1. Introduction to Macroeconomics Chapter 2 Opportunity Cost, Specialization, and Trade

2. Introduction to Macroeconomics Chapter 2. Opportunity Cost, Specialization, and Trade 1. Microeconomics –Specialization by Individuals 2. Macroeconomics –Production Possibilities Curve (PPC) 3. Applications

3. Introduction to Macroeconomics U.S. Trade in Goods, 2000 (billions of dollars) Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.

4. Introduction to Macroeconomics 1. Specialization by Individuals Division of Labor Opportunity Cost Costs of Exchange Comparative and Absolute Advantage

5. Introduction to Macroeconomics 1. Specialization by Individuals Division of Labor Reasons for Specialization Increase skill from repetition Reduce time wasted shifting between tasks Incentive to invest resources in developing specialized tools and machines Opportunity Cost

6. Introduction to Macroeconomics 1. Specialization by Individuals Opportunity Costs Opportunity Cost The highest valued alternative foregone (given up) in making any choice.

7. Introduction to Macroeconomics 1. Specialization by Individuals Opportunity Costs Calculating Opportunity Costs

8. Introduction to Macroeconomics 1. Specialization by Individuals Opportunity Costs Incentive to Specialize

9. Introduction to Macroeconomics 1. Specialization by Individuals Opportunity Costs Exchange Prices

10. Introduction to Macroeconomics 1. Specialization by Individuals Costs of Exchange Negotiation costs Transportation costs Artificial barriers to trade (e.g., import tariffs)

11. Introduction to Macroeconomics U.S. Trade in Goods with Mexico NAFTA Peso Crisis Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.

12. Introduction to Macroeconomics Notes Page

13. Introduction to Macroeconomics 1. Specialization by Individuals Comparative and Absolute Advantage Absolute Advantage - a person can produce a good or service with fewer resources than can another person Comparative Advantage - a person can produce a good or service with lower opportunity cost than can another person

14. Introduction to Macroeconomics 2. Production Possibilities Curve (PPC) Assumptions Opportunity Costs Comparative and Absolute Advantage Where Should the Economy Operate?

15. Introduction to Macroeconomics 2. Production Possibilities Curve (PPC) Assumptions Identifies all combinations of the maximum amount of any two goods or services that can be produced by a given economy. Production Possibilities Curve (PPC)

16. Introduction to Macroeconomics 2. Production Possibilities Curve Assumptions A B C D * * * *

17. Introduction to Macroeconomics 2. Production Possibilities Curve Assumptions Only 2 goods or services (or aggregates of goods or services) are produced Full and efficient use of all available resources Supplies of resources (i.e., land, labor, and capital) are fixed Technology is held constant

18. Introduction to Macroeconomics 2. Production Possibilities Curve Assumptions Improvement that benefits both products. PPC shifts outward (to the right), from PPC 1 to PPC 2. PPC 1 PPC 2 Increase in Resources or Technology

19. Introduction to Macroeconomics 2. Production Possibilities Curve Assumptions Improvement that benefits Food production only. PPC 1 PPC 2 Increase in Specialized Resources

20. Introduction to Macroeconomics 2. Production Possibilities Curve Assumptions Improvement that benefits clothing production only. PPC 1 PPC 2 Increase in Specialized Resources

21. Introduction to Macroeconomics 2. Production Possibilities Curve Opportunity Cost Two important characteristics of the PPC: Opportunity Cost - The PPC slopes downward and to the right Increasing Opportunity Cost - The PPC is "bowed outward" (concave) from the origin

22. Introduction to Macroeconomics 2. Production Possibilities Curve Opportunity Cost As you increase production of food you sacrifice increasing quantities of clothing Increasing Opportunity Cost

23. Introduction to Macroeconomics 2. Production Possibilities Curve Comparative and Absolute Advantage Assumptions: 2 countries 2 products Straight-line PPCs to simplify model (constant opportunity cost)

24. Introduction to Macroeconomics 2. Production Possibilities Curve Comparative and Absolute Advantage PPC Country A PPC Country B

25. Introduction to Macroeconomics 2. Production Possibilities Curve Comparative and Absolute Advantage

26. Introduction to Macroeconomics 2. Production Possibilities Curve Comparative and Absolute Advantage PPC Country A PPC Country B

27. Introduction to Macroeconomics 2. Production Possibilities Curve Comparative and Absolute Advantage

28. Introduction to Macroeconomics 3. Applications Scarcity and Choice –the “cruel dilemma” facing less-developed countries Opportunity Costs –staffing professors in two departments

29. Introduction to Macroeconomics 3. Applications The Cruel Dilemma of the Poor Subsistence Level Production Possibilities Curve

30. Introduction to Macroeconomics 3. Applications Staffing University Departments

31. Introduction to Macroeconomics 3. Applications Staffing University Departments