Transcript Chapter Goals - Virginia Community College System

CHAPTER 2
The Production Possibility Model,
Trade, and Globalization
No one ever saw a dog make a fair and
deliberate exchange of one bone for another
with another dog .
— Adam Smith
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
The Production Possibilities Model
• The production possibilities model can be
presented in both a table and in a graph
• A production possibility table lists the opportunity
cost of alternative outputs that can be achieve with
your inputs.
• An output is a result of an activity
• An input is what you put in production
process to achieve an output
2-2
The Production Possibilities Model
• A production possibility curve (PPC) shows the
maximum combination of outputs that can be
obtained from a given number of inputs
• It is a graphical representation of the
opportunity cost concept
2-3
A Production Possibilities Curve
2 subjects and 20 hours of study time
Econ Grade
100
16 hrs for Econ and
4 hrs for History
88
10 hrs for each
History and Econ
70
PPC
40
58
66
78
• There is a limit to what you
can achieve, given existing
institutions, resources, and
technology
• Every choice you make has
an opportunity cost
100 History grade
2-4
Production Possibilities Curve
for Susan’s grades in English and Economics (10 hrs of study)
• If she spends most of
her time studying
economics, she can earn
an A in economics …
and a D in English.
• If she splits her time
between the two, she
can earn a B in
Economics and English.
• If she spends most of
her time studying
English, she can earn a
D in Economics …
and an A in English.
Expected
grade in
Economics 101
Production Possibilities
Curve ( PPC )
A
B
C
D
F
F
D
C
B
A
Expected
grade in
English
101
• Mapping out all the possibilities of
how Susan can divide her time
(limited resources) between these
activities shows us her Production
Possibilities Curve ( PPC ).
Increasing Marginal Opportunity Cost
Butter
The principle of increasing marginal opportunity
cost states that opportunity costs increase the
more you concentrate on the activity
• Slope is flat at A
• This means there is a low opportunity
cost to produce more guns
A
B
• Slope is steep at B
• This means there is a high
opportunity cost to produce more
guns
Guns
2-6
Comparative Advantage
• The reason the opportunity cost of guns increases
as we produce more guns is that some resources
have comparative advantage over other resources
• A resource (or geographical area) has comparative
advantage if it has the ability to be better suited
to the production of one good than another
2-7
Trade and Comparative Advantage
• The PPC is bowed because individuals specialize in
the production of goods for which they have a
comparative advantage
• For a society to produce on its PPC, individuals must
produce those goods for which they have a
comparative advantage and trade for other goods
• According to Adam Smith, humankind’s proclivity to
trade leads to individuals using their comparative
advantage
2-8
The Benefits from Trade
Textiles (yds)
If each country specializes according
to comparative advantage and trades,
they can consume beyond their PPCs
5,000
4,000
Why should Pakistan
specialize in textiles
and Belgium specialize
in chocolates?
Pakistan
3,000
Belgium
2,000
1,000
1
2
3
4
5
Chocolate (tons)
2-9
Comparative Advantage and the Combined PPC
Combined PPC with trade
Textiles (yds)
Pakistan + Belgium
5,000
The slope of the combined
PPC is determined by the
country with the lowest
opportunity cost
4,000
Pakistan
3,000
2,000
Belgium
1,000
1
2
3
4
5
Chocolate (tons)
2-10
Areca
Guns
12
8
4
0
Butter
0
2
4
6
Bonsai
Guns
16
12
8
4
0
Butter
0
1
2
3
4
2-11
Application: U.S. Textile Production and
Trade
• Two hundred years ago, the U.S. had a comparative
advantage in textile production
• Now, countries with cheaper labor (such as
Bangladesh) have the comparative advantage in
textiles
• The gains from trade are higher wages for workers
in Bangladesh and lower-priced cloth for U.S.
consumers
2-12
Outsourcing, Trade and Comparative Advantage
• Outsourcing is the relocation of production once
done in the United States to foreign countries
• Outsourcing occurs because many other countries
have a comparative advantage in labor costs
• The U.S. has comparative advantage in technology,
institutional structure, and specialized knowledge
2-13
Outsourcing, Trade and Comparative Advantage
• Globalization is the increasing integration of
economies, cultures, and institutions across the
world
• A positive effect of globalization is that it provides
larger markets than the domestic economy
• The global economy increases the number of
competitors and this increased competition can be a
negative effect of globalization
2-14
Outsourcing, Trade and Comparative Advantage
Exchange Rates and Comparative Advantage
• The U.S. comparative advantage in innovation results
in higher wages in the U.S.
• As industries mature, they move to lower wage
countries
• In order to regain our comparative advantage, the
U.S. exchange rate will decline and foreign wages will
increase to make U.S. exports cheaper and imports
to the U.S. more expensive
2-15
Outsourcing, Trade and Comparative Advantage
The Law of One Price
• The law of one price is the wages of equal workers in
one country will not differ significantly from the
wages of workers in another institutionally similar
country
• If the U.S. loses its comparative advantage based on
technology and institutional structure, U.S. wages will
decrease relative to wages in many other countries
The reality is that the citizens in the U.S. has
been living better than it could have otherwise
because of trade and outsourcing
2-16