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Production Possibility Frontier

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

The Production Possibilities

Frontier

Lets introduce the Production

Possibilities Frontier
better known as the PPF.

The PPF is a basic workhorse in

economics.
Important for understanding some basic
issues in economics.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

The PPF
Great application is with international
trade theory.
Helps one understand and distinguish
between comparative advantage and
absolute advantage.
An important historical figure in all this is
David Ricardo.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

David Ricardo
Famous 19th century British economist.
Some consider him the grandfather of
international trade theory.
Very influential in pioneering the theory of
comparative advantage, inter alia.
Very interesting, very bright guy.
Had a lot of say about the corn laws in
England.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

The Production Possibility

Frontier - What Is It?
The description of the best possible
combinations of two goods to produce
using all of the available resources.
Shows the trade-off between more of
one good in terms of the other.
Assumes: input endowments given,
technology given, time given and
efficient production.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

Opportunity Cost

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

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

A Typical PPF Picture

The marginal
opportunity cost of
guns in terms of
butter is
increasing as we
move down the
PPF!

Butter
just attainable

inefficient

unattainable

just attainable

The PPF is
typically bowedout or linear.
It is not bowed-in

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Guns

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

Comparative Advantage
The person with the lower marginal
opportunity cost of an activity has the
comparative advantage at that activity.
This means that the person with the
comparative advantage can produce
the activity by giving up the smallest
amount of the alternative activity.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

The Idea of Comparative

Advantage and Trade
Specialization and free trade will benefit
all trading parties, even when some are
absolutely more efficient producers
than others.
Need to understand absolute vs.
comparative advantage.

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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

Absolute vs. Comparative

Absolute advantage: if your country uses fewer resources
Advantage
to the
Trade
to produce a given Applied
unit of output than
other country.

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Comparative advantage: if your country can produce the

output at a lower marginal cost in terms of other goods
foregone than the other country.
Every country (or person, or economy) has a comparative
advantage at some activity.
Absolute advantage is not important and may not always
happen. Sometimes people or countries have the absolute
advantage in nothing! Yet trade possibilities still exist.
Its all about comparative advantage.

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

10

PPFs and Comparative

Advantage
Maximum Production Rates

Production P

Random Relative Price Relative Price

Access
of RAM (kg of Corn Meal
Corn meal Memory (k
corn per k
(k chips per
Producer (kg/day) chips/day)
chips)
kg corn meal)
Juanita
12
4
3.00
0.33
Julio
8
2
4.00
0.25

In this example, there are two goods being produced: Corn meal and RAM.
Juanita has an absolute advantage at both: she can produce more of each than
Julio.
Juanita has a comparative advantage at producing RAM compared to Julio: she
gives up 3.00 kg/day of corn meal to make an additional 1k of chips.
Julio has a comparative advantage at producing corn meal compared to Juanita: he
gives up 0.25 k chips to make an additional kg of corn meal.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Production Possibilities
Production Possibilities (2)
8.00

7.00

RAM (k chips/day)

6.00

Julio varies production of both while Juanita stays

specialized in RAM. Slope equals Julio's price of corn
meal in terms of RAM = -0.25 k chips/kg corn meal.
Juanita varies production
of both while Julio stays
specialized in corn meal.
Slope equals Juanita's
price of corn meal in
terms of RAM = -0.33 k
chips/kg corn meal.

5.00

4.00

3.00

2.00

1.00

0.00
0 1 2 3 4 5 6 7 8 9 10 111213 141516 171819 202122 232425 262728 2930

When we draw the

production possibilities
for Juanita and Julio,
there is a kink at 8
kg/day corn meal and
4.00 k chips/day RAM.
The chart shows who
specializes in corn
meal and RAM at each
production level.

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Corn m eal (kg/day)

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Adding a Third Producer

Maximum Production Rates

Production P
Random Relative Price Relative Price
Access
of RAM (kg of Corn Meal
Corn meal Memory (k
corn per k
(k chips per
Producer (kg/day) chips/day)
chips)
kg corn meal)
Juanita
12
4
3.00
0.33
Julio
8
2
4.00
0.25
Sergio
2
1
2.00
0.50

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Sergio has no absolute advantage; however, he has a

comparative advantage over both Juanita and Julio in the
production of RAM.
He sacrifices 2.00 kg of corn meal to make an additional 1k of
chips.
Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Adding a Fourth Producer

