2. Is wind power free?

3. 3
The Economic Problem
CHAPTER CHECKLIST
When you have completed your study of this chapter, you will be able to
1 Explain and illustrate the concepts of scarcity, production efficiency, and tradeoff using the production possibilities frontier.
2 Calculate opportunity cost.
3 Explain what makes production possibilities expand.
4 Explain how people gain from trade.
5 Explain why free trade agreements are controversial
Notes and teaching tips: 5, 6, 16, 33.
To view a full-screen figure during a class, click the red “expand” button.
To return to the previous slide, click the red “shrink” button.
To advance to the next slide, click anywhere on the full screen figure.
To enhance your lecture, check out the Lecture Launchers, Land Mines, and Class Activities in the Instructor’s Manual.

4. 3.1 PRODUCTION POSSIBILITIES
Production Possibilities Frontier
Production possibilities frontier
The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology.
The PPF is a valuable tool for illustrating the effects of scarcity and its consequences.

5. 3.1 PRODUCTION POSSIBILITIES
The PPF puts three features of production possibilities in sharp focus:
Attainable (aka feasible) and unattainable (i.e. not feasible) combinations
Efficient and inefficient production
Tradeoffs and free lunches

6. 3.1 PRODUCTION POSSIBILITIES
Attainable and Unattainable Combinations
Because the PPF shows the limits to production, it separates attainable combinations from unattainable ones.
Figure 3.2 on the next slide illustrates the attainable and unattainable combinations.

7. 3.1 PRODUCTION POSSIBILITIES
We can produce at any point inside the PPF or on the frontier.
We cannot produce at any point outside the PPF such as point G.
The PPF separates attainable combinations from unattainable combinations.

9. 3.1 PRODUCTION POSSIBILITIES
Efficient and Inefficient Production
Production efficiency is a situation in which we cannot produce more of one good or service without producing less of something else.
Figure 3.3 on the next slide illustrates the distinction between efficient and inefficient production.

10. 3.1 PRODUCTION POSSIBILITIES
1. When production is on the PPF, such as at point E or D, production is efficient.
2. If production were inside the PPF, such as at point H, more could be produced of both goods without forgoing either good.
Production is inefficient.

12. 3.1 PRODUCTION POSSIBILITIES
Tradeoffs and Free Lunches
A tradeoff is an exchange—giving up one thing to get something else.
A free lunch is a gift—getting something without giving up something else.
Figure 3.3 on the next slide illustrates the distinction between a tradeoff and a free lunch.

13. 3.1 PRODUCTION POSSIBILITIES
3. When production is on the PPF, we face a tradeoff.
4. If production were inside the PPF, there would be a free lunch.
Moving from point H to point D does not involve a tradeoff.

14. The Opportunity Cost of X
The opportunity cost of good X (cell phone) is the decrease in the quantity of Y (DVDs) divided by the increase in the number of cell phones as we move along the PPF.
Mathematically, opportunity cost of X is the absolute value of the slope of the PPF:
Students almost instinctively relate costs to monetary costs. To help them grasp the idea of opportunity cost while moving along the PPF, it is important to get students to realize very early on that thinking only of monetary costs is a narrow view and that it ignores the most important cost of all—opportunity cost. Demonstrate the fact that that opportunity cost does not necessarily involve money by launching your lecture with an example that hits close to home. Ask your students to take a minute to write down a list of things that qualify as the opportunity cost to them of attending your economics class. Expect a fairly wide range of answers from the downright silly to the very thoughtful. Stress that the true opportunity cost of any endeavor is only the one next best alternative forgone. The reason is because you can only perform one other activity in place of whatever it is you are doing at present. In other words, you will need to convince your students that even though they have come up with a fairly long list of items, the opportunity cost of attending your economics class can only be one of them. This one is the one that will rank above the others as the next best available alternative. Here might be some possible answers: by taking economics your students cannot take biology, physics or chemistry; they might have to give up overtime at work (if they are taking a night class); or the cost could be the forgone extra sleep they could have enjoyed if they are taking an 8:00 a.m. class!

15. 3.2 OPPORTUNITY COST EXAMPLE
Point X Y A 72 B 8 70 C 15 66 D 21 60 E 26 52 F 30 42 G 33 H 35 16 I 36

17. Note, as the economy produces more of X, its opportunity cost rises.
As we produce more Y, its opportunity cost rises.

