I'm reading an economics textbook and trying to make sense of PPF (or PPC) concept. All examples I could find are like producing computers vs food. I can't understand how it can be evaluated and applied to real life situation. Do you know any practical example of PPF?
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5 Answers
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In the 1940's the RAND corporation put together a series of simulations about war between the USA and the USSR. In the end, they came out with a series of two "good" possibilities, degree of victory and number of crew lives saved.
The US Air Force asked RAND to apply systems analysis to design a first strike on the Soviets. .... Paxson and RAND were initially proud of their optimization model and the computing power that they brought to bear on the problem, which crunched the numbers for over 400,000 configurations of bombs and bombers using hundreds of equations. The massive computations for each configuration involved simulated games at each enemy encounter, each of which had first been modeled in RAND’s new aerial combat research room. They also involved numerous variables for fighters, logistics, procurement, land bases, and so on. Completed in 1950, the study recommended that the United States fill the skies with numerous inexpensive and vulnerable propeller planes, many of them decoys carrying no nuclear weapons, to overwhelm the Soviet air defenses. Though losses would be high, the bombing objectives would be met. While RAND was initially proud of this work, pride and a haughty spirit often go before a fall. RAND’s patrons in the US Air Force, some of whom were always skeptical of the idea that pencil-necked academics could contribute to military strategy, were apoplectic. RAND had chosen a strategy that would result in high casualties, in part because the objective function had given zero weight to the lives of airplane crews.
Retrospectives: The Cold-War Origins of the Value of Statistical Life
RAND quickly backpedaled on the study, and instead moved to a more cautious approach which spelled out a range of choices: for example, some choices might cost more in money but be expected to have fewer deaths, while other choices might cost less in money but be expected to have more deaths. The idea was that the think tank identified the range of choices, and the generals would choose among them. But of course, financial resources were limited by political considerations, and so the choices made by the military would typically need to involve some number of deaths that was higher than the theoretical minimum--if more money had been available. In that sense, spelling out a range of tradeoffs also spelled out the monetary value that would be put on lives lost.
The Origins of the Value of a Statistical Life Concept
Maybe that's too much like the two input story of Aerandal. Depends on if you consider the saved lives a "savings" or a "good". For a clearer example of the guns vs. butter tradeoff, consider another example from WW II.
In February 1942, Fisher Body completely stopped making auto bodies and began assembling the famous M-4 "Sherman" tank in its No. 1 plant in Flint. The operation eventually moved to Grand Blanc and would turn out 11,358 tanks by 1945.
Buick tackled the manufacture of ammunition, churning out 75,000 casings per month for the duration. By the war's end, the division had supplied more than 12.5 million casings.
Buick also retooled to meet the demands of making engines for the B-24 bomber. At first, they talked of about 500 engines a month, but the government doubled its order by the time Buick had its tooling in place. By 1944, Buick's Melrose Park factory was regularly turning out 2,000 engines a month....
In all, more than 113,000 employees left GM to serve while the company churned out $12.3 billion in aircraft, tanks, vehicles and arms.
When it was all counted up after the war, GM had produced 854,000 trucks (including the legendary DUKW, or "Duck" amphibious vehicles), 198,000 diesel engines, 206,000 aircraft engines, and 38,000 tanks, tank destroyers, and armored vehicles, not to mention vast quantities of guns and ammunition.
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$\begingroup$ I like the second part of your answer. I'm not really sure whether PPF in these cases was curved inward or outward. Still, they are true real life case when one product takes resources from another. $\endgroup$– modularCommented Jan 20, 2015 at 20:20
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Production possibility frontier is not about producing two different goods, it is about producting one good, with two different resources, typically labour and capital.
For instance, a PPF would be how to produce a car, with either machines or workers. If you have a lot of machines you need less workers, and conversely.
Edit1 Note that these domains are -to my limited knowledge- mainly used for theoretical purposes, namely the two welfare theorems and their implications. I am not sure it is the most applied branch of economics
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$\begingroup$ I like your definition of PPF in a sense that its real world application is quite obvious: e.g. time is money. But I'm talking about this PPF meaning $\endgroup$– modularCommented Jan 20, 2015 at 14:43
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$\begingroup$ damn since the opening of this SE i keep rediscovering undergrad economics -_- I edited my answer a little bit, Ill think more about it a bit later $\endgroup$ Commented Jan 20, 2015 at 15:23
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$\begingroup$ I find theoretical basis of mainstream economics very unconvincing (at least as it's often taught) - that's why I'm asking about applications of PPF concept. $\endgroup$– modularCommented Jan 20, 2015 at 20:29
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$\begingroup$ @Aerandal A production possibility frontier shows combinations of two goods that can be produced from given resources. A line showing possible combinations of two resources to produce a given quantity of a good is known as an isoquant. $\endgroup$ Commented Jan 21, 2015 at 8:23
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Another example for the different possibilities of maximum amounts of good/services that an economy/country can produce could be that of guns or butter, the country must make a decision between the two possibilities and how much of the two goods they want to produce. in this case guns mean armaments (for the defence of the country) and butter means food (to be consumed for the population). futhermore, the choice made between two possibilities involves an oppurtunity cost and the country/economy must make a decision based on its current economic situation. A country might want to produce more of capital goods as they will create a future stream of benefits whereas consumer goods are consumed immediately having no long term benefits. Another choice that the economy could face is between education and healthcare, if the country has as ageing population like Japan, they might want to invest more in healthcare, but with a growing population like that in India, the country might want to invest in the alternative of education more than investing in healthcare. Since the resources required in any of the examples are not the same the PPC is always going to be curved.
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An example of an opportunity cost would be Japan giving up quality education for better healthcare. The marginal benefit would be having more healthcare for Japan´s elderly citizens.
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I remember all those graphs from macro economics classes. I mentally imagined interns at the Fed collecting data from industry and dutifully plotting data that quantified the tradeoff between “bicycles vs computers”, and “guns vs butter”, etc. which after monthly open conference calls at the Fed translated to multi-billion dollar contracts getting awarded to Trek vs IBM, and Raytheon vs Land'O'Lakes.
But no such thing, I think these are merely theoretical examples to illustrate conceptually how and why an entity (company, country, etc.) that is good at many things could find ways to profitably trade with others that may be less good at some or even all those things.
In practice, in a free-market economy (even one with extensive government subsidies and incentives) these trades are independently discovered and executed by countless individuals and firms on countless opportunities. There is no bureau where statisticians create and publish these PPF charts.
Even inside a single company, even one with a limitless market research budget, do you even get to see the canonical "Price vs Quantity" demand curve in anything but tiny glimpses, because no one can really afford to run the experiment running from zero price to zero demand. You'll see products go on and off sale to get local estimates, to get some sense of it, but do that too much and customer behavior will start to change and affect the curve.
