1. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 MACROECONOMICS: EXPLORE & APPLY by Ayers and Collinge CHAPTER 2 “Production and Trade”

2. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 2 Learning Objectives 1.Analyze tradeoffs facing both individuals and countries 2.Relate the types of resources an economy possesses. 3.Model a country’s production possibilities, and how these possibilities respond to technological development. 1.Analyze tradeoffs facing both individuals and countries 2.Relate the types of resources an economy possesses. 3.Model a country’s production possibilities, and how these possibilities respond to technological development.

3. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 3 Learning Objectives 4.Describe how economies can grow faster if they are willing to cut back on current consumption. 5.Visualize the flow of goods and services, resources, and money in the economy. 6.Explain how people and countries gain from trade by specializing according to comparative advantage. 7.(E&A) Convey how economic strength can lead to victory, sometimes without a fight. 4.Describe how economies can grow faster if they are willing to cut back on current consumption. 5.Visualize the flow of goods and services, resources, and money in the economy. 6.Explain how people and countries gain from trade by specializing according to comparative advantage. 7.(E&A) Convey how economic strength can lead to victory, sometimes without a fight.

4. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 4 2.1 SCARCITY AND CHOICE Economics exist because resources are scarce relative to our wants. Scarcity means that we have to make choices. Economics exist because resources are scarce relative to our wants. Scarcity means that we have to make choices.

5. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 5 Opportunity Costs Opportunity costs. represent the value of forgone alternatives All choices involve opportunity costs! Opportunity costs. represent the value of forgone alternatives All choices involve opportunity costs! There is no such thing as a free lunch!!!

6. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 6 ResourcesResources The four categories of resources are: LandLand LaborLabor EntrepreneurshipEntrepreneurship CapitalCapital – Human capital –Physical capital The four categories of resources are: LandLand LaborLabor EntrepreneurshipEntrepreneurship CapitalCapital – Human capital –Physical capital

7. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 7 2.2 PRODUCTION POSSIBILITIES A production possibility frontier is a model that illustrates both scarcity and choice by assuming that only two goods may be produced.

8. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 8 The Economy of Castaway Island

9. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 9 A Graph of a Production Possibility Frontier A B C D E F 12345 Fish 10 16 19 21 22 Coconuts

10. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 10 The Economy of Castaway Island - The Bowed Outward PPF -

11. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 11 Marginal Opportunity Cost A B C D E F 12345 Fish 10 16 19 21 22 Coconuts The marginal opportunity cost is the additional opportunity cost of one more fish.

12. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 12 Marginal Opportunity Cost A B C D E F 12345 Fish 10 16 19 21 22 The bowed or concave slope (shape)of the PPF curve reflects the Principle of “the law of increasing cost”. Coconuts

13. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 13 Law of Increasing Cost DataPoint Fish caught per day Opportunity Cost # of coconuts forgone Marginal Opportunity Cost (change in # of coconuts forgone) F00undefined* E111 D232 C363 B4126 A52210

14. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 14 Technologically Efficient and Feasible Points Good X Good Y Not Feasible Feasible but Inefficient All points on the PPF are are technologically efficient and feasible.

15. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 15 Technologically Efficient and Feasible Points Good X Good Y Allocative efficiency implies a specific point on the PPF that is the most valuable combination of outputs. In general, there will be only one point on the PPF that is allocatively efficient.

16. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 16 Whenever the production possibility frontier shifts outward, the economy is said to have experienced economic growth. Whenever the production possibility frontier shifts outward, the economy is said to have experienced economic growth. Economic Growth

17. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 17 Economic Growth Good X Good Y Economic growth can be caused by an increase in resources.

18. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 18 Characteristics of the production possibilities frontier (PPF): The ppf shows how much of one good can be produced for any amount of another.The ppf shows how much of one good can be produced for any amount of another. When on the frontier, the opportunity cost of one good is less of the other good.When on the frontier, the opportunity cost of one good is less of the other good. The frontier is bowed outward.The frontier is bowed outward. Every point on the frontier is technologically efficient.Every point on the frontier is technologically efficient. Points inside the frontier imply unemployed resources.Points inside the frontier imply unemployed resources. Points outside the frontier are unattainable.Points outside the frontier are unattainable. Shifting the frontier outward implies economic growth.Shifting the frontier outward implies economic growth. The ppf shows how much of one good can be produced for any amount of another.The ppf shows how much of one good can be produced for any amount of another. When on the frontier, the opportunity cost of one good is less of the other good.When on the frontier, the opportunity cost of one good is less of the other good. The frontier is bowed outward.The frontier is bowed outward. Every point on the frontier is technologically efficient.Every point on the frontier is technologically efficient. Points inside the frontier imply unemployed resources.Points inside the frontier imply unemployed resources. Points outside the frontier are unattainable.Points outside the frontier are unattainable. Shifting the frontier outward implies economic growth.Shifting the frontier outward implies economic growth.

19. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 19 Technological Growth Pretzels Pumpkins Starting PPF New PPF General Growth Pretzels Pumpkins Starting PPF New PPF Specialized Growth

20. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 20 Specialized Growth Specialized growth pivots the production possibility frontier in the direction of more output in the industry affected by the technological change.Specialized growth pivots the production possibility frontier in the direction of more output in the industry affected by the technological change.

21. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 21 Capital Consumer Goods B A Sacrificing current consumption for capital formation hastens economic growth ppf as Capital Depreciates and is Not Replaced. ppf as Capital Grows. Specialized Growth

22. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 22 2.3 THE CIRCULAR FLOW MODEL OF ECONOMIC ACTIVITY The circular flow model depicts how markets use the medium of money to determine what goods and services are produced and who gets to buy them. The model depicts both the output market and the input market.

23. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 23 The Circular Flow Model of Economic Activity Households Businesses $ Purchases Goods & Services $ Incomes Land, Labor, Capital, Entrepreneurship

24. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 24 2.4 EXPANDING CONSUMPTION POSSIBILITIES THROUGH TRADE For their own self interest economies engage in trade with other economies.For their own self interest economies engage in trade with other economies. This is true for national economies, regional economies, local economies, and even individuals (personal economies).This is true for national economies, regional economies, local economies, and even individuals (personal economies). For their own self interest economies engage in trade with other economies.For their own self interest economies engage in trade with other economies. This is true for national economies, regional economies, local economies, and even individuals (personal economies).This is true for national economies, regional economies, local economies, and even individuals (personal economies).

25. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 25 Expanding Consumption People specialize in their jobs according to their interest and opportunities.People specialize in their jobs according to their interest and opportunities. Then they use the income they earn to purchase goods and services.Then they use the income they earn to purchase goods and services. Countries engaged in international trade operate the same way, first they decide what to produce, then what to consume.Countries engaged in international trade operate the same way, first they decide what to produce, then what to consume. People specialize in their jobs according to their interest and opportunities.People specialize in their jobs according to their interest and opportunities. Then they use the income they earn to purchase goods and services.Then they use the income they earn to purchase goods and services. Countries engaged in international trade operate the same way, first they decide what to produce, then what to consume.Countries engaged in international trade operate the same way, first they decide what to produce, then what to consume.

26. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 26 Comparative Advantage vs. Absolute Advantage An economy has a comparative advantage in producing a good if it can produce a good at a lower opportunity cost than could other countries. An economy has an absolute advantage if it is able to produce something with fewer resources than others could. An economy has a comparative advantage in producing a good if it can produce a good at a lower opportunity cost than could other countries. An economy has an absolute advantage if it is able to produce something with fewer resources than others could.

27. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 27 International Trade 4 International trade is more important to small countries than to large countries. 4 Exports: Goods and services a country sells to other countries 4 Imports: Goods and services a country buys from other countries. 4 International trade is more important to small countries than to large countries. 4 Exports: Goods and services a country sells to other countries 4 Imports: Goods and services a country buys from other countries.

28. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 28 International Trade Through trade, a country can consume a combination of goods and services that lies outside its PPF, meaning that the country’s consumption possibilities will exceed its production possibilities.

29. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 29 Exports as a Percentage of GDP

30. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 30 Specialization According to Comparative Advantage Productivity per worker in Japan and England Productivity per worker in Japan and England

31. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 31 Computing Opportunity Cost and Comparative Advantage Product Location Opportunity Cost (C is computer chips and B is Barrels of oil) Opportunity Cost (per unit) Computer chips in Japan 10C=4B 2/5 barrel of oil (.4B)* Computer chips in England 5C=3B 3/5 barrel of oil (.6B) Oil in Japan 4B=10C 5/2 computer chips (2.5C) Oil in England 3B=5C 5/3 computer chips (1.67C)*

32. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 32 2.5 EXPLORE & APPLY Victory Guns and Butter – From a Strong Economy  In World War 2, the US was able to quickly convert many civilian industries to military production and play a pivotal role in defeating the both the Nazi’s and Japan.  Nearly 5 decades later it was able to defeat the Soviet Union “economically”, without any shots being fired. That’s the best kind of victory.

33. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 33 Terms along the Way opportunity costs landlabor human capital capitalentrepreneurshiptechnology production possibilities frontier law of increasing cost opportunity costs landlabor human capital capitalentrepreneurshiptechnology production possibilities frontier law of increasing cost economic growth moneybarter circular flow output market input market comparative advantage absolute advantage Exportsimports

34. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 34 Test Yourself 1.The opportunity cost of a new city police contract is: a.the amount of money it takes in order to provide the city with the most highly qualified personnel. b.the value of the other goods and services that the city and taxpayers will be forced to give up in order to pay for the contract. c.the cost to victims of crimes that the new contract would prevent. d.the value of the opportunities that city policemen acquire by accepting it. 1.The opportunity cost of a new city police contract is: a.the amount of money it takes in order to provide the city with the most highly qualified personnel. b.the value of the other goods and services that the city and taxpayers will be forced to give up in order to pay for the contract. c.the cost to victims of crimes that the new contract would prevent. d.the value of the opportunities that city policemen acquire by accepting it.

35. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 35 Test Yourself 2.Which of the following items is the best example of an economic resource? a.A stock certificate. b.A one-hundred dollar bill. c.A tractor. d.A plate of spaghetti. 2.Which of the following items is the best example of an economic resource? a.A stock certificate. b.A one-hundred dollar bill. c.A tractor. d.A plate of spaghetti.

36. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 36 Test Yourself 3. A production possibilities frontier shows combinations of: a.inputs that can produce a specific quantity of output. b.outputs that people consume. c.outputs that can be achieved as technology improves. d.outputs that can be achieved in a given time period with all available resources employed using current technology. 3. A production possibilities frontier shows combinations of: a.inputs that can produce a specific quantity of output. b.outputs that people consume. c.outputs that can be achieved as technology improves. d.outputs that can be achieved in a given time period with all available resources employed using current technology.

37. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 37 Test Yourself 4. If a Nation’s production possibilities indicates that 1,000,000 battle tanks and 6,000,000 houses could be produced, or alternatively, 750,000 tanks and 8,000,000 houses could also be produced, the opportunity cost of each additional house would be: a.250,000 tanks. b.8 tanks. c.0.125 tanks. d.2,000,000 tanks. 4. If a Nation’s production possibilities indicates that 1,000,000 battle tanks and 6,000,000 houses could be produced, or alternatively, 750,000 tanks and 8,000,000 houses could also be produced, the opportunity cost of each additional house would be: a.250,000 tanks. b.8 tanks. c.0.125 tanks. d.2,000,000 tanks.

38. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 38 Test Yourself 5. As a nation develops economically, its production possibilities frontier: a.remains stable. b.shifts towards the origin. c.shifts away from the origin. d.becomes steeper, but does not shift. 5. As a nation develops economically, its production possibilities frontier: a.remains stable. b.shifts towards the origin. c.shifts away from the origin. d.becomes steeper, but does not shift.

39. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 39 Test Yourself 6. When a country can produce a good with fewer resources than any other country, the country has: a.a comparative advantage. b.a resource advantage. c.an absolute advantage. d.an unfair advantage. 6. When a country can produce a good with fewer resources than any other country, the country has: a.a comparative advantage. b.a resource advantage. c.an absolute advantage. d.an unfair advantage.

40. ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 40 The End! Next Chapter 3 “Demand and Supply"