18. The Opportunity Cost of a Cell Phone
The opportunity cost of a cell phone is the decrease in the quantity of DVDs divided by the increase in the number of cell phones as we move along the PPF.
Figure 3.4 illustrates the calculation of the opportunity cost of a cell phone.
Students almost instinctively relate costs to monetary costs. To help them grasp the idea of opportunity cost while moving along the PPF, it is important to get students to realize very early on that thinking only of monetary costs is a narrow view and that it ignores the most important cost of all—opportunity cost. Demonstrate the fact that that opportunity cost does not necessarily involve money by launching your lecture with an example that hits close to home. Ask your students to take a minute to write down a list of things that qualify as the opportunity cost to them of attending your economics class. Expect a fairly wide range of answers from the downright silly to the very thoughtful. Stress that the true opportunity cost of any endeavor is only the one next best alternative forgone. The reason is because you can only perform one other activity in place of whatever it is you are doing at present. In other words, you will need to convince your students that even though they have come up with a fairly long list of items, the opportunity cost of attending your economics class can only be one of them. This one is the one that will rank above the others as the next best available alternative. Here might be some possible answers: by taking economics your students cannot take biology, physics or chemistry; they might have to give up overtime at work (if they are taking a night class); or the cost could be the forgone extra sleep they could have enjoyed if they are taking an 8:00 a.m. class!

19. 3.2 OPPORTUNITY COST
Moving from A to B, 1 cell phone costs 1 DVD.

21. 3.2 OPPORTUNITY COST
Moving from B to C, 1 cell phone costs 2 DVDs.

22. 3.2 OPPORTUNITY COST
Moving from C to D, 1 cell phone costs 3 DVDs.

23. 3.2 OPPORTUNITY COST
Moving from D to E, 1 cell phone costs 4 DVDs.

24. 3.2 OPPORTUNITY COST
Moving from E to F, 1 cell phone costs 5 DVDs.

25. 3.2 OPPORTUNITY COST Increasing Opportunity Cost
The opportunity cost of a cell phone increases as more cell phones are produced.

27. Opportunity Cost and the Slope of the PPF
The magnitude of the slope of the PPF measures opportunity cost.
The slope of the PPF in Figure 3.4 measures the opportunity cost of a cell phone.
The PPF is bowed outward. As more cell phones are produced, the PPF becomes steeper and the opportunity cost of a cell phone increases.

28. Opportunity Cost Is a Ratio
The opportunity cost of a cell phone is the quantity of DVDs forgone divided by the increase in the quantity of cell phones gained.
The opportunity cost of a DVD is the quantity of cell phones forgone divided by the increase in the quantity of DVDs gained.
When the opportunity cost of a cell phone is x DVDs, the opportunity cost of a DVD is 1/x cell phones.

29. Opportunity Cost Is a Ratio
The opportunity cost of a X is the quantity of Y forgone divided by the increase in the quantity of X gained.

30. Increasing Opportunity Costs Are Everywhere
Just about every activity has an increasing opportunity cost.
If you increase the number of hours spent on studying, you will realize that after 10 hours, the gain in knowledge becomes small, and the opportunity cost (say in terms of sleep) gets high.

31. Wind power is not free.
Its opportunity cost includes:
the cost of wind turbines,
the cost of transmission lines, and
power transmission loss.
Wind turbines can produce electricity only when there is wind, which is, at best, 40 percent of the time and, on average, about 25 percent of the time.
Also some of the best wind farm locations are a long way from major population centers, so transmission lines would be long and power transmission losses large.

32. Point A is a point of efficient electricity production.
If the United States produces 55 percent of the electricity using South Dakota wind power, …
the United States would be operating inside its PPF such as a point like Z.

33. 3.3 ECONOMIC GROWTH
Economic growth is the sustained expansion of production possibilities.
An economy grows when it develops better technology, improves the quality of labor, or increases the quantity of capital.
When an economy’s resources increase, its production possibilities expand and its PPF shifts outward.
To study economic growth, we begin at the PPF with consumption goods on one axis and a capital good on the other.

34. 3.3 ECONOMIC GROWTH
If we produce at point J, we produce only cell-phone factories and no cell phones.
If we produce at point L, we produce cell phones and no cell-phone factories.
At L, consumption remains at 5 million cell phones every year.

36. 3.3 ECONOMIC GROWTH
1. But if we cut production of cell phones to 3 million this year, we can produce 2 cell-phone factories at point K.
2. Then next year, our PPF shifts outward because we have more capital.
We can consume at a point outside our original PPF, such as K'.

37. 3.4 GAINS FROM TRADE
Main result:
If people (or countries) have different relative productivity (different opportunity cost) in producing goods, then they can all gain from trading with each other (more goods can be produced). This is without working more, and without using more resources!
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations

38. Absolute vs. Comparative Advantage
3.4 GAINS FROM TRADE
Absolute vs. Comparative Advantage
Absolute advantage - A person (or a country) has absolute advantage in producing a good if he can produce that good with less resources (say less time, less inputs).
Comparative advantage - A person (or a country) has a comparative advantage in producing a good if he can produce it at lower opportunity cost.
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations

39. 3.4 GAINS FROM TRADE Example 1 1 5 1/5
Nicki and Drake operate an Italian pizza bar “Anaconda”, and produce pizza and salads.
Time required (in min.) to:
Opportunity Cost of one unit
Make a pizza (X)
Make a salad (Y) X Y
Nicki
1.5
Drake 10 2 1 1
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations 5
1/5
Nicki has absolute advantage in both goods.
Nicki has comparative advantage in pizza (X) and Drake has comparative advantage in salad (Y).

