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Production Possibility Frontier Analysis

The document discusses two firms, A and B, that produce shoes (X) and boots (Y) using labor as the sole production factor. Firm A has an absolute advantage in producing shoes, while Firm B has an absolute advantage in producing boots, with Firm B also holding a comparative advantage in boots. The production possibility frontier (PPF) for the economy is to be drawn based on the comparative advantages of the firms.

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5 views1 page

Production Possibility Frontier Analysis

The document discusses two firms, A and B, that produce shoes (X) and boots (Y) using labor as the sole production factor. Firm A has an absolute advantage in producing shoes, while Firm B has an absolute advantage in producing boots, with Firm B also holding a comparative advantage in boots. The production possibility frontier (PPF) for the economy is to be drawn based on the comparative advantages of the firms.

Uploaded by

st105973
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

EXERCISE: THE RICARDO POINT

Two firms are operating in the economy – Firm A and Firm B. Each firm can produce two
products – X (shoes) and Y (boots) using only one factor of production (labor).
Firm А:
𝑋 𝐴 = 𝛼 𝐴 ⋅ 𝐿𝐴𝑋 𝑌 𝐴 = 𝛽 𝐴 ⋅ 𝐿𝐴𝑌 𝐿𝐴𝑋 + 𝐿𝐴𝑌 = 𝐿̅
where 𝛼 and 𝛽 are marginal products of labor, correspondingly, in shoe production and boot
production. 𝐿̅ is the total stock of time to be spent on production per day (typically, 8 hours).
Specifically:
𝑋 𝐴 = 4 ⋅ 𝐿𝐴𝑋 𝑌 𝐴 = 3 ⋅ 𝐿𝐴𝑌 𝐿𝐴𝑋 + 𝐿𝐴𝑌 = 8 ℎ𝑜𝑢𝑟𝑠
where 4 is the number of shoes that firm A produces during 1 hour of work, and 3 is the number
of boots that firm A produces during 1 hour of work.
Similarly, for Firm B:
𝑋 𝐵 = 𝛼 𝐵 ⋅ 𝐿𝐵𝑋 𝑌 𝐵 = 𝛽 𝐵 ⋅ 𝐿𝐵𝑌 𝐿𝐵𝑋 + 𝐿𝐵𝑌 = 𝐿̅
𝑋 𝐵 = 2 ⋅ 𝐿𝐵𝑋 𝑌 𝐵 = 5 ⋅ 𝐿𝐵𝑌 𝐿𝐵𝑋 + 𝐿𝐵𝑌 = 8 ℎ𝑜𝑢𝑟𝑠
It can be seen that Firm A has an absolute advantage in producing Х (𝛼 𝐴 > 𝛼 𝐵 ), while Firm B
has an absolute advantage in producing Y (𝛽 𝐴 < 𝛽 𝐵 ).
It is easy to check that the generic outlook of the production possibility frontier (PPF) of a single
firm is be represented by the following equation:
1 𝛽
𝑌(𝑋) = 𝛽 ⋅ 𝐿𝑌 = 𝛽 ⋅ (𝐿̅ − 𝐿𝑋 ) = 𝛽 ⋅ (𝐿̅ − ⋅ 𝑋) = 𝛽 ⋅ 𝐿̅ − ⋅ 𝑋
𝛼 𝛼
𝛽
which means that in this case PPF is linear. Evidently, coefficient reflects the comparative
𝛼
advantage.
In our example, Firm B has a comparative advantage in production of Y, while (automatically)
firm A has it in production of X:
𝛽𝐵 𝛽 𝐴 𝛼𝐵 𝛼 𝐴
> ⇔ <
𝛼𝐵 𝛼 𝐴 𝛽𝐵 𝛽 𝐴

TASK
Draw the production possibility frontier for the whole economy where the two firms operate.

GLOSSARY
Factor of production is any input used to produce goods and services.
Marginal product of labor (MPL) – the additional units of a good that a firm produces by
employing one more unit of labor, holding all other inputs and efficiency constant.

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