P roduction P ossibilities F rontiers

1. ProductionPossibilitiesFrontiers Rick Weber See also: http://www.rick-weber.com/EC101/tag/ppf/

2. What’s the big idea?! • Thinking on paper with 2D graphs • Ceteris paribus which means “all else equal” • Law of diminishing marginal returns • Marginal/Opportunity cost

3. Disclaimer! • There’s going to be a bit of jargon here • Sometimes different terms describe the same phrase • I usually use the “fancier” term out of habit. • These are some big concepts that are central to economics! • And we’re moving fast! Slides are online at Rick-Weber.com/EC101

4. Welcome to the Cartesian Plane • AKA: two-dimensional space • AKA: graphs, like back in high school where • THIS WILL COME BACK AGAIN AND AGAIN! • Get a handle on it now to make your life easier in the future!

5. What is this 2D graph thing? • Each axis represents some thing. • Moving further along the axis indicates different quantities. • Each point represents some combination of the two things. • Pro Tip: Consider 2x2 tables. • Bottom left: not much of either thing • Top right: lots of both things • Top left/Bottom right: lots of just one of the things • A graph allows us to show relationships between the two things. • Note that we are only changing these two variables (i.e. “everything else held equal”).

6. Ceteris Paribus: All Else Equal • This is one of the most important things you can take away from economics. • This is a tool of thought experiments • It’s much easier to think about changing two variables than changing all variables at once. • Also, using the Latin makes you sound fancy!

7. Draw a Budget Constraint • On a piece of paper, draw a 2D graph that illustrates how much fish and/or coconuts you can afford. • If you spent all of your money on coconuts, how many do you get? • This is a point on the “coconut” axis. • You can get the same point for fish axis. • Connect these two points with a straight line.

8. Buying Fish and Coconuts • Fish costs $9.99 each • Coconuts cost $3.33 each • You have $50

9. What if you didn’t buy fish/coconuts with cash? • What does your budget constraint look like if you’re “buying” fish/coconuts with your own effort.

10. Hunting/gathering Fish and Coconuts • At the grocery store, it’s easy to get more fish or coconuts… just pay more. • When you’re stranded on an island, some coconuts are laying on the ground, but others will be harder to find.

11. PPF – Production Possibilities Frontier • A PPF illustrates the maximum combinations of products that can be produced with a given set of resources and talent • Production: we’re looking at what we can produce • Possibilities: we’re looking at what we can produce • Frontier: we’re looking at the edge or maximum possible levels of production • Simplifying assumption: we’re looking at just two goods

12. Law of Diminishing Marginal Returns Defined • Principle of diminishing value: “The more you have of a good [ceteris paribus] the less you value having a little more.” • This is essentially the same thing as… • LoDMR: “If you hold all inputs but one constant and increase that one, eventually its marginal product begins to decline.”

13. Hunting/gathering Fish and Coconuts • Some coconuts are laying on the ground, but some will be harder to find. • However many coconuts you could gather in a day, the last one you find before giving up will be the hardest.

14. Economic growth! • Over the last few days you’ve spent less time hunting/gathering so you could collect vines and make a net! • What happens to your PPF? (discuss with the person next to you)

15. Economic growth! • If you spend all your time gathering coconuts, the net is worthless. • If you spend all your time fishing, the net is fantastic!

16. Law of Diminishing Marginal Returns • The first coconut you collect will be the easiest one. • If you decide to look for more, you will then start looking higher up trees. • If you spend all your time gathering coconuts, you give up the chance to catch fish

17. PPFs illustrate cost: • What is the cost of the 3rd fish? • http://www.polleverywhere.com/multiple_choice_polls/53o7uxEmFEPLcD4 • What is the cost of the 22nd coconut? • http://www.polleverywhere.com/multiple_choice_polls/VfecyfjBBSFLosO

18. Opportunity Cost: Example • You have a $5 gift certificate that expires tonight. • You can spend that on either: • Two slices of pizza • A slice and a coke • What is the cost of the second slice of pizza? • Hint: TANSTAAFL

19. Opportunity Cost • This is (another) one of the most important things you can take away from economics. • If you choose one thing, you can’t do something else. • Even if you have unlimited money and you’ll live forever, this moment (right now!) is still scarce. • The cost of your choice is the opportunity to do something else. • But had you done something else, you wouldn’t have been able to do some third thing… what matters is what you would have done had you not made the choice you did.

20. Marginal Cost (MC) • Just a refinement of “Opportunity cost” • The opportunity cost of “one more”, or a small change in behavior. • Comparing MC to marginal benefit (MB) tells you if you’re going in the right direction. • If you spend one more hour studying physics you have less time to study economics. If that hour studying physics will raise your GPA .0005 and the hour studying econ will raise your GPA .0006, then you’re spending too much time on physics. • Also, maybe, you might enjoy spending time with your friends.

21. Review: The big ideas • Thinking on paper with 2D graphs. • Ceteris paribus assumption makes our thought experiments useful. • PPF describes how much we can produce, ceteris paribus. • Law of diminishing marginal returns makes our PPF bend outward. • Marginal/Opportunity cost is (kindasorta) shown by the slope of PPF. • Kind of because cost is what you give up. • Not quite because what you really give up is the benefit of the good that you give up.