PRODUCTION POSSIBILITIES AND
COMPARATIVE ADVANTAGE
Economics 2023
Principles of Microeconomics
Dr. McCaleb
Production Possibilities and
Comparative Advantage
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TOPIC OUTLINE
I.
Production Possibilities
II. Comparative Advantage, Specialization and
Exchange
Production Possibilities and
Comparative Advantage
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Production Possibilities
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Production Possibilities Frontier (PPF)
Definition
The boundary between the combinations of goods and services that
can be produced and the combinations that cannot be produced, given
the available resources and the state of technology.
The PPF is a valuable tool for illustrating the effects of scarcity and
its consequences.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Production Possibilities Frontier (PPF)
Available resources
• Land: both raw land and natural resources taken from the land
• Capital: Machines, tools, other equipment, buildings, and business
inventories
• Labor force: All people willing and able to work whether they are
currently employed or unemployed
Increases (decreases) in the available resources increase (decrease) the
economy’s production possibilities--the PPF shifts out (in).
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
Production Possibilities
Frontier
The diagram shows the PPF for
bottled water and CDs. Each point
on the graph represents a column of
the table.The line through the points
is the PPF.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Production Possibilities Frontier (PPF)
The PPF illustrates three features of production
possibilities
• Attainable and unattainable combinations
• Full employment and unemployment
• Tradeoffs
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
Attainable and
Unattainable Combinations
We can produce at any point inside
the PPF or on the frontier.
Points outside the PPF such as point
G are unattainable.
Because the PPF shows the limits to
production, it separates attainable
combinations from unattainable
ones.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
Full Employment and
Unemployment
Full employment occurs when all
the available resources are being
used. Unemployment occurs when
some resources are available but are
not used.
When resources are fully employed,
production occurs at points on the
PPF such as D and E.
When resources are unemployed,
production occurs at a point inside
the PPF such as point H.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
Tradeoffs
A tradeoff is a constraint or limit to
what is possible that forces an
exchange or a substitution of one
thing for something else.
When production is on the PPF, we
face a tradeoff. To get more of one
good we must forgo some of the
other good as we move along the
PPF.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 The PPF and Opportunity Cost
The opportunity cost of a bottle of water
The PPF shows the marginal opportunity cost of a bottle of water.
The opportunity cost of a bottle of water is the decrease in the
quantity of CD’s divided by the increase in the number of bottles of
water as we move down along the PPF.
It is the quantity of CD’s that must be given up for one more bottle of
water, given the number of bottles of water we already have.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
The PPF and Opportunity Cost: Illustration
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 The PPF and Opportunity Cost
The Opportunity Cost of a CD
The opportunity cost of a CD is the decrease in the quantity of bottles
of water divided by the increase in the quantity of CD’s as we move
up along the PPF.
It is the quantity of bottles of water that must be given up for one
more CD, given the number of CD’s we already have.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
The PPF and Opportunity Cost: Illustration
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Increasing Opportunity Cost
Most activities are characterized by increasing
opportunity cost
The opportunity cost of a bottle of water increases as the quantity of
bottled water produced increases.
The opportunity cost of a CD increases as the quantity of CD’s
produced increases.
The shape of the PPF is bowed outward because opportunity cost
increases.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Consumption, Investment, and Economic
Growth
Using the PPF to illustrate the benefits and costs of
economic growth
More investment today means more total output in the future and an
increase in potential consumption. The decisions we make today about
how much to save and invest and how much to consume determine the
position of the future PPF.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
 Consumption, Investment, and Economic
Growth
The benefit of more current investment is more future consumption.
The opportunity cost of more current investment is less current
consumption. There is a trade-off between current consumption and
future consumption.
The shift in the PPF represents economic growth. Faster economic
growth requires that society devote more of its current resources to
investment and less to consumption.
Production Possibilities and
Comparative Advantage
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PRODUCTION POSSIBILITIES
The PPF and Economic
Growth
A country that chooses point A,
representing a relatively high level
of current consumption and a
relatively low level of investment,
sees its future PPF shift out to PPF
2010 with A.
A country that chooses point B,
representing a relatively lower level
of current consumption and a
relatively higher level of
investment, sees its future PPF shift
out to PPF 2010 with B.
Production Possibilities and
Comparative Advantage
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What is the effect of a technological improvement on an
economy’s production possibilities?
1. Increases (PPF shifts out)
2. No effect (PPF is unchanged)
3. Decreases (PPF shifts in)
Production Possibilities and
Comparative Advantage
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What is the effect of a hurricane on an economy’s
production possibilities?
1. Increases (PPF shifts out)
2. No effect (PPF is unchanged)
3. Decreases (PPF shifts in)
Production Possibilities and
Comparative Advantage
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What is the effect of an increase in the labor force* on an
economy’s production possibilities?
*Labor force=everyone willing and able to work, whether actually
employed or not=employed + unemployed
1. Increases (PPF shifts out)
2. No effect (PPF is unchanged)
3. Decreases (PPF shifts in)
Production Possibilities and
Comparative Advantage
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What is the effect of a decrease in unemployment on an
economy’s production possibilities?
1. Increases (PPF shifts out)
2. No effect (PPF is unchanged)
3. Decreases (PPF shifts in)
Production Possibilities and
Comparative Advantage
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Why do lawyers hire paralegals to do legal research even
though most lawyers can do legal research better than their
paralegals?
Why are more cows raised in Texas and more oranges in
Florida even though most of the land in Florida is more
productive than most of the land in Texas?
