Monday, May 5, 2014

PPF illustration with maps of Corn and Soybean acreage. Nice real life example.

In the first week of an introductory Economics students encounter the Production Possibilities Frontier (PPF) as the first formal model used in both Micro and Macroeconomics.

The PPF illustrates the productive capacity of an economy if it were fully-employing all of its useful resources (Land, Labor, Capital, Entrepreneurship). The model is flexible and can be used in a Macro sense comparing the production of the broad categories of Capital and Consumer Goods or in a Micro sense comparing the production of two specific goods such as Corn and Soybeans.

If the economy is producing ON (does not matter where) the PPF it is achieving "Productive Efficiency". This means it is fully utilizing its productive resources in the the most efficient and lowest cost way.

WHERE on the PPF, or the particular bundle of the two goods, the economy produces is called "Allocative Efficiency".  That bundle a society produces and consumes is determined by the economic system (market vs socialist vs command) or some combination thereof.  In the US, the price mechanism and/or government policy determines the Allocatively Efficient bundle of goods in the market place.

Nowhere is this more evident than in Agriculture.

Let's look at the two-good model---Corn and Soybeans.

Both require roughly the same climate, terrain and soil to grow.  The Opportunity Cost of switching from growing one to the other is minimal--an acre of land for growing corn will produce a maximum yield in either corn or soybeans.

So, our PFF for Corn and Soybeans, shown below, illustrating the trade-off between growing one or the other would be a straight line representing "constant opportunity costs".  Assume our initial equilibrium point in the year 2001 was at combination of Corn and Soybean planted and harvested acreage---Point "A".

However, in the mid-2000's due to a policy change we had a relatively massive "Allocative Efficiency" change and a re-allocation of land resource from the production of Soybeans to Corn--Point "A" to Point "B".  How do I know this?

See the map below.  The RED areas on the map on the left show the DECREASE in acreage planted for Soybeans and the BLUE areas on the right map show the INCREASE in acreage planted to Corn.

Matches up pretty well, wouldn't you say?

Source:  From USDA Atlas Maps

What was the major the policy change that prompted this reallocation?  I will just leave you with a picture to ponder that one...

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