CHAPTER 2 “Production and Trade”

1. MACROECONOMICS: EXPLORE & APPLYby Ayers and Collinge CHAPTER 2“Production and Trade”

2. Learning Objectives • Analyze tradeoffs facing both individuals and countries • Relate the types of resources an economy possesses. • Model a country’s production possibilities, and how these possibilities respond to technological development.

3. Learning Objectives • Describe how economies can grow faster if they are willing to cut back on current consumption. • Visualize the flow of goods and services, resources, and money in the economy. • Explain how people and countries gain from trade by specializing according to comparative advantage. • (E&A) Convey how economic strength can lead to victory, sometimes without a fight.

4. 2.1SCARCITY AND CHOICE • Economics exist because resources are scarce relative to our wants. • Scarcity means that we have to make choices.

5. 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. Resources The four categories of resources are: • Land • Labor • Entrepreneurship • Capital • Human capital • Physical capital

7. 2.2PRODUCTION POSSIBILITIES A production possibility frontier is a model that illustrates both scarcity and choice by assuming that only two goods may be produced.

8. The Economy of Castaway Island

9. A Graph of a Production Possibility Frontier Coconuts F E 22 D 21 19 C 16 B 10 A 1 2 3 4 5 Fish

10. The Economy of Castaway Island- The Bowed Outward PPF -

11. Marginal Opportunity Cost Themarginal opportunity costis the additional opportunity cost of one more fish. Coconuts F E 22 D 21 19 C 16 B 10 A 1 2 3 4 5 Fish

12. Marginal Opportunity Cost Thebowed or concave slope (shape)of the PPF curve reflects the Principle of “the law of increasing cost”. Coconuts F E 22 D 21 19 C 16 B 10 A 1 2 3 4 5 Fish

13. Law of Increasing Cost

14. All points on the PPF are are technologically efficient and feasible. Technologically Efficient and Feasible Points Not Feasible Good Y Feasible but Inefficient Good X

15. Allocative efficiency implies a specific point on the PPF that is the most valuable combination of outputs. Technologically Efficient and Feasible Points Good Y In general, there will be only one point on the PPF that is allocatively efficient. Good X

16. Economic Growth Whenever the production possibility frontier shifts outward, the economy is said to have experienced economic growth.

17. Economic Growth Economic growth can be caused by an increase in resources. Good Y Good X

18. Characteristics of the production possibilities frontier (PPF): • 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. • The frontier is bowed outward. • Every point on the frontier is technologically efficient. • Points inside the frontier imply unemployed resources. • Points outside the frontier are unattainable. • Shifting the frontier outward implies economic growth.

19. Technological Growth General Growth Specialized Growth Pumpkins Pumpkins New PPF New PPF Starting PPF Starting PPF Pretzels Pretzels

20. Specialized Growth • Specialized growth pivots the production possibility frontier in the direction of more output in the industry affected by the technological change.

21. Specialized Growth ppf as Capital Grows. A Consumer Goods Sacrificing current consumption for capital formation hastens economic growth B ppf as Capital Depreciates and is Not Replaced. Capital

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 andwho gets to buy them. The model depicts both the output market and the input market.

23. The Circular Flow Model of Economic Activity Goods & Services $ Purchases Businesses Households $ Incomes Land, Labor, Capital, Entrepreneurship

24. 2.4EXPANDING CONSUMPTION POSSIBILITIES THROUGH TRADE • 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).

25. Expanding Consumption • People specialize in their jobs according to their interest and opportunities. • 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.

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.

27. International Trade International trade is more important to small countries than to large countries. Exports: Goods and services a country sells to other countries Imports: Goods and services a country buys from other countries.

28. International Trade Through trade, a country can consume a combination of goods and services that lies outside its PPF, meaning that thecountry’s consumption possibilities will exceed itsproduction possibilities.

29. Exports as a Percentage of GDP

30. Specialization According to Comparative Advantage Productivity per worker in Japan and England

31. Computing Opportunity Cost and Comparative Advantage

32. 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. 2.5 EXPLORE & APPLYVictory Guns and Butter – From a Strong Economy

33. opportunity costs land labor human capital capital entrepreneurship technology production possibilities frontier law of increasing cost economic growth money barter circular flow output market input market comparative advantage absolute advantage Exports imports Terms along the Way

34. Test Yourself • The opportunity cost of a new city police contract is: • the amount of money it takes in order to provide the city with the most highly qualified personnel. • 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. • the cost to victims of crimes that the new contract would prevent. • the value of the opportunities that city policemen acquire by accepting it.

35. Test Yourself 2. Which of the following items is the best example of an economic resource? • A stock certificate. • A one-hundred dollar bill. • A tractor. • A plate of spaghetti.

36. Test Yourself 3. A production possibilities frontier shows combinations of: • inputs that can produce a specific quantity of output. • outputs that people consume. • outputs that can be achieved as technology improves. • outputs that can be achieved in a given time period with all available resources employed using current technology.

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: • 250,000 tanks. • 8 tanks. • 0.125 tanks. • 2,000,000 tanks.

38. Test Yourself 5. As a nation develops economically, its production possibilities frontier: • remains stable. • shifts towards the origin. • shifts away from the origin. • becomes steeper, but does not shift.

39. Test Yourself 6. When a country can produce a good with fewer resources than any other country, the country has: • a comparative advantage. • a resource advantage. • an absolute advantage. • an unfair advantage.

40. The End! Next Chapter 3 “Demand and Supply"