Transcript TRADE, TRADE-OFFS, AND GOVERNMENT POLICY

Chapter 2
THE PRODUCTION
POSSIBILITY MODEL, TRADE,
AND GLOBALIZATION
Last class
marginal cost
sunk cost
marginal benefits
opportunity cost
Invisible hand
Today’s lecture will:
• Production possibility curve (PPC)
• The functions of production possibility
curve (PPC)
• Shifts in the production possibility
curve (PPC)
A Production Possibilities Curve
for an Individual
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Definitions
• Production possibility curve (PPC)
A production possibility curve is a curve
measuring the maximum combination of
outputs that can be obtained from a given
number of inputs.
Output is a result of an activity.
Input is what you put into a production
process to achieve an output.
The function of PPC
• Demonstrate opportunity costs with a
production possibilities curve.
Opportunity cost is the best alternative that
we give up when we make a choice or a
decision.
A Production Possibilities Curve
for an Individual
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Grade in
history
98
96
94
92
90
88
86
84
82
80
78
76
74
72
70
68
66
64
62
60
58
Hours of study
in economics
0
1
2
3
4
5
6
7
8
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Grade in
economics
40
43
46
49
52
55
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61
64
67
70
73
76
79
82
85
88
91
94
97
100
Economics grade
Hours of study
in history
20 hours of economics
0 hours of history
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B
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58 66
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20 hours of
history
0 hours of
economics
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History grade
The functions of PPC
• Demonstrate the efficient and inefficient
outputs with a production possibilities
curve.
Productive efficiency – achieving as much output as
possible from a given amount of resources – occurs at
any point on the PPC.
Any point within the PPC represents inefficiency.
Any point outside the PPC is unattainable, given present
resources and technology.
A Production Possibilities
Table for Society
% of resources
% of resources
devoted to
devoted to
production
production Pounds
Number
of guns
of butter
of butter Row
of guns
0
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40
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80
100
0
4
7
9
11
12
100
80
60
40
20
0
15
14
12
9
5
0
A
B
C
D
E
F
Efficiency and Inefficiency
Unattainable point,
given available technology,
resources and labor force
10
Guns
8
6
C
Efficient
points
B
4
2
0
Inefficient
point
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4
D
A
6
Butter
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10
Question
• Why all the points on the production
possibility curves represent efficiency?
Because production possibility curves
represent the maximum combination of
outputs that can be obtained from a given
number of inputs.
Shifts in the PPC
• Society can produce more output if:
– Technology is improved,
– More resources are discovered.
– Economic institutions get better at fulfilling
our wants.
• More output is represented by an
outward shift in the PPC.
Shifts in the PPC
Neutral Technological Change
Biased Technological Change
Butter
C
C
B
A
0
Guns
B
D
0
Guns
A
Question
• The improvement of technology lowers the
cost of manufactured goods.
• Global warming increases the cost of
producing agriculture goods.
• Hurricanes destroy the natural resources.
• A new technology is discovered that
doubles the speed at which all goods can
be produced.
PPC for Society
Butter
1 pound 15 A
of butter
14
2 pounds
of butter 12
B
C
D
9
5
E
5 pounds
of butter
0
4
4 guns
7
3 guns
9
F
11 12 Guns
1 gun
Increasing Marginal Opportunity
Cost
A
The principle of increasing marginal
opportunity cost states that opportunity costs
increase as you produce more of one product.
B
Guns
Comparative Advantage
• Comparative advantage is
used to
describe the opportunity cost of two
products.
• The producer who has a smaller
opportunity cost of producing one good
is said to have a comparative advantage in
producing that good.
Example
• Assume there are two guys Tom and
John. And I suppose that both of them
know how to produce potatoes and meat.
For Tom: 1pound of potatoes 1hour
1pound of meat1hour
For John: 1pound of potatoes1hour
1pound of meat2 hours
Opportunity Cost of
1 pound of potatoes 1 pound of meat
Tom:
1 pound of meat
1 pound of potatoes
John:
1/2 pound of meat
2 pounds of potatoes
Example
• Conclusion:
Tom has a comparative advantage in
producing meat and John has a
comparative advantage in producing
potatoes.
Example
• If both of them need meat and potatoes
and they only have two hours to produce
them every day.
Meat
Potatoes
Tom:
1 pound
1 pound
John: 1/2 pound
1 pound
Total: 1.5 pounds
2 pounds
Example
• If we let Tom produce meat only and John
produce potatoes only.
Meat
Potatoes
Tom:
2 pounds
------John:
------2 pounds
Total:
2 pounds
2 pounds
Total:
1.5 pounds
2 pounds
Question
• Assume the United States can produce
Toyotas at the cost of $18,000 per car and
Chevrolets at $16,000 per car. In Japan,
Toyotas can be produced at 1,000,000
yen and Chevrolets at 500,000 yen.
a. In term of Chevrolets, what is the
opportunity cost of producing Toyotas in
each country?
Question
• Assume the United States can produce
Toyotas at the cost of $18,000 per car and
Chevrolets at $16,000 per car. In Japan,
Toyotas can be produced at 1,000,000
yen and Chevrolets at 500,000 yen.
b. Who has the comparative advantage in
producing Chevrolets?
Question
• c. Assume American purchase 500,000
Chevrolets and 300,000 Toyotas each
year and that the Japanese purchase far
fewer of each. Which country should
produce Chevrolets and which country
should produce Toyotas?