lecture 2 - Valdosta State University
Section 2
Production Possibility Frontier
& Trade
Chapter 2: pages 32-60
KEY DEFINITIONS
Production possibilities frontier is a curve showing the maximum attainable combinations of two products that may be produced with available resources.
Opportunity Cost The highest-valued alternative that must be given up in order to engage in an activity.
Practice Problem 2-1 (on your own). Highly
Recommended!
Constant opportunity cost PPFs vs.
Increasing opportunity cost PPFs
Increasing Marginal Opportunity Costs
500
Economic Growth
Economic Growth
Assumptions
Let’s assume there are two products (Apples and cherry).
There are two persons in our small society now: you and your neighbor.
To be or not to be...
To be self-sufficient and produce everything we need
OR
To cooperate with others - TRADE
The benefit of trade is pretty obvious if you only have apple trees and your neighbor only has cherry.
Furthermore, the benefit of trade also seems obvious if you are much better in picking apples and your neighbor is better in picking cherry.
In this case you should SPRECIALIZE in apple production and your neighbor should
SPECILIZE in cherry production.
And you should TRADE
But what happens if one of you is much better in picking both apples and cherry?
Your Production and Consumption
Possibilities without TRADE
Your neighbor’s Production and
Consumption possibilities
Without Trade
You
Your neighbor
Opportunity cost of picking
1 pound of apples
1 pound of cherries
2 pounds of cherries
Opportunity cost of picking 1 pound of cherries
1 pound of apples
.5 pound of apples
Absolute vs. Comparative Advantage
Absolute advantage The ability of an individual, firm, or country to produce more of a good or service than competitors using the same amount of resources.
Comparative advantage The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than other producers.
TRADE
You should specialize in whatever you have comparative advantage in.
The Principle of
Comparative Advantage
Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.
Practice
Solved Problem 2-2 on your own (Highly recommended!)
Should the United States trade with other countries?
As we all know Americans enjoy a lot