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Brooks Wilson's Economics Blog: Ethanol and the Production Possibilities Frontier

Monday, January 24, 2011

Ethanol and the Production Possibilities Frontier

People acting through their government face trade-offs.  The production possibilities frontier is a simple model showing food and ethanol production that illustrates some trade-offs.  In the United States, ethanol is made from corn.  To get more ethanol, resources have to move from the production of food and into the production of ethanol.

Markets are usually the best way to organize economic activities.  The graph shows the market production combination point.  Economic agents, acting through markets, buy a great deal of food and little ethanol.  People acting through markets do not consume much ethanol. 

Governments can sometimes improve market outcomes.  In the light of rising oil prices, a warming climate, and the war in Iraq, some suggested that oil production is associated with three significant negative externalities that contributed to each problem.  Economists usually recommend that negative externalities be taxed.

This is not the course the government took.  At the urging of almost all corn growers and a few environmentalists, the Congress passed and President Bush signed legislation that subsidized the production of ethanol in three ways: consumers must buy blended gasoline containing 10% ethanol, blenders received a 45 cent per gallon subsidy for mixing the gasoline and ethanol, and importers must pay a 54 cent per gallon tariff (taxes on imports) on foreign ethanol.  In response to these incentives, farmers took resources from food production and put it into ethanol production.  Forty percent of corn production in the United States is now used to make ethanol.  This is shown in the graph at the point “Production Combination with Ethanol Subsidies.”

Environmentalist no longer support ethanol production.  The EPA believes that corn production has a minimal to negative impact on the environment.  David Pimentel, a Cornell University scientist, estimates that the United States would achieve only a 4% reduction in oil consumption if the entire corn crop were devoted to ethanol production.  Let me suggest that, at the margin, such a small reduction in oil consumption would not significantly reduce the odds of entering a war to protect oil production.

At a time of slow growth, lingering high unemployment from the Great Recession, and budget deficits that threaten the financial stability of the government, ethanol subsidies should be ended.  Instead, protection has been extended and expanded.  When consumers did not buy the mandated level of ethanol, the Obama administration lifted the cap on how much ethanol could be blended into gasoline from 10% to 15% and increased the number of car models that are approved to use the 15% blend.  The Congress also extended subsidies to ethanol production. 


  1. I think that ethanol is a great idea, but obviously environmentalists do not. They believe that only 4% is not worth it, but we are not creating ethanol to not go to war, but to not have to buy so much oil. With oil prices soaring up we need some sort of alternate fuel, and ethanol has been proven to work. I say let the project continue for a little bit and see where it heads, and if it does not work out then we can cancel the funding.

  2. I don't pretend to understand the nuances of government subsidized agriculture to meet a specific need or the complexity of the oil market. However, it seems to me the more the government tries to positively effect a particular market by artificially propping it up, i.e. large subsidies, the greater the danger of that market bursting in the future.

    If large percentages of corporate and private farms shift to production of ethanol, purchase specialized equipment and invest into new technologies; a dangerous bubble is created. What ever happened to letting the invisible had guide the future of the ag and oil markets?

    What happens when the next scientific breakthrough occurs? Will the ethanol giant cease to exist forcing the agriculture industry to seek a new quick fix subsidized by the government? Or will the new technology be suppressed because of the ramifications to the national economy?

  3. Even if we do not push ethanol for emissions, there are many other reasons to do so. By focusing more on using a product that we can produce here in our country, it will reduce our dependence on other countries as well as helping our economy. Since Bush started pushing for ethanol, corn production for fuel has doubled since 2007.
    With Obama speaking about the US becoming a more competitive nation, this would be a step in the right direction. Many believe we are fighting wars overseas because of oil, by producing our own fuel and becoming less dependent on foreign fuel we would save billions of dollars and many lives. Both of which would make us more competitive in the global economy.
    Ethanol also burns at a higher octane which can allow vehicles to run more timing or higher compression ratio resulting in a more efficient engine.

  4. Hi,

    I am an economics teacher and am creating a project that teaches the fundamental economic concepts using scarcity of corn for feed, food, fuel, etc. I want to integrate PPCs. Do you have any statistics that I could use to allow students to create PPCs to demonstrate scarcity and opportunity costs?


  5. Hi, are there any current production frontier examples you can think of? Thanks!