Maximum Production Rates

Producti
Random Relative Price Relative Price
Access
of RAM (kg
of Corn Meal
Corn meal Memory (k
corn per k (k chips per kg
Producer (kg/day) chips/day)
chips)
corn meal)
Juanita
12
4
3.00
0.33
Julio
8
2
4.00
0.25
Sergio
2
1
2.00
0.50
Maria
8
1
8.00
0.13

Question: What is Marias comparative advantage with

respect to each of the other three producers?
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Production Possibilities (All)

8.00

7.00

RAM (k chips/day)

6.00

5.00

4.00

3.00

2.00

1.00

0.00
0 1 2 3 4 5 6 7 8 9 1011 1213 141516 1718 192021 2223 242526 2728 2930

producers enter the

economy, the
production possibility
curve gets more and
more bowed out
(concave).
Along any segment,
most of the producers
are fully specialized.
Only one producer is
producing both goods
along any segment.

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Comparative Advantage and

Specialization
As more and more

Corn meal (kg/day)

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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The Supply Curve from the

PPF

At each relative
price of RAM in
terms of foregone
corn meal, we
can determine the
market supply

Maximum Production Rates

Producti
Random Relative Price Relative Price
Access
of RAM (kg
of Corn Meal
Corn meal Memory (k
corn per k (k chips per kg
Producer (kg/day) chips/day)
chips)
corn meal)
Juanita
12
4
3.00
0.33
Julio
8
2
4.00
0.25
Sergio
2
1
2.00
0.50
Maria
8
1
8.00
0.13

Supply Curve for RAM

The table shows

how much is
supplied and who
is producing.

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Quantity
of RAM (k
Chips)
0
1
5
7
8

Relative
Price of RAM
(kg corn/k
RAM)
0.00
2.00
3.00
4.00
8.00

Who is Producing RAM

Chips
No one
Sergio
Sergio, Juanita
Sergio, Juanita, Julio
Sergio, Juanita, Julio, Maria

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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The Supply Curve for RAM

Relative Price (kg corn
m eal/k chips)

Supply Curve for RAM

10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
0

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RAM (k chips/day)

The graph shows the supply curve for RAM based on the data in the previous table. Each
additional supplier is shown above the segment where that supplier determines the relative
price.

The supply curve of RAM is rising, reflecting the increasing opportunity cost (also called
marginal cost) of RAM in terms of foregone corn meal.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Supply Curve for Corn Meal

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Do the exact same thing...

But in reverse!

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Supply Curve for Corn Meal:

Graph
Relative Price (k chips/kg
m eal)

Supply Curve for Corn Meal

0.700
0.600
0.500
0.400
0.300
0.200
0.100
0.000
0 1

2 3 4 5

6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
Corn Meal (kg/day)

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The supply curve for corn meal is shown above.

The new producer along each segment is
indicated above.
Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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International Trade
Maximum Production Rates
Random
Relative Price Relative Price
Access
of RAM (kg
of Corn Meal
Corn meal Memory (k
corn per k (k chips per kg
Producer
(kg/day)
chips/day)
chips)
corn meal)
Country U
12
4
3.00
0.33
Country M
8
2
4.00
0.25
International price
3.50
0.29

All the facts are the same as in the previous example except that now we are
talking about countries that can trade at an international price.
The international price is between the relative prices that prevail in each country
when no trade is permitted.
There are many countries in the market in addition to the two shown so that a
country can buy or sell as much as it wants or produces at the international price.
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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RAM (k
chips/day) no
Trade
RAM (k
chips/day) with
Trade

4.00
3.50

RAM (k chips/day)

Country U Production Possibilities

3.00
2.50
2.00
1.50
1.00
0.50
0.00
0

10

11

12

13

14

15

Corn Meal (kg/day)

advantage in RAM
production.
The blue line shows its
production possibilities
without trade. Slope = 0.33.
The red line shows the
possibilities at the
international price of 0.29 k
chips per kg corn (or 3.50
kg corn/ k chips RAM).
Slope = 0.29.
The gain to trade is the
distance between the two
production possibility curves.
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Country Us Production and

Gains from Trade
Country U has a comparative

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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RAM (k
chips/day) no
Trade
RAM (k
chips/day) with
Trade

2.50

2.00

RAM (k chips/day)

Country M Production Possibilities

1.50

1.00

0.50

0.00
0

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Corn Meal (kg/day)

advantage in corn meal

production.
The blue line shows its
production possibilities
without trade. Slope = 0.25.
The red line shows the
possibilities at the
international price of 0.29 k
chips/ kg corn (or 3.50 kg
corn/ k chips RAM). Slope =
0.29.
The gain to trade is the
distance between the two
production possibility curves.
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Country Ms Production and

Gains from Trade
Country M has a comparative

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Question
If country U chooses to consume 7
kg/day of corn meal, what is the gain to
trade from specializing in RAM
production, measured in k chips/day of
RAM?