40. 3.4 GAINS FROM TRADE Example 1 1 5 1/5
Same information can be given in terms of output per hour.
Output per hour:
Opportunity Cost of one unit
Pizza (X)
Salads (Y) X Y
Nicki 40
Drake 6 30 1 1
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations 5
1/5
Nicki has absolute advantage in both goods.
Nicki has comparative advantage in pizza (X) and Drake has comparative advantage in salad (Y).

41. Time reallocation and gains from trade
Nicki
Pizza (X)
Salads (Y)
Drake
Total change in output
1 hour
+40
-40
2 hours
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations
-12
+60
+28
+20

42. Conclusions 3.4 GAINS FROM TRADE
Nicki and Drake reallocated their time towards the production of the good in which they have comparative advantage in. As a result, their total production of both goods went up.
How do we gain from trade? By lowering opportunity cost.
The reallocation in the example can be increases, which will increase the total gain.
How much extra consumption each of them gains depends on the trade agreement.
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations

43. 3.4 GAINS FROM TRADE
Main result:
If people (or countries) have different relative productivity (different opportunity cost) in producing goods, then they can all gain from trading with each other (more goods can be produced). This is without working more, and without using more resources!
Comparative advantage and absolute advantage are concepts that give students trouble. It flies in the face of intuition to say that even though someone has the ability to produce something using fewer resources than someone else, nonetheless, it still pays for the two to trade. It is an especially difficult concept to grasp when you up the ante by saying that the same would still be true even if that person enjoyed an absolute advantage in everything over their trading partner! This might be a good opportunity to use a very concrete example that students should be able to compute right in the classroom. Lay out the following scenario: Assume Suzie, a computer consultant, is very good at repairing computers and also happens to be a very good house painter. In fact, she is so good that it turns out she is more productive at both things than her neighbor, Bob, who happens to paint houses for a living. To the right is a table that shows the amount of time it takes for Suzie and Bob to perform each of the two activities. In addition, let’s assume that Suzie and Bob earn $100 per computer repaired and Bob and Suzie earn $960 per house painted. Ask the students to compute the opportunity cost for Suzie and Bob repairing a computer and painting a house. The new table to the right contains the opportu54 nity costs. (To calculate these numbers, take Suzie’s opportunity cost of painting a house. In the 30 hours it takes her to paint a house, she could have repaired 15 computers, so the opportunity cost is 15 computers times $100 each.) It reveals that Suzie has the lower opportunity cost of repairing computers and Bob has the lower opportunity cost of painting houses. What this example demonstrates so powerfully is that a person can have an absolute disadvantage in everything, as is the case for Bob, but still manage to have a comparative advantage in an activity. Point out to students that this logic applies between individuals and also across cities, states, and nations

44. 3.5 Controversy About Free Trade Agreements
NAFTA
TPP
Hillary Clinton
Initially for, since 2008 against
Initially for, since 2016 against
Barack Obama
Against
For (created the agreement)
Bernie Sanders
Donald Trump
Disagreements on free trade are not necessary according to political affiliation.
European Union
United Kingdom
In European Union since Suppose to leave the union by 2019.

45. 3.5 Controversy About Free Trade Agreements
We showed that the economy overall benefits from trade. However, some industries shrink, and workers lose jobs.
More trade means more production transportation of goods, and more environmental cost. This is called negative externality, and is discussed in length in micro class (ECON 101).

46. Policies against free trade are costly.
3.5 Controversy About Free Trade Agreements
Policies against free trade are costly.
"over a thousand Americans are working today because we stopped a surge in Chinese tires.“ (Barack Obama 2012, State of the Union Address, Quote about tariff increase on Chinese tires imports).
Estimated jobs saved by the tariff: 1,200.
Cost to consumers (who spend more on tires): 1.1 billion in 2011 alone.
Cost per job save in tire industry: $833,000 per job.
Without the tariff, the 1.1 billion could be spent on other goods and services, and create 11,000 jobs (at 100k).

47. PPFs of countries 1, 2 (per worker).
Question 1
Country 1 has absolute advantage in X.
Country 2 has absolute advantage in Y.
Country 1 has comparative advantage in Y.
Country 2 has absolute and comparative advantage in X.
PPFs of countries 1, 2 (per worker). Y 1 2 X

48. PPFs of countries 1, 2 (per worker).
Question 2
Country 1 has absolute advantage in both goods, and therefore cannot gain from trade with country 2.
Country 1 has absolute advantage in both goods, but comparative advantage only in X.
Country 1 has absolute advantage in both goods, but comparative advantage only in Y.
Both countries have comparative advantage in X.
PPFs of countries 1, 2 (per worker). Y 1 2 X

49. PPFs of countries 1, 2 (per worker).
Question 3
Which statement is incorrect?
Neither country has comparative advantage in either good X or Y.
County 1 has absolute advantage in both goods.
Neither country can gain from trading with the other country.
Neither country has absolute advantage in either good X or Y.
PPFs of countries 1, 2 (per worker). Y 1 2 X