1. McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Goals
Demonstrate opportunity cost with a production possibility curve
Discuss the increasing marginal opportunity cost
Relate the concept of comparative advantage to the production possibility curve
Show how through comparative advantage and trade, a country can consume beyond their production possibility
Explain how globalization and outsourcing are part of a global process guided by the law of one price
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3. The Production Possibilities Model
The production possibilities model can be presented in both a table and in a graph
A production possibility table lists a choice’s opportunity cost by summarizing what alternative outputs you can 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
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4. Application: A Production Possibilities Table
History
Economics
Hrs of Study
Grade 20
98%
40% 18
94% 2
46% 16
90% 4
52% 14
86% 6
58% 12
82% 8
64% 10
78%
70%
74%
76%
66%
88%
62%
100%
What is the output? input?
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5. The Production Possibilities Model
A production possibility curve (PPC) is a curve measuring 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
A PPC is created from a production possibility table by mapping the table in a two-dimensional graph
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6. Application: A Production Possibilities Curve
Econ Grade
A PPC demonstrates:
There is a limit to what you can achieve, given existing institutions, resources, and technology
Every choice you make has an opportunity cost
100
16 hrs for Econ and 4 hrs for History 88
10 hrs for each History and Econ 70
PPC 40 58 66 78
100
History grade
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7. Increasing Marginal Opportunity Cost
The principle of increasing marginal opportunity cost states that opportunity costs increase the more you concentrate on the activity
Butter A
Slope is flat at A
This means there is a low opportunity cost to produce more guns
Slope is steep at B
This means there is a high opportunity cost to produce more guns B
Guns
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8. 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 has comparative advantage if it has the ability to be better suited to the production of one good than another
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9. Efficiency
Productive efficiency is achieving as much output as possible from a given amount of inputs or resources
Butter A
Point of efficiency D
Unattainable with given amounts of inputs C
Point of inefficiency B
Guns
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10. Efficiency and Technological Change
Neutral technological increase or an increase in resources
Biased
technological increase A A B B
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11. Distribution and Productive Efficiency
The productive possibility curve focuses on efficiency and ignores distribution
If a method of production will change income distribution we cannot determine if that method is efficient or not
Efficiency has meaning when analyzing a particular goal
In our society, most people prefer more to less, and many policies have relatively small distribution effects
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12. 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
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13. Markets, Specialization, and Growth
Growth in per capita income during the past 2000 years
$6,000
$5,000
Income
$4,000
$3,000
$2,000
$1,000
Year
500
1000
1500
2010
What caused this growth?
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14. The Benefits from Trade
When people freely enter into trade, both parties can be expected to benefit from trade
Textiles (yds)
Without trade, each country can only consume those combinations of goods along their PPCs
5,000
4,000
Pakistan
3,000
2,000
Belgium
1,000
Chocolate (tons) 1 2 3 4 5
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15. The Benefits from Trade
If each country specializes according to comparative advantage and trades,
they can consume beyond their PPCs
Textiles (yds)
5,000
4,000
Why should Pakistan specialize in textiles and Belgium specialize in chocolates?
Pakistan
3,000
2,000
Belgium
1,000
Chocolate (tons) 1 2 3 4 5
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16. 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
Chocolate (tons) 1 2 3 4 5
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17. 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
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18. 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
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19. Outsourcing, Trade and Comparative Advantage
Globalization
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
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20. 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
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21. 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
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22. Chapter Summary
The production possibility curve embodies the opportunity cost concept
Increasing marginal opportunity cost exists
Trade allows people to use their comparative advantage and shifts out society’s combined production possibility curve
Efficient, inefficient and unattainable points on the PPC
Through specialization and trade, countries can increase consumption
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23. Chapter Summary
The typical outward bow of the PPC is the result of comparative advantage and trade
Because many goods are cheaper to produce in foreign countries, production of goods formerly in the U.S. is being outsourced
Outsourcing is the product of the law of one price
Globalization is the increasing integration of economies, cultures, and institutions across the world
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24. Preview of Chapter 3: Economic Institutions
Define market economy
Compare and contrast capitalism with socialism
Describe how businesses, households, and government interact in a market economy
Summarize briefly the advantages and disadvantages of various types of businesses
Explain why, even though households have the ultimate power, much of the economic decision making is done by business and government
State six roles of government
Explain why global policy issues differ from national policy issues
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