Lewis Model & Dual Economies in Asia
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The document discusses Arthur Lewis's model of dual economies and its application to Asia. The Lewis model describes an economy with two sectors - a subsistence agricultural sector and a higher productivity manufacturing sector. Workers transfer from the agricultural sector to the manufacturing sector as wages equalize, driving economic growth. Eventually, a "Lewis turning point" is reached where no new workers are available and wages begin rising in both sectors, slowing growth. The document argues China may be approaching this turning point and examines implications for other Asian economies like India. It also discusses assumptions and extensions of the Lewis model over time.
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Lewis Model & Dual Economies in Asia
- 1. Lewis Model & The Dual Economies in Asia Chirantan Chatterjee Lecture 6, 7, 8 – Rise of Asian Economies 1
- 2. Arthur Lewis making a come-back 2
- 3. Lewis Model – Building Blocks 3
- 4. Lewis Model – Building Blocks 4
- 5. Lewis Model – Building Blocks 5
- 6. Lewis Model Building Blocks 6
- 7. Lewis Model – Messages? 7
- 8. Lewis Model @ Utopia 8
- 9. Lewis Model @ Utopia - Calculations Lag 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Qag 0 15.6 30.4 44.4 57.6 70 81.6 92.4 102.4 111.6 120 127.6 134.4 140.4 145.6 150 153.6 156.4 158.4 159.6 160 Lmfg 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Qmfg 0 9.9 19.6 29.1 38.4 47.5 56.4 65.1 73.6 81.9 90 97.9 105.6 113.1 120.4 127.5 134.4 141.1 147.6 153.9 160 9
- 10. Lewis Model @ Utopia – Output Maximization Point Lag 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Qag 0 15.6 30.4 44.4 57.6 70 81.6 92.4 102.4 111.6 120 127.6 134.4 140.4 145.6 150 153.6 156.4 158.4 159.6 160 Lmfg 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Qmfg 0 9.9 19.6 29.1 38.4 47.5 56.4 65.1 73.6 81.9 90 97.9 105.6 113.1 120.4 127.5 134.4 141.1 147.6 153.9 160 Sum 160 169.5 178 185.5 192 197.5 202 205.5 208 209.5 210 209.5 208 205.5 202 197.5 192 185.5 178 169.5 160 10 Key point that can be shown: Output maximized at MPequalization of both sectors
- 11. Lewis Model – Graphical Intuition APLag MPLag MPLag APLag Lag 11
- 12. Lewis’ Key Idea: Agriculture Interacts w/Manufacturing with different principles. APLag MPLag MPLmfg MPLag APLag Lag Lmfg Rural sector was allocating output equally, using AP Mfg. sector used the marginal-principle. MP-Lmfg vs. AP-Lag. 12
- 13. Lewis’ Key Idea APLag MPLag MPLmfg MPLag APLag L1 Equilibrium if the Lewis principle is true is at L1. 13
- 14. Comparative Statics APLag MPLag MPLmfg MPLag APLag L1 Productivity in Mfg. > Productivity in Ag. Wage rate in Mfg. > Wage rate in Ag. “Even if I accept a lower than current Mgf. wage, I can migrate to other sector and earn a higher than my current Ag. Wage.” 14
- 16. Reassignment across sectors till wages equalize APLag MPLag MPLmfg MPLag APLag L1 16
- 17. Highest Level of Output one can obtain? APLag MPLag MPLmfg APLag L1 17
- 18. Wage Rate is Lower @ Highest Output Point APLag MPLag MPLmfg MPLag L APLag L1 18
- 19. Manufacturing Hires More Agriculture in Equilibrium APLag MPLag MPLmfg MPLag Lag L APLag L1 Lmfg Rural workers now accept less than their previous wage rate. MP-Lag moves back up in the process of re-allocation. “Go to the city young person”! 19
- 20. Has been happening in Much of Asia 20
- 21. Wage Rate is Lower @ Highest Output Point APLag MPLag MPLmfg MPLag L APLag L1 21
- 22. Lewis Turning Point APLag MPLag MPLmfg MPLag L APLag L1 A Point Comes when Rural Workers are no longer going to work at Lower Wage Rates. Discontent! No more labor forthcoming, wages start rising again. Output growth slows down Shades of Solowian Convergence (but with more than 1 sector in the model) ? 22
- 23. China is witnessing a Lewisian Turning Point? 23
- 24. China is witnessing a Lewisian Turning Point? Not Yet – But Maybe by 2020-2025 What About India/Japan? Great Research Project How to slow the reaching of a turning point? Rings a Bell with Asian Financial Crisis? 24
- 25. Before we go ahead, assumptions made by Lewis? 25
- 26. Before we go ahead, assumptions made by Lewis? 1) What about Lag+Lmfg=Population? 2) What about Agricultural shifting to MP from AP-paradigm? 3) How about Rural Employment Guarantee Schemes? 4) What about technology (from heaven or otherwise) in manufacturing? 5) What about interest rates? 26
- 27. Lewis was not alone Other Economists like Kaldor & Harrod-Domar model considered dual-sectors. Ranis and Fai mathematically improved this model. But Lewis’ work triggered lots of work in micro-development economics. The basic question: How can you improve the lives of poor to prevent their migration? Structural Changes. Peer-paper for example: https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=IIO 27
- 28. Did Japan ever reach a turning point? 1) Open Question. 2) But it certainly had a very robust and vibrant though protected non-export sector. 3) Dragging down overall productivity & growth of the economy. 4) Efforts are on to structurally address this dual-economy in Japan. 5) Let’s finish our round-up of Japan. 28
Editor's Notes
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.
- Take a radically simplified view of the world. Look at a single economy, at a point in time. Only two goods produced: food and machines. PPF describes combinations of food and machines that can be produced as resources of the economy are shifted from food industry to machine industry. At each point, slope of the line tells us how much more food we get by sacrificing a unit of machines, and vice versa. Value of production depends on prices. GDP in this simple framework is simply=PmQm+PfQf. For any given set of prices, Pf and Pm, value of GDP will be maximized when economy produces at the point where ratio of prices is tangent to PPF, at Q1. You can see this graphically. As you move to left, you sacrifice too much food for an extra bit of machines, given what food is worth. As you move to the right, you give up too many machines for a unit of food, given what machines are worth. Only at the point where slope of PPF is same as ratio of relative prices are you sacrificing food for machines at a ratio that reflects the relative value of these two goods.