2)
Notes #2: Production Possibilities Frontier Model and Comparative Advantage (Ch. 3)
A. Production Possibilities Model
6 simplifying assumptions of the model:
A.
B.
Two goods are produced
Constant opportunity costs
C.
Fixed resources
D.
Fixed technology2
E.
Maximum efficiency
F.
Full employment
simple yet allows for opportunity costs
assumes perfectly substitutable
1
inputs; we'll relax this later
These two together:
i) determine potential output
ii) determine the position of the curve
iii) changes in either shift the curve
These two together:
i) determine actual output
ii) determine the point on the diagram
iii) changes in either move the point
1
an input that can be switched
from production process to
another without changing its
productivity, i.e., it’s equally
well suited to either process.
2
applied knowledge.
Monitors
Examp
ple 1. Constant Opportunity Costs.
Producction-Possibilities Schedule
Point
1000
Marginal opp
Monitors . cost (TV)
TV sets
800
A
0
1000
B
100
800
C
200
600
D
300
400
E
400
200
F
500
0
---
600
400
200
TV sets
constant opportunity cost =>
constant slope =>
curve is linear (straight line)
100
200
300
400
500
Calculating marginal opportunity costs (MOC)
MOCTV
=
M2 – M1
TV2 – TV1
note this is just the slope formula, “rise/run”
Now, to calculate the cost of moving from point A to point B, letting A be 1 and B be 2, we have
=
800 100 -
1000
0
=
-200
100
=
-2
ignoring the negative sign (“cost” implies a
negative), the marginal cost of an extra TV set is
2 monitors
Butter
500
Examp
ple 2. Increasing Opportunity Costs.
Producction-Possibilities Schedule
400
Point
Marginal opp.
cost (Guns)
Butter
Guns
A
0
400
B
100
380
300
---
200
C
200
300
D
300
180
E
400
0
100
increasing opportunity cost =>
increasing (steepening) slope =>
curve bows outward (concave to origin)
Guns
100
200
300
400
B. Comparative advantage example (based on David Ricardo, Principles of Political Economy and Taxation, 1817)
Maximum production possibilities per day
England
Portugal
Cloth
Wine
1000
800
1500
1800
Wine
Production-Possibilities Schedule
England
Production-Possibilities Schedule
Portugal
Point
Point
Cloth
Wine
Cloth
Wine
A
0
800
A
0
1800
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
B
1000
0
B
1500
0
OPPORTUNITY COST CALCULATIONS
2000
Opportunity Cost of CLOTH (c)
England: OCc = Qw/Qc = 800/1000 = 0.8 units of wine
1500
Portugal: OCc = Qw/Qc =1800/1500 = 1.2 units of wine
Since England's cost is lower, it has the comparative
advantage in CLOTH production.
1000
Opportunity Cost of WINE (c)
England: OCw = Qc/Qw = 1000/800 = 1.25 units of cloth
500
Portugal: OCw = Qc/Qw =1500/1800 = 0.83 units of cloth
Since Portugal's cost is lower, it has the comparative
advantage in WINE production.
500
1000
1500
2000
Cloth
Notes: (1) Always put
the good you are
calculating the cost of in
the DENOMINATOR of
the formula.
(2) The cost of CLOTH
production must be
measured in terms of
foregone units of wine
production, and vice
versa.
(3) Each country will
have the comparative
advantage in one of the
goods.