Saturday, April 12, 2008

A PPF with Increasing Opportunity Costs

A PPF with Increasing Opportunity Costs: Alternative Uses of Farmland in the United States

Consider an extreme use of farmland in the United States. Pretend all U.S. farmland is used to grow oranges. Orange trees are planted in the tropical areas, such as Florida and California. In areas less suited to growing oranges, green houses are built to create a tropical environment in which to grow oranges. There is a maximum quantity of oranges that can be produced with the finite amount of farmland and other resources in the United States. This point is illustrated by point A in the graph below. Now suppose the United States considers using some of the farmland to grow wheat instead of oranges. It makes sense to stop growing oranges and begin growing wheat on the farmland that is not well suited for growing oranges but is well suited for growing wheat (perhaps Kansas or Nebraska). In order to gain a billion bushels of wheat, the U.S. must sacrifice a relatively small amount of orange production (2 million tons). It is a relatively small amount of oranges because the land was not well suited for orange production anyway.


INSERT DIAGRAM HERE.

Figure 3-5. A production possibilities frontier (PPF) for U.S. farmland.
Curved PPFs illustrate increasing opportunity costs.

If the U.S. continues to switch farmland out of orange production and into wheat production, then the quantity of oranges produced will go down and the quantity of wheat produced will increase. For each additional ton of wheat produced, however, the sacrifice (in terms of reduced orange production) increases. Land that was a little bit better at growing oranges (such as Oklahoma) will be used to grow wheat. So in order to gain an additional thousand tons of wheat, the U.S. must sacrifice a relatively larger amount of orange production.

Suppose this process continues until the entire country is planted in wheat (point E). This implies bulldozing orange groves in Florida and California to build greenhouses to grow wheat. To obtain those last billion bushels of wheat (moving from point D to point E), the U.S. must sacrifice a relatively large amount of orange production (10 million tons).

In this example, the opportunity cost of producing additional wheat increases as wheat production increases. The amount of orange production that must be foregone in order to produce additional wheat increases as wheat production increases. Thus, this is an example of increasing opportunity costs. Increasing opportunity costs occur when the quantity of one product that must be foregone to obtain a unit of another product increases as more is produced.
Graphically, increasing opportunity costs are illustrated by a production possibilities frontier that is convex to the origin. The slope of the PPF, which represents the opportunity costs, increases as the production point moves down the curve.

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