Introduction to Macroeconomics

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

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

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

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

5. 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 Introduction to Macroeconomics

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

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

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

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

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

11. 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. Introduction to Macroeconomics

12. Notes Page Introduction to Macroeconomics

13. 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 Introduction to Macroeconomics

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

15. 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) Introduction to Macroeconomics

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

17. 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 Introduction to Macroeconomics

18. 2. Production Possibilities Curve Assumptions Increase in Resources or Technology Improvement that benefits both products. PPC shifts outward (to the right), from PPC1 to PPC2. PPC2 PPC1 Introduction to Macroeconomics

19. 2. Production Possibilities Curve Assumptions Increase in Specialized Resources Improvement that benefits Food production only. PPC1 PPC2 Introduction to Macroeconomics

20. 2. Production Possibilities Curve Assumptions Increase in Specialized Resources Improvement that benefits clothing production only. PPC2 PPC1 Introduction to Macroeconomics

21. 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 Introduction to Macroeconomics

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

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

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

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

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

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

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

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

30. 3. Applications Staffing University Departments Introduction to Macroeconomics

31. 3. Applications Staffing University Departments Introduction to Macroeconomics