1. Unit 1 Chapter 2 Trade-offs and Trade
AP Economics
Unit 1
Chapter 2 Trade-offs and Trade

2. Review Explain Scarcity. Differentiate between positive and normative.
Define opportunity cost.
What is a resource?
Name 10 different teachers at RWHS.

3. I. The Production Possibilities Frontier (curve)
Illustration of the trade-offs facing an economy that produces only two goods. Shows the maximum quantity of one good that can be produced for any given production of the other.

4. The Production Possibility Frontier
Quantity of coconuts 30 D
Feasible and
efficient
in production
Not feasible A 15
Figure Caption:
Figure The Production Possibility Frontier
The production possibility frontier illustrates the trade-offs facing an economy that produces two goods. It shows the maximum quantity of one good that can be produced given the quantity of the other good produced. Here, the maximum quantity of coconuts that Tom can gather depends on the quantity of fish he catches, and vice versa. His feasible production is shown by the area inside or on the curve. Production at point C is feasible but not efficient. Points A and B are feasible and efficient in production, but point D is not feasible.
Feasible but
not efficient B 9 C
Production possibility frontier
PPF 20 28 40
Quantity of fish

5. Increasing Opportunity Cost
Quantity of coconuts
Producing the first
20 fish . . .
…requires giving up
5 coconuts 35 30
But producing
20 more fish . . . A 25 20
…requires giving up
25 more coconuts… 15
Figure Caption:
Figure Increasing Opportunity Cost
The bowed-out shape of the production possibility frontier reflects increasing opportunity cost. In this example, to produce the first 20 fish, Tom must give up 5 coconuts. But to produce an additional 20 fish, he must give up 25 more coconuts. 10 5
PPF 10 20 30 40 50
Quantity of fish

6. Economic Growth
Quantity of coconuts
Production is initially at point A (20 fish and 25 coconuts),  it can move to point E (25 fish and 30 coconuts).
Economic growth results in an outward shift of the PPF because production possibilities are expanded.
The economy can now produce more of everything. 35 E 30 A 25 20 15
Figure Economic Growth
Economic growth results in an outward shift of the production possibility frontier because production possibilities are expanded. The economy can now produce more of everything. For example, if production is initially at point A (20 fish and 25 coconuts), it could move to point E (25 fish and 30 coconuts). 10 5
Original
New
PPF
PPF 10 20 25 30 40 50
Quantity of fish

7. PPC Practice Draw a PPC showing changes for each of the following:
Pizza and Robots (3)
1. New robot making technology
2. Decrease in the demand for pizza
3. Mad cow disease kills 85% of cows
Consumer goods and Capital Goods (4)
4. BP oil spill in the Gulf
5. Faster computer hardware
6. Many workers unemployed
7. Significant increases in education

8. New robot making technology
Question #1
New robot making technology Q
A shift only for Robots
Robots Q
Pizzas 8

9. Question #2 Decrease in the demand for pizza Q
The curve doesn’t shift!
A change in demand doesn’t shift the curve
Robots Q
Pizzas 9

10. Mad cow disease kills 85% of cows A shift inward only for Pizza
Question #3
Mad cow disease kills 85% of cows Q
A shift inward only for Pizza
Robots Q
Pizzas 10

11. Question #4 BP Oil Spill in the Gulf Q
Decrease in resources decrease production possibilities for both
Capital Goods (Guns) Q
Consumer Goods (Butter) 11

12. Question #5 Faster computer hardware Q
Quality of a resource improves shifting the curve outward
Capital Goods (Guns) Q
Consumer Goods (Butter) 12

13. Question #6 Many workers unemployed Q The curve doesn’t shift!
Unemployment is just a point inside the curve
Capital Goods (Guns) Q
Consumer Goods (Butter) 13

14. Question #7 Significant increases in education Q
The quality of labor is improved. Curve shifts outward.
Capital Goods (Guns) Q
Consumer Goods (Butter) 14

15. Production Possibilities for Two Castaways
(a) Tom’s Production Possibilities
Quantity of coconuts 30
Tom’s consumption
without trade
Figure Caption:
Figure Production Possibilities for Two Castaways
Here, each of the two castaways has a constant opportunity cost of fish and a straight-line production possibility frontier. In Tom’s case, each fish always has an opportunity cost of 3⁄4 of a coconut. 9
Tom’s
PPF 28 40
Quantity of fish

16. Production Possibilities for Two Castaways
(a) Hank’s Production Possibilities
Quantity of coconuts 20
Hank’s consumption
without trade
Figure Caption:
Figure Production Possibilities for Two Castaways
Here, each of the two castaways has a constant opportunity cost of fish and a straight-line production possibility frontier. In Hank’s case, each fish always has an opportunity cost of 2 coconuts. 8
Hank’s
PPF 6 10
Quantity of fish

17. Tom and Hank’s Opportunity Costs
Tom’s Opportunity Cost
Hank’s Opportunity Cost
One fish
3/4 coconut
2 coconuts
One coconut
4/3 fish
1/2 fish

18. Specialize and Trade
Both castaways are better off when they each specialize in what they are good at and trade.

19. Comparative Advantage and Gains from Trade
(a) Tom’s Production and Consumption
(b) Hank’s Production and Consumption
Quantity of coconuts
Quantity of coconuts 30
Tom’s consumption without trade
Hank’s production with trade
Tom’s consumption with trade 20
Hank’s consumption with trade 10
Figure Caption:
Figure 2-5: Comparative Advantage and Gains from Trade By specializing and trading, the two castaways can produce
By specializing and trading, the two castaways can produce and consume more of both goods. Tom specializes in catching fish, his comparative advantage, and Hank— who has an absolute disadvantage in both goods but a comparative advantage in coconuts—specializes in gathering coconuts. The result is that each castaway can consume more of both goods than either could without trade.
Tom’s production with trade 10
Hank’s consumption without trade 9 8 T o m 's
Hank's
PPF
PPF 28 30 40 6 10
Quantity of fish
Quantity of fish

20. How the Castaways Gain from Trade
Both Tom and Hank experience gains from trade:
1. Tom’s consumption of fish increases by two, and his consumption of coconuts increases by one.
2. Hank’s consumption of fish increases by four, and his consumption of coconuts increases by two.

21. II. Absolute vs. Comparative Advantage
Absolute advantage: greater total output. (ie. Tom)
Hank has a comparative advantage in coconut gathering (opportunity cost is lower than Toms).
Tom can better use his time catching fish.
Comparative Advantage: Opportunity cost for producing something is lower for one person over the other.

22. III. The Circular-Flow Diagram
Model that represents the transactions in an economy by flows around a circle.

23. The Circular-Flow Diagram
Money
Households
Money
Goods
Factors
and
services
Markets for goods and services
Factor Markets
Goods
Figure Caption:
Figure 2.7: The Circular-Flow Diagram
This diagram represents the flows of money and goods and services in the economy. In the markets for goods and services, households purchase goods and services from firms, generating a flow of money to the firms and a flow of goods and services to the households. The money flows back to households as firms purchase factors of production from the households in factor markets.
and
Factors
services
Firms
Money
Money

24. Circular-Flow cont.
Household: a person or groups of people that share their income.
Firm: Organization that produces goods and services for sale.
Firms sell goods and services in the product market.
Firms buy resources they need to produce in the factor market.