs don’t change, then we can model this as a shifting out of the PPF

GrowthGrowth

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New PPF

Changes in TechnologyChanges in Technology

What if a book called “How to Make Radios Out of Coconuts in Half the Time!” washes up on shore? Everyone can now make radios faster. This is a change in the technology of radio production. While this does not allow us to make more huts, we can make more radios with the same resources.

Technology ChangeTechnology Change

Huts

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New PPF

Technology ChangeTechnology Change

• Note that the slope of the PPF changed - implying the opportunity cost changed

• This is because it now takes less time to make a radio, which means we are giving up less huts each time we make a radio!

How Does This Apply to The How Does This Apply to The Real World?Real World?

Gilligan’s Island is not real (I am sorry to say), but the lessons from it are very real.

• Our economy has thousands of goods, but we have a PPF like the crew has except instead of two axes for two goods, our PPF has many more axes.

Real World (Cont.)Real World (Cont.)

• Our economy has opportunity costs - a recent article pointed out that all of the money spent on new sports stadiums in the last 5 years could refurbish every elementary and secondary public school in the country.

• Our economy has growth - when the population grows or new resources are discovered the PPF shifts out.

Real World (Cont.)Real World (Cont.)

• Our economy faces technology changes - when the assembly line was invented we could make many goods faster. This moved our PPF much in the same way as it did in the example on Gilligan’s Island.