Production Possibilities Frontier 1

Outline I. Introduction to Gilligan’s Island A. Production Possibilities Table B. Production Possibilities Frontier II. Economic Concepts Illustrated with a PPF A. Opportunity Cost B. Scarcity C. Productive Efficiency D. Growth/Technology Change 2

Gilligan’s Island Recall that in the Gilligan’s TV show there are seven people stranded on a desert island: Gilligan, The Skipper, Maryanne, Ginger, Mr and Mrs. Howell, and the Professor. Assume that they only produce two things - huts (from Palm trees) and radios (from coconuts)

Production Possibilities (per month) If everyone is making huts they can produce 112 huts in one month and implicitly no radios. Let’s say they figure that it’s probably a good idea to make some radios. Who do they ask to stop making huts?

Who? The Professor Because he has been trained to do this and is not all skilled in hut production. So now the crew can make 7 radios and 98 huts in a month. What if they want to make more radios - who do they ask to do it?

Who Next? Whomever is next best at making radios relative to making huts - let’s say that is Maryanne. If Maryanne and the Professor are making radios, then the crew can produce 13 radios and 80 huts in a month.

Three Production Possibilities At this point we have three production possibilities for the crew. One in which they all make huts, one where all but the Professor make huts, and one where the Professor and Maryanne make radios and the rest make huts. Let’s look at this information in a table.

Production Possibilities Table Production Possibilities Table - a table that shows all combinations of goods and services that can be produced given the resources of society and the existing state of technology

Production Possibilities Table (Part I) Huts Radios 112 [The Whole Crew Makes Huts] [Professor Makes Radios The Rest Make Huts] 98 7 [Professor and Maryanne Make Radios, The Rest Make Huts] 80 13

The Rest of the Crew Now, let’s consider what would happen if, one by one, the rest of the crew moved into radio production from hut production. Remember -- you want to take the people who are best at making radios and not very good at making huts out of hut production and put them in radio production first.

Who Next? First the Mr. Howell, then Mrs. Howell, then Ginger, then The Skipper, and lastly - of course would be Gilligan, since he is probably the worst at making radios. Let’s see how we might include each of these production possibilities in our table.

Production Possibilities Table (Complete) Huts Radios 112 98 7 80 13 60 18 40 22 22 25 8 27 28

Production Possibilities Frontier This table let’s us know how much our island economy can produce. Now, let’s try to get a graphical sense of these possibilities. To do this we to measure the quantity of each good on the x and y axes.

Production Possibilities Frontier Quantity of Huts Quantity of Radios 14

Production Possibilities Frontier Huts 120 90 60 30 Radios 7 14 21 28 15

Production Possibilities Frontier Huts 120 90 This is the first line in the table - where there are no radios and 112 huts produced 60 30 Radios 7 14 21 28 16

Production Possibilities Frontier Huts 120 90 This is the second line in the table - where there are 7 radios and 98 huts produced 60 30 Radios 7 14 21 28 17

Production Possibilities Frontier Huts These are all of the production possibilities from our table 120 90 60 30 Radios 7 14 21 28 18

Production Possibilities Frontier Huts When we connect the points we have the “Production Possibilities Frontier” 120 90 60 30 Radios 7 14 21 28 19

Production Possibilities Frontier Defined Production Possibilities Frontier (PPF) - graph that shows all combinations of goods and services that can be produced given the resources of society and the existing state of technology 20

Assumptions made in using a PPF There are only 2 goods in the economy Everything produced is consumed Resources and technology are held constant

Concepts Illustrated by the PPF Opportunity Cost Constant Increasing Scarcity Productive Efficiency Growth

Opportunity Cost Opportunity Cost - the next best alternative forgone when a resource is used. “There is no such thing as a free lunch.”

Opportunity Cost in Gilligan’s Island When The Professor makes 7 radios, he is using his labor - a resource. That labor could have been used to make something else, specifically, it could have made 14 huts. Thus the opportunity cost of making the first 7 radios is 14 huts.

Per Unit Opportunity Cost in Gilligan’s Island If the opportunity cost of making 7 radios is 14 huts, then the opportunity cost of making 1 radio must be 2 huts. Most of the time when we are thinking about opportunity cost, it is easier to think of it in “per unit” terms. In other words, ask yourself “what is the opportunity cost of making one unit of a good or service?”

How to Find Per Unit Opportunity Cost A simple way to find the per unit opportunity cost is to use the following equation: Opportunity Cost of a Good or Service Produced = Units of Good or Service Forgone Units of a Good or Serve Produced

Examples of Opportunity Cost on Gilligan’s Island The Professor gave up making 14 huts for 7 radios. The opportunity cost of The Professor making a radio is 14/7 = 2 huts. Maryanne gave up making 18 huts to produce 6 radios. The opportunity cost of Maryanne making a radio is 18/6 = 3 huts. We can also find the opportunity cost of Maryanne making a hut = 6/18 = 1/3 of a radio.