Why does the United States raise cotton and make it into
cloth, then ship the cloth to Pakistan, Bangladesh, and Sri
Lanka where it is made into garments (pants, shirts, etc.),
which are then shipped back to the United States?
Production Possibilities and
Comparative Advantage
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Comparative Advantage, Specialization and
Exchange
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Dewey, Cheatem, and Howe can
prepare 2 business tax returns in an
8 hour day or 4 personal tax returns,
or any linear combination.
H&R Blockhead can prepare 1
business return or 3 personal returns
in an 8 hour day, or any linear
combination.
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
Personal
Busines
s
Production Possibilities and
Comparative Advantage
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
25
COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
1. Which firm is more productive in
the preparation of business tax
returns?
2. Which firm is more productive in
the preparation of personal tax
returns?
Personal
Busines
s
Production Possibilities and
Comparative Advantage
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
26
COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
3. What is Dewey, Cheatem’s
opportunity cost to prepare a
business tax return?. . . to prepare
a personal return?
Personal
4. What is Blockhead’s opportunity
cost to prepare a business tax
return?. . . to prepare a personal
return?
Busines
s
Production Possibilities and
Comparative Advantage
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
27
COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
5. Which firm is the lower cost
preparer of business tax returns?
6. Which firm is the lower cost
preparer of personal tax returns?
Personal
Busines
s
Production Possibilities and
Comparative Advantage
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
28
COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Suppose the price of a personal
return is $50.
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
7. What is the minimum price
Blockhead would charge for a Personal
business return?
Busines
s
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
8. What is the minimum price
Dewey, Cheatem would charge
for a business return?
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
Comparative Advantage:
Example
Suppose the price of a business
return is $150.
Dewe
y, Che
atem and
Howe
Personal
0 1 2 3 4
Busines
s
2 1.5 1 0.5 0
9. What is the minimum price
Blockhead would charge for a Personal
personal return?
Busines
s
H&RBlockh
ead
0 1 2 3
1 0.670.33 0
10.What is the minimum price
Dewey, Cheatem would charge
for a personal return?
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
 Absolute and Comparative Advantage
Absolute advantage
The ability to perform more of an activity or produce more of a good
or service with a given amount of resources or in a given amount of
time. Absolute advantage reflects greater physical productivity.
Comparative advantage
The ability to perform an activity or produce a good or service at a
lower opportunity cost. Comparative advantage reflects greater
economic efficiency.
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
 Absolute and Comparative Advantage
Comments
A person, state, region, or country can have an absolute advantage in
everything.
A person, state, region, or country cannot have a comparative
advantage in everything.
Every person, state, region, or country has a comparative advantage
in something.
Production Possibilities and
Comparative Advantage
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Katie completes a math problem in 5 minutes and a
chemistry problem in 10 minutes. Joanne completes a
math problem in 15 minutes and a chemistry problem in
20 minutes. Katie has an absolute advantage in
completing
1. Math problems only
2. Chemistry problems only
3. Both math and chemistry problems
4. Neither math nor chemistry problems
Production Possibilities and
Comparative Advantage
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Katie completes a math problem in 5 minutes and a
chemistry problem in 10 minutes. Joanne completes a
math problem in 15 minutes and a chemistry problem in
20 minutes. Katie has a comparative advantage in
completing
1. Math problems only
2. Chemistry problems only
3. Both math and chemistry problems
4. Neither math nor chemistry problems
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
 Comparative Advantage
The law of comparative advantage
Individuals, firms, states, regions, and nations all gain by
• specializing in the production of goods for which their
opportunity cost is relatively low
• not producing goods for which their opportunity cost is
relatively high
• and exchanging the goods they produce for other goods they
wish to consume.
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
The Law of Comparative
Advantage: Example
If Tom produces his own bottles and
his own water, his production and
consumption possibilities are
defined by his PPF.
If Nancy produces her own bottles
and her own water, her production
and consumption possibilities are
defined by her PPF.
For example, if both Tom and
Nancy are at point A, they each
produce and consume 1,000 bottles
and 1,000 gallons per hour.
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
The Law of Comparative
Advantage: Example
Suppose Tom and Nancy specialize
in producing the good in which they
have a comparative advantage.
Tom has a comparative advantage
in bottles so he produces 4,000
bottles and no water (point B).
Nancy has a comparative advantage
in water so she produces 4,000
gallons of water and no bottles
(point B’).
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
The Law of Comparative
Advantage: Example
By exchanging goods, Tom’s and
Nancy’s consumption possibilities
are defined by the red trade line.
Tom produces 4,000 bottles and
buys water from Nancy.
Nancy produces 4,000 gallons of
water and buys bottles from Tom.
Both consume at point C, which is
outside their PPFs. Both Tom and
Nancy are better off with
specialization and exchange.
Production Possibilities and
Comparative Advantage
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COMPARATIVE ADVANTAGE
 Gains from Exchange
Specialization and exchange increases economic
efficiency
Specialization and exchange according to the law of comparative
advantage results in net gains for all.
Gains from specialization and trade are determined by comparative
advantage, not absolute advantage.
Comparative advantage results from opportunity costs that differ. So
when opportunity costs differ, gains from specialization and trade are
always available.
Production Possibilities and
Comparative Advantage
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Katie completes a math problem in 5 minutes and a
chemistry problem in 10 minutes. Joanne completes a
math problem in 15 minutes and a chemistry problem in
20 minutes. They can complete the most problems in the
least time if
1. Katie works all the problems.
2. Katie works none of the problems.
3. Katie works the math problems and Joanne works
the chemistry problems.
4. Katie works the chemistry problems and Joanne
works the math problems.
Production Possibilities and
Comparative Advantage
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