Transcript lecture 2 - Valdosta State University

Section 2
Production Possibility Frontier
& Trade
Chapter 2: pages 32-60
KEY DEFINITIONS
 Production possibilities frontier is a curve
showing the maximum attainable
combinations of two products that may be
produced with available resources.
 Opportunity Cost The highest-valued
alternative that must be given up in order to
engage in an activity.
 Practice Problem 2-1 (on your own). Highly
Recommended!
 Constant opportunity cost PPFs vs.
Increasing opportunity cost PPFs
Increasing Marginal Opportunity Costs
500
Economic Growth
Economic Growth
Assumptions
 Let’s assume there are two products (Apples
and cherry).
 There are two persons in our small society
now: you and your neighbor.
To be or not to be...
 To be self-sufficient and produce everything
we need
OR
 To cooperate with others - TRADE
 The benefit of trade is pretty obvious if you
only have apple trees and your neighbor
only has cherry.
 Furthermore, the benefit of trade also seems
obvious if you are much better in picking
apples and your neighbor is better in
picking cherry.
 In this case you should SPRECIALIZE in
apple production and your neighbor should
SPECILIZE in cherry production.
 And you should TRADE
 But what happens if one of you is much
better in picking both apples and cherry?
Your Production and Consumption
Possibilities without TRADE
Your neighbor’s Production and
Consumption possibilities
Without Trade
You
Your
neighbor
Opportunity
Opportunity
cost of picking cost of picking 1
1 pound of
pound of
apples
cherries
1 pound of
1 pound of
cherries
apples
2 pounds of
.5 pound of
cherries
apples
Absolute vs. Comparative Advantage
Absolute advantage The ability of an
individual, firm, or country to produce more
of a good or service than competitors using
the same amount of resources.
Comparative advantage The ability of an
individual, firm, or country to produce a
good or service at a lower opportunity cost
than other producers.
TRADE
 You should specialize in whatever you have
comparative advantage in.
The Principle of
Comparative Advantage
Comparative advantage and differences in
opportunity costs are the basis for
specialized production and trade.
Whenever potential trading parties have
differences in opportunity costs, they can
each benefit from trade.
Practice
 Solved Problem 2-2 on your own (Highly
recommended!)
Should the United States trade with other
countries?
 As we all know Americans enjoy a lot of
goods produced by other countries.
 Imports: goods produced abroad and sold
domestically.
 Exports: goods produced domestically and
sold abroad.
The Circular-Flow Diagram
Revenue
Goods &
Services sold
Market for
Goods
and Services
Firms
Inputs for
production
Wages, rent,
and profit
Spending
Goods &
Services
bought
Households
Market for
Factors
of Production
Labor, land,
and capital
Income