Production possibilities frontier
Economic growth through investment How investing for capital formation can expand the production possibilities frontier (PPF)
Economic growth through investment
- In the last few videos we have been talking
- about the Production Possibilities Frontiers.
- A relatively static thing, something you couldn't change
- but you could move along.
- What I want to do in this video is
- think about maybe there are ways
- to change or expand the Production Possibilities Frontier.
- And to do that, let's assume that our little
- hunter-gatherer has decided to become a strict carnivore.
- So he's only focused on rabbits now.
- And his whole happiness in life is optimising
- the number of rabbits he can catch and eat in a given day.
- And so let's, on one axis, let's draw
- the number of rabbits that he can catch in a given day.
- So say it's 1, 2, 3, 4, 5, 6, 7, I can keep going on and on.
- So this right over here is rabbits
- that he can catch in a given day.
- But remember, he wants to optimise this.
- He wants to think about how he can increase
- his productivity in terms of the number of rabbits.
- And he knows, we will assume, he knows
- how to build rabbit traps.
- So now we are going to do a Production Possibilities Frontier,
- not between rabbits and berries,
- but between rabbits and building rabbit traps.
- So rabbit traps. Rabbit traps.
- So maybe some type of.. He is able to get twigs together
- and you know...he builds something...
- he puts the twigs together in a little thing.
- You know, it's a little box.
- That maybe he puts a little, I don't know,
- some type of carrot down over there.
- And then if the rabbit comes and takes the carrot,
- then the box falls on the rabbit or something like that.
- We do not have to go into the particulars of the actual trap.
- But he can also spend his time building rabbit traps.
- So let's say 1 rabbit trap, 2 rabbit traps and 3 rabbit traps.
- And let's say that we are going to hold all other things equal.
- Ceteris Paribus, so we are not worrying about other things.
- And as we will see in most introductory economics classes,
- whenever you do a Production Possibilities Frontier,
- you are only doing it with 2 dimensions.
- And so that's why you have a regular curve.
- You could have one with 3 dimensions,
- where you are doing a trade off between three things.
- But then you'd have to have a 3 dimensional graph.
- And essentially,
- the Production Possibilities Frontier would be a surface.
- But let's just focus on this right now.
- Maybe I will do surface in the future just for fun.
- So these are rabbit traps.
- And let's say that the Production Possibilities Frontier
- between the rabbit traps and rabbits
- looks something like this.
- He could spend all his time making rabbit traps
- but in that case he won't get any rabbits and
- he will probably starve and that wouldn't be a good scenario.
- Or he could spend all of his time hunting for rabbits
- and he would catch on average 5 rabbits per day.
- But that would leave him no time to make rabbit traps.
- So this is our current Production Possibilities Frontier.
- Let me just draw it.
- This is our current Production Possibilities Frontier.
- So I'll call this, 'P' - Production Possibilities Frontier.
- And I will put a little zero subscript there.
- That's our starting point.
- So he could sit anywhere over here and
- he would achieved productive efficiency
- anywhere on this curve,
- but as we saw if he just spent all of his time
- if he just spent all of his time doing this over here
- he will never get any rabbit traps and
- so he won't be able to change
- the Productive Possibility Frontier.
- But what happens if instead
- he decides that he does want to build rabbit traps?
- So he decreases the number of rabbits a day to four.
- And that allows him to make 1 rabbit trap per day.
- So he wants to hang out in this scenario.
- So every day that goes by,
- on average he is going to make four rabbits
- and he is going to build a rabbit trap.
- So what's going to happen?
- So as we go, maybe into the next period,
- he would now have a rabbit trap after just one day
- that he can use to help catch rabbits.
- So that will actually change
- the Production Possibilities Frontier.
- So if he makes this investment, it will actually allow him
- in a given amount of time to actually catch more rabbits.
- So if he does that, the Production Possibilities Frontier..
- Having a rabbit trap won't allow him
- to make more rabbit traps in a day.
- So the most rabbit traps he could make in a day
- is still going to be 3.
- But maybe now he can catch 6 rabbits a day.
- So it might look something like that.
- So now he could either stop making rabbit traps
- and catch 6 a day, just with that one rabbit trap he has,
- or he can continue, he can continue that
- and now actually he can catch 5 rabbits a day
- and still make 1 rabbit trap per day.
- And maybe he decides to do that.
- But it could be anywhere along
- this Production Possibilities Frontier.
- So he could say I am happy eating the 4 rabbits a day.
- I am going to make 2 rabbit traps now everyday.
- And now after another period he gets even more productive
- and so then the production.
- So let me call this one, this is after one day,
- Production Possibilities Frontier after one day.
- And then after two days
- let's say he did this scenario right over here.
- Now he's produced two rabbit traps. Obviously this is...
- Maybe I am exaggerating
- how quickly his productivity would grow.
- But maybe now the new Production Possibilities Frontier
- looks like, looks something like this.
- He now has two rabbit traps.
- So, or he may have two more rabbit traps.
- He already had one.
- So he now has three rabbit traps after two days.
- And so now if he wanted to devote himself purely
- to rabbit trapping, he could get 8 rabbits a day.
- Or he could do some combination in between.
- And actually this curve, this shouldn't go up at all.
- I do not want to give you the impression that
- it went up and then down. It just goes kind of straight,
- does something like that right over here.
- So this right over here,
- I will call this Production Possibilities Frontier 2.
- So what this hunter-gatherer is doing,
- in this scenario right here is,
- he is making an investment.
- He is accumulating capital. This right over: this is capital.
- He is choosing instead of to consume all of his resources.
- So there's two things he can do,
- he can either spend all of his time in pure consumption
- getting as many rabbits as possible in a day and
- then eating them all, pure consumption.
- Or he could reduce his consumption and then
- allocate some of his resources towards investment.
- So this right over here, this is an investment.
- It makes him more productive.
- This right over here is consumption.
- There is some base level of consumption he needs to survive
- but if he invests, it increases his overall productive capacity.
- So if you viewed him as an economy by himself,
- by investing, instead of consuming all of his resources
- by investing some of his resources and
- in this case his resources are his time, his expertise.
- By investing some of them,
- he is able to increase his productivity.
- And if you viewed him as an economy,
- he is experiencing ... Economic Growth.
- And so there are multiple types of investment and
- we will talk about these in multiple videos.
- In this case, he is doing Capital Accumulation.
- He is building tools that will make him more productive.
- Another type of investment, is essentially
- Technological Change, Technological Improvement,
- which will would actually make his tools even better.
- So he could have a..
- We can maybe draw another Production Possibilities Frontier
- between making rabbit traps and
- then doing R&D on inventing new types of rabbit traps.
- So he could decide on
- which of those two things he wants to decide between.
- But what I wanted you to just appreciate in this video is that,
- the Production Possibilities Frontier can change.
- You can become more productive
- if you do have investment in R&D or Capital Accumulation.
- And in this case that just happened to be Rabbit Traps.
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