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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Answer

Country U Production Possibilities

RAM (k
chips/day) no
Trade
RAM (k
chips/day) with
Trade

4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
0

10

11

12

13

14

15

Corn Meal (kg/day)

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The vertical distance

between the blue and
red PPFs at a corn meal
consumption of 7 kg/day
measures country Us
gain to trade in k chips
RAM/day.
The point on the blue
PPF is the best country
U can do without trade.
With trade country U can
consume more RAM per
day, up to the point on
the red PPF.

RAM (k chips/day)

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Question
What is country Ms gain if it chooses to
consume 1.5 k chips per day,
measured in kg/day of corn meal?

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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Answer

Country M Production Possibilities

RAM (k
chips/day) no
Trade
RAM (k
chips/day) with
Trade

2.50

2.00

1.50

1.00

0.50

0.00
0

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Corn Meal (kg/day)

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The horizontal distance

between the red and blue
PPFs measures country
Ms gain to trade at a
RAM consumption of 1.5
k chips/day.
The blue PPF is the best
that country M can do
without trade.
Trade allows country M
to specialize in the
production of corn meal
and still benefit from a
higher consumption of
RAM.

RAM (k chips/day)

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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The International Supply

Curve for RAM

The international supply

curve for RAM is a rising
function of the opportunity
cost of RAM in terms of
foregone corn meal.
Which countries actually
produce RAM for the
international market will
depend upon where the
demand curve crosses this
supply curve.

Relative Price (kg corn meal/k chips)

Least Efficient
Producers

Most Efficient
Producers

Demand

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RAM (K chips/day)

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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The Sources of
Comparative
Advantage

The Heckscher-Ohlin Theorem is a theory that

explains the existence of a countrys comparative
advantage by its factor endowments.
Factor endowments: the quantity and quality of labor,
land, and natural resources of a country.
From Sweden in the early 1900s

According to the H-O theorem, a country has a

comparative advantage in the production of a product
if that country is relatively well endowed with inputs
used intensively in the production of that product.

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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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The Sources of
Comparative
Advantage

Edward Leamer of UCLAs five biggies:

Natural resources
Knowledge capital
Physical capital
Land

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Skilled and unskilled labor

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Other Explanations for

Observed Trade Flows

Product differentiation and competitive

markets
Acquired comparative advantage
Natural comparative advantages
Economies of scale
Trading Environments
Openness of Economy
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Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Note of Caution

Information on comparative advantage is often given in

many other forms - pay careful attention to the information
you are given.
Two more ways to present the same kind of information:
1 yd. of cloth
1 barrel of wine

England
2 hours
40 hours

Portugal
1 hour
10 hours

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England
Portugal
1 yd. of cloth
1 hour of labor in cloth .5 yd. of cloth
1 hour of labor in wine 1/40 bl. of wine 1/10 a bl. of wine

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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Absolute Advantage and

Comparative Advantage
1 yd. of cloth
1 barrel of wine

England
2 hours
40 hours

Portigal
1 hour
10 hours

England
Portigal
1 yd. of cloth
1 hour of labor in cloth .5 yd. of cloth
1 hour of labor in wine 1/40 bl. of wine 1/10 a bl. of wine

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Portugal has the A.A. in both wine and cloth.

England has the C.A. in cloth.
Portugal has the C.A. in wine.
Can you figure out the marginal opportunity cost for
each output in each country?
Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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From Opportunity Cost to

Marginal Cost

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The concept of marginal cost is the most important

concept in the theory of producer supply behavior.
Marginal cost is the additional cost associated with
increasing production by one unit.
In our production possibility examples, marginal cost
is the value of the activity that is reduced when the
other activity is increased by one unit.
Marginal cost is, therefore, the same thing as
marginal opportunity cost.

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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PPF Gymnastics

Butter

PPF new

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PPF old

The PPF is also useful

for many other types of
questions.
Questions about
efficiency.
Questions about equity.
Questions about tax
and transfer policy.
Questions about
composition of output.
Questions about growth
and productivity.
Guns

Prof. John M. Abowd and Jennifer P. Wissink, Cornell University

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