Overview
This lecture covers the Production Possibilities Frontier (PPF), how it illustrates opportunity cost and trade-offs, and methods for calculating opportunity cost using both graphical and numerical approaches.
The Role of Economists and Models
- Economists analyze situations as scientists (describe how things are) and as policy advisors (prescribe actions).
- Economic models simplify reality to focus on essential relationships, such as with the circular flow diagram and the PPF.
The Production Possibilities Frontier (PPF)
- A PPF shows the maximum combinations of two goods an economy can produce using available resources and technology.
- Moving from producing more of one good to another involves a trade-off, captured by the PPF's slope.
Opportunity Cost and Trade-Offs
- Opportunity cost is what is given up to obtain something else.
- On the PPF, opportunity cost is represented by the slope: as you produce more of one good, you must give up some amount of the other.
- For example, moving from 5,000 tons of wheat and 0 computers to 0 wheat and 500 computers means giving up 5,000 wheat to gain 500 computers.
Calculating Opportunity Cost: Methods
- Mankiw's method: Opportunity cost equals the absolute value of the slope (rise over run) between two points on the PPF.
- Professor's method: Use extreme PPF points; opportunity cost = what you give up (numerator) divided by what you get (denominator).
- Example: Opportunity cost of 1 computer = 5,000 wheat ÷ 500 computers = 10 wheat per computer.
Comparing Opportunity Costs Between Countries
- Calculate what each country gives up to make more of one good (using their PPF extremes).
- Lower opportunity cost means a country sacrifices less of one good to produce another.
- Example: France gives up 2 wines per cloth, England gives up 2/3 wine per cloth; England has lower opportunity cost for cloth.
Shifts in the PPF
- The PPF shifts outward with more resources or better technology, indicating increased production potential.
- The PPF can be straight or "bow-shaped" (curved), reflecting different opportunity costs at different points.
Key Terms & Definitions
- Production Possibilities Frontier (PPF) — curve showing all possible combinations of two goods that can be produced with available resources and technology.
- Opportunity Cost — the value of the next best alternative foregone when making a choice.
- Trade-off — sacrificing one good or service to produce more of another.
Action Items / Next Steps
- Practice calculating opportunity costs using both the slope method and the "give up/get" method.
- Review examples comparing opportunity costs between countries.
- Prepare for Chapter 3 on applying PPF concepts to international trade.