The Production Possibility Curve (Frontier) demonstrates that we cannot produce

Question

The Production Possibility Curve (Frontier) demonstrates that we cannot produce all the products in a large enough quantity to satisfy all the worlds' needs and wants. We must therefore make wise decisions on how to use all the resources as efficiently as possible.

There are ideas and actions that will prevent the resources from being efficiently used. Two of them are price ceilings and price floors. Let's look at price floors first. Price floors are prices established by the government or with government blessing. The idea being to have the producer receive an above market price for their products. This will encourage them to produce more which will mean producers will increase their revenue while buyers will pay lower prices because of the subsidy. But, where did this magic money come from? You and me in higher taxes. In reality, the subsidies paid to the buyer raise prices for consumers in order to encourage farmers to produce more in order to increase their income. It is also a method used to encourage farmers to continue to farm. In 1900 approximately half our population was engaged in agriculture. Today it is approximately 2% yet we have increased farm output many fold.

Why were their so many people engaged in agriculture? If we are interested in not losing jobs, why isn't the government encouraging people to return to farming? These questions are linked if you understand the first question you will have found the answer to the second question.

Agriculture is an example of price floors. I grew up on a farm---640 acres, a full section (1 mile square) While growing up, our corn, on the open market, would have earned $1.35 @ bushel. But, to keep people down on the farm, the government paid a subsidy of 20 cents a bushel. We were therefore paid $1.55 @ bushel. The taxpayers paid the 20 cents. This made products that used corn more expensive. Who benefited? The farmers. Who paid the price? The consumers/taxpayers.

Price floors are an above market price established by the government or with government blessing. In every case I know of it has led to a surplus. Farmers, because of the pure or economic profit, will produce as much as possible to increase their revenues as much as possible. Farm subsidies and minimum wages are examples of a price floor.

Then there are price ceilings. A price ceiling is a price below market price. It is established by government. In every case it leads to a shortage. Examples are wage controls, price controls and rent controls.

Just before the start of our involvement in WWII, we began building up our military and starting to increase our military aid (planes,tanks, etc.) to our allies. We also started drafting men into the military which meant we needed workers for the defense plants. Men, but mostly women, were being brought in to the major metropolitan areas in large numbers. This put a terrible strain on the housing market. Prices rocketed upward (price rises to ration scarce goods) and threatened to derail our war effort. In order to provide affordable housing for the work force, Congress passed a housing act that established rent controls for the duration of the war plus six months. Would someone tell New York, San Francisco, Los Angeles, et al, that the war ended in 1945!

If you require a rent of $1000 a month to allow you to cover property taxes, building maintenance and a profit but the government will only allow you to charge $800, what will you do? First you will depreciate the property to the fullest. Then you will simply abandon the property and take a capital loss on your taxes. The local government now owns the property. This is why New York city, as an example, is the largest slum owner in the world! This is also another example of the Law of Unintended Consequences.

If you don't pay your property taxes, for 5 years, your property can be seized by the government for non-payment of taxes and sold at a tax auction. Do you really own your property or do you merely hold title to it at the pleasure of the government?

There are 3 embedded questions.      

Explanation / Answer

A production possibility Frontier has a slope which increases in value and that makes the production possibility Frontier concave in shape. The opportunity cost of producing one more unit of a good that is measured on the horizontal Axis goes on increasing as we reduce the quantity of the good that is measured on the vertical axis. Because the model of production possibilities assumes only two goods initially it does not represent the entire economy but gives us an idea of how the location between two goods can be made efficient. The opportunity cost continues to increase because as a resource become scares, it becomes expensive.

Suppose that a nation has 100 units of labour. The nation can produce two goods, machines and food. Labour is assumed to be skilled enough to produce both goods with same efficiency. If the nation is producing a combination of Machines and food, and it attempts to increase the production of food it has to move its labour units from the production of Machines to the production of food. This movement of labour is costly and as more and more labour is taken out from one sector and is employed in another, the opportunity cost continue to rise. Because the opportunity cost is continuously increasing along the PPF, the marginal cost which includes this opportunity cost, also exhibits increasing value.

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