Production and Trade Chapter 2

There is no such thing as a free lunch Opportunity cost: The value of the best alternative opportunity forgone What you give up Subjective $ plus utility Utility – satisfaction or enjoyment from an action

Resources Are combined to produce outputs of goods and services Inputs Productivity – the ability of a resource to produce output.

Resources Land – natural resources in their natural state Labor – human capital Human capital is acquired skills and abilities embodied within a person Capital – anything that is produced in order to increase productivity in the future. Physical capital – buildings, machinery, etc

Entrepreneurship Is taking personal initiative to combine resources in productive ways Technology – possible techniques of production

Production Possibilities Frontier A model that shows the various combinations of two goods the economy is capable of producing Scarcity and choice CDDVD

Production Possibilities CD DVD 0 0 A B.C.D A./B –efficient points C. – inefficient point D. – unattainable given the assumptions Any point on the line is efficient

Production Possibilities Marginal opportunity cost which is the additional opportunity cost from one more unit of output Law of increasing cost – the rise in the marginal opportunity cost of producing a good is more of that good is produced.

Production Possibilities Technological efficiency Using the production process to the minimum waste of resources Allocative Efficiency Implies a specific point on the production possibilities frontier that is the most valuable combination of inputs. Only one point

Economic Growth Production possibilities will depend on how much of each resource the economy has and on the technology that is available to make use of those resources. Assumptions: Fixed resources Fixed technology

Economic Growth The ability of the economy to produce more or better output. Change in technology Change in resource base Frontier shifts outward

Production Possibilities The production possibilities frontier shows how much of one good can be produced for any feasible amount of another good If an economy is on its frontier, the opportunity cost of producing more of one good is less of another good

Production Possibilities The production possibilities frontier is bowed outward, consistent with the law of increasing cost, which notes the increasing marginal opportunity cost of additional output Every point along the production possibilities frontier is technological efficient

Production Possibilities Points inside the frontier imply some unemployed or misallocated resources and are thus inefficient Points outside the frontier are unattainable with current resources and technology Economies grow by acquiring resources or better technology, which shifts the frontier outward If the economy acquires resources that are specialized in the production of certain good, the production possibilities frontier expands outward

Circular Flow of Economic Activity Money – a medium of exchange that removes the need for barter, also a measure of value and a way to store value of time

Barter The exchange of goods and services directly for one another, without the use of money

Circular Flow A model of economy that depicts how the flow of money facilitates a counter flow of resources, goods, and services in the input and output markets

Market Output market The market where goods and services are bought and sold Input market The market where resources are bought and sold

Circular Flow Output Market Input Market Money Goods

Comparative Advantage The ability to produce a good at a lower opportunity cost (other goods forgone) than others could do Produce the good with lowest opportunity cost and trade for good for highest opportunity cost Buy cheap => Sell dear Example

Absolute Advantage The ability to produce a good with fewer resources than other producers. To gain from trade, specialize according to comparative advantage, whether or not you have any absolute advantage

Trade Countries gain from trade whether or not they have an absolute advantage in anything

Trade Exports - Goods and services a country sells to other countries Imports – goods and services a country buys from other countries

Trade Through trade, a country can consume a combination of goods and services that lies outside its production possibilities frontier, meaning the country’s consumption possibilities will exceed its production possibilities. example

Example