Potential Real GDP vs Actual Real GDP and the PPF.

Here is a  nice illustration of "Potential Real GDP" vs "Actual Real GDP.  Potential GDP is an estimate at a given point in time of an economy's potential to produce Real GDP given its available resources (Land, Labor, Capital, Entrepreneurship).  Gives me an opportunity to show how two important AP Macroeconomic concepts are related to each other.

The Congressional Budget Office (CBO) publishes a forward looking projection of Potential RGDP years in advance.  This graphic gives the estimated trajectory of Potential RGDP that was calculated in a given year (2007,09,11,13,15, and 2017).  The heavy BLACK line is the trajectory of the "Actual RGDP" that was recorded in the respective year.

It is evident Actual RGDP, since the advent of the 2008 recession has been below the projected Potential---the difference is known as the "Output Gap".

It is noteworthy that after 2008 the CBO consistently lowered the estimate of the US economy's potential to produce Real GDP.

Source: VOXEU

Below I paired this graphic with the Production Possibilities Frontier (PPF).  The PPF is an important model in AP Macro.

I color coded the PPF frontiers in a similar color as the one in the graphic to show the contraction of the US PPF over time (as calculated by the CBO).  I used Point "A" to represent the heavy black line and a consistent under-utilization of societal resources, shown as a point inside the PPF.

Both of these models show the same thing---an output gap that suggests more resources could be put into use before we reach our economic potential.

Nice resource for illustrating "Increasing Opportunity Costs" and the concave nature of the PPF

Here is a nice article on the great productivity slowdown in the US, and in the developed world for the most part.

The article is interesting throughout but the excerpt below caught my eye.

It goes to the edge but does not explicitly mention the important concept of "Increasing Opportunity Costs" and the reason the Production Possibility Frontier (or Curve) is "bowed", or concave from the origin.

While Services Sector Booms, Productivity Gains Remain Elusive 

“The changing distribution of workers might be able to explain up to one-half of the slowdown in labor productivity growth from 2.5% to 1.5% per year since the 1960s," said Dietrich Vollrath, a University of Houston economist. Indeed, this effect has accelerated since 2000, when workers, in aggregate, started to move from higher to lower productivity sectors. 

Services productivity, besides its natural disadvantage, may be facing an added headwind: The sector is absorbing millions of workers whose underlying skills may not be well suited to the jobs they take on. 

If people start doing work they are relatively good at, and if manufacturers shed their least efficient workers first, manufacturing productivity will improve as it downsizes but services-sector productivity will suffer as it absorbs workers who are a poor fit. (Sections in bold are mine).

All resources, including labor, are not "perfectly adaptable" to a alternative uses.  If you employ/deploy resources to such alternative uses they tend to be less productive, hence more costly.

Simple example.  The decline of steel manufacturing coincided with a increased demand for truck drivers.  While some unemployed steel workers may make fine truck drivers, the "marginal" ones may not be so good. They may have more accidents or load mishaps and are more expensive (ceteris paribus) to employ.

A short lesson on the difference between a "Constant Cost" and "Increasing Cost" Production Possibilities Frontier. A must know for AP Econ!!

Understanding the difference between a "Constant Cost (Straight Line)" and an "Increasing Cost (Concave)" Production Possibilities Frontier (PPF) is not necessarily a difficult concept, but it one that does seem to be-devil the student in an introductory economics class.

I put together a series of slides that takes you through the differences step by step.

The main purpose for the PPF is to illustrate the principle of Opportunity Cost when it comes to resource allocation. If an economy is at Full-employment to get more of one thing then something has to be given up.

Sometimes that trade-off may be "constant"--the resources taken away from the production of one good are "perfectly adaptable" to produce more of another good.  A simple example is a farmer who has land where he can grow Corn and/or Soybeans. The land suitable for growing corn is the same as the land for growing soybeans (I live in Central Ohio--I see this just down the street). One the same acre of land, the farmer can get a maximum yield in corn or soybeans. Switching from one to the other entails virtually no cost in resource allocation for the farmer.  How it affects society is another question.

However, if the crop mix is different and the resources used are NOT easily adaptable for a different use, then the opportunity costs are not constant but "increasing".

I use Corn and Rice as an example below.  The land use for either is not identical.  If I want to grow Corn where I once grew Rice then it may take 2 acres of rice field acreage in order to get corn yield equivalent to what I would get out of land perfectly suitable for corn production.  My opportunity cost for more rice is not just one acre or rice production (Constant Cost) but two acres (Increasing Cost).

If the farmer persists in converting more of the rice field into corn production, then it may take 3 acres to get the equivalent in Corn. So on and so forth.

TINSTAAFL!   Corn and Rice---now I am hungry.  My opportunity cost of doing this blog entry is a delayed breakfast. You gave up eating lunch to read it.   I hope it was worth it to you.  Was for me.  :)