JOURNAL OF ECONOMICS AND FINANCE EDUCATION Vol. 14 · Number 1· Summer 2015 (pp. 31-40) Market-Dependent Domestic Production Set Henrik Egbert 1 & Nadeem Naqvi 2 ABSTRACT A remarkable feature of the 21 st century is extremely rapid international capital mobility compared to considerably sluggish annual FDI flows in the last quarter of the 20 th century. If this empirically significant assumption of internationally footloose capital is adopted, an economy’s production set, and its boundary, the production possibility frontier, are, under this assumption, rendered market dependent insofar as domestic commodity price variation causes a swift relocation of the production frontier, contrasted with the market-invariant frontier in standard theory. Other conclusions of economic analysis are, in general, also modified, rendering this change in assumption materially relevant to economic theory. Keywords: PPF, production possibility frontier, market-invariant PPF, market-dependent PPF, general equilibrium with production Introduction The economic crisis of 2008 hit the world economy with remarkable vigor. Economists – by and large – failed to predict the crisis adequately. One consequence of the crisis was that it sparked an intensive discussion on the usefulness of models used in economic textbooks (e.g., Krugman 2009; Blinder 2010; Shiller 2010; Stiglitz 2011). In fact, Stiglitz (2011, p. 594) writes: Because any model is a simplification, an idealization, of reality, it is not a [legitimate] criticism to suggest that some aspect of reality has been left out. But it is a [valid] criticism if what is left out is essential to understanding the problem at hand, including the policy responses. Taking precisely such an approach to methodology, we address the fundamental concept of a Production Possibility Frontier (PPF) and argue that indeed the world has changed and that our teaching of the model needs to undergo a corresponding modification. We do not argue that this concept as found in textbooks today 3 is inadequate for communicating to students such important ideas as scarcity in a two commodity world, or the crucial concept of opportunity cost of producing a commodity. We do claim, however, that conveying to students of economics, perhaps inadvertently, the additional message that in any given year a PPF remains more or less stationary in its location and that economic policy changes do not displace its location, would fail to take account of recent, dramatic changes in the character of modern-day economies. Indeed, if this practice in teaching were to be allowed to persist, it would be a disservice to students of economics, because such information is not merely inaccurate, but it also leads to inaccurate conclusions based on economic analysis that is predicated on such an empirically invalid assumption. The principal result of this paper is that we, as economists, draw a PPF assuming a given amount of resources—such PPFs are to be termed market-invariant. In doing so, we gloss over the possibility that the levels of 1 Professor of Economics, Anhalt University of Applied Sciences, Strenzfelder Allee 28, D-06406 Bernburg, Germany, h.egbert@wi.hs- anhalt.de. 2 Professor of Economics, KIMEP University, Valikhanov 212/4 Abai Avenue, 050010 Almaty, Kazakhstan, naqvi@kimep.kz. 3 For examples of recent textbooks, see Baumol and Blinder (2012, pp. 37-41), Varian (2010), Krugman and Wells (2013, pp. 27-34), Goolsbee et al. (2013, pp. 590-592). For an experimental teaching example of a PPF see Carson and Tsigaris (2011). Cf. additionally Olson (1997) who addresses shortcomings of a Consumption Possibilities Frontiers in textbooks.