The PPF: Position, Properties and Opportunity Costs

Lecture 3

Dr. Jennifer P. Wissink©2015 John M. Abowd and Jennifer P. Wissink, all rights reserved.

September 1, 2015

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OFFICE HOURS NOTE for WISSINK: This week only Wissink’s Wednesday office hours will be from 11:45am-12:45pm.

i>clicker questionWhich one of the following would an economist classify as capital (K)?

A. An entrepreneur's $100 bill.B. The guitars used by the members in the band Fun.C. A corporate bond issued by IBM.D. Unfinished lumber purchased by a furniture manufacturer to make chairs.

The PPF: What You Get Typical teaching set-up:

– Two final goods.» Guns (G) and Butter (B)

– Two input goods and final goods technologies.» So drop “land” for now, no big deal.» Have Kapital (K) and Labor (L) that both go into making guns and butter

according to some known and given technology that can be described by production functions.

» G = g(K, L) and B = b(K, L)

– PPF is a frontier that shows the maximum amount of one good you can produce given a fixed amount of the other.

– Frontier is a graph.

GUNS

K LGuns(tons)

2 0 0

2 1 1

2 2 2

2 3 3

2 4 4

2 5 5

Gun Production Data (Given) &The Gun Production Function

Butter Production Data (Given) &The Butter Production Function

BUTTER

K LButter(lbs)

1 0 0

1 1 21

1 2 30

1 3 37

1 4 39

1 5 40

Guns & Butter & The PPF

GUNS

K LGuns(tons)

2 0 0

2 1 1

2 2 2

2 3 3

2 4 4

2 5 5

BUTTER

K LButter(lbs)

1 0 0

1 1 21

1 2 30

1 3 37

1 4 39

1 5 40

THE PPF

Butter

(lbs)Guns(tons)

The PPF Graphed

THE PPF

Butter

(lbs)Guns(tons)

40 0

39 1

37 2

30 3

21 4

0 5

i>clicker questionWhich one of the following output combinations is the most efficient?

A. The output combination at point A.B. The output combination at point B.C. The output combination at point C.D. The output combination at point D.E. None of the above.

The PPF & Its Properties

Its location depends on the endowment of resources, the time frame and the state of technologies and efficient production.

Its direction will typically be downward sloping.

– WHY?» If you are efficient and at the frontier,

you must give up “this” to get more of “that,” that is, there is a real cost!

Its curvature is typically “bowed-out” away from the origin [OR it’s a downward sloping straight line].

– WHY would it be “bowed-out”?» Heterogeneous factors of production» The law of diminishing marginal returns

The PPF:What It Tells Us & What is Does Not

What’s Feasible?

What’s Not?

What’s Efficient?

What’s Not?

What’s best?

What do guns cost us?

What does butter cost us?

Opportunity Cost The opportunity cost of an activity is the value of the

resources used in that activity when they are measured by what they would have produced when used in their next best alternative.

Total opportunity cost (TOC)

Marginal opportunity cost (MOC)

The slope of the PPF measures the marginal opportunity cost of producing one good in terms of the amount of the other good foregone.

The PPF: Measuring Opportunity Costs

Butter

lbs.Gunstons

40 0

39 1

37 2

30 3

21 4

0 5

The PPF, Its Slope & Increasing MOC

Increasing MOC: So Why The Bowed-Out PPF Curve?

Two-fold answer:– (1) Heterogeneous factors of production

– (2) The “Law of Diminishing Marginal Returns” (LDMR): As you add more and more of a variable factor to some activity, in the presence of a fixed factor, the marginal contribution of the variable factor will eventually decline.

Checking For The LDMR:Look At Marginal Product

Consider the marginal productivity of labor in each technology. Marginal productivity of labor=MPL= (change in output)/(change in labor)

Checking For The LDMR In Guns & ButterGUNS

K L Guns MP

2 0 0

2 1 1

2 2 2

2 3 3

2 4 4

2 5 5

BUTTER

K L Butter MP

1 0 0

1 1 21

1 2 30

1 3 37

1 4 39

1 5 40

production function for Guns

production function for Butter