Opportunity Cost and the PPF Huts 120 Amount of Huts Given Up 90 Amount of Radios Gained 60 30 Radios 7 14 21 28 28

Opportunity Cost and the PPF Huts 120 90 Amount of Huts Given Up 60 Amount of Radios Gained 30 Radios 7 14 21 28 29

Opportunity Cost and the PPF We know that the opportunity cost of radios is huts given up divided by radios gained. Graphically, that is the same thing as the vertical change divided by the horizontal change (if we ignore the negative sign). In other words, the opportunity cost of making a radio is the slope of the the PPF.

Increasing Opportunity Costs If we compute the opportunity cost of making radios for each member of the crew we find the following opportunity costs: Professor - 2 Maryanne - 3 Mister Howell - 4 Ginger - 5 Mrs. Howell - 6 The Skipper - 7 Gilligan - 8

Increasing Opportunity Cost Opportunity Cost increased because we picked people who were best at radios to make radios first. Then we kept choosing the best radio maker from all of the hut makers until we we left with the worst radio maker, Gilligan.

Increasing Opportunity Cost (Cont.) This is because different parts of our economy are better suited for making different things. When starting to produce something we are going to want to make it as cheaply as possible. In other words - giving up as little as possible of other things. That is why the first person who makes radios is the professor, since he has the lowest opportunity cost of making radios.

Increasing Opportunity Cost (Cont.) Note that generally as we make more and more of a good, the opportunity cost of making it increases. This is called the “The Law of Increasing Opportunity Cost.”

Constant Opportunity Cost If all of the crew are equally skilled at making huts and radios, then there are Constant Opportunity Costs This means that the slope of the PPF is constant.

Constant Opportunity Cost Huts 120 The opportunity cost of making a radio is 6 huts. This is true regardless of what combination of goods is produced. 90 60 30 Radios 7 14 21 28

Scarcity Huts Since we have scarce resources, i.e. only 7 people, we are limited in what we can produce. We cannot make 60 huts and 28 radios. 120 90 60 30 Radios 7 14 21 28 37

Productive Efficiency In order to be productively efficient, our economy must not be able to produce more of one good without producing less of another. In other words, we must be on the PPF. If we are inside of the PPF, we could produce more of one good without producing less of another. Consider the 3 points on the following graph:

Productive Efficiency Huts 120 90 60 A B C 30 Radios 7 14 21 28 39

Productive Efficiency Point A cannot be productively efficient since we can increase production of radios from 7 to 18 while still producing 60 huts.

Productive Efficiency (Cont.) Point B is efficient since if we want to increase production of radios from 18 to 28, we must decrease our hut production from 60 to 0.

Productive Efficiency (Cont.) Point C is unattainable, since no matter how we juggle our resources, we cannot produce that much. It is outside of our PPF.

Growth We all remember the special Gilligan’s Island movie where the Harlem Globetrotters’ (a very cool basketball team) plane crashed on the island. The episode involved a game for control of the world, but that is another story! For our purposes, let’s consider what would happen to our PPF.

Growth (Cont.) Now we have 10 more people who can produce huts and radios. If we assume that opportunity costs don’t change, then we can model this as a shifting out of the PPF

Growth Huts 120 New PPF 90 60 30 Radios 7 14 21 28 45

Changes in Technology What if a book called “How to Make Radios Out of Coconuts in Half the Time!” washes up on shore? Everyone can now make radios faster. This is a change in the technology of radio production. While this does not allow us to make more huts, we can make more radios with the same resources.

Technology Change Huts 120 New PPF 90 60 30 Radios 7 14 21 28 47

Technology Change Note that the slope of the PPF changed - implying the opportunity cost changed This is because it now takes less time to make a radio, which means we are giving up less huts each time we make a radio!

How Does This Apply to The Real World? Gilligan’s Island is not real (I am sorry to say), but the lessons from it are very real. Our economy has thousands of goods, but we have a PPF like the crew has except instead of two axes for two goods, our PPF has many more axes.

Real World (Cont.) Our economy has opportunity costs - a recent article pointed out that all of the money spent on new sports stadiums in the last 5 years could refurbish every elementary and secondary public school in the country. Our economy has growth - when the population grows or new resources are discovered the PPF shifts out.

Real World (Cont.) Our economy faces technology changes - when the assembly line was invented we could make many goods faster. This moved our PPF much in the same way as it did in the example on Gilligan’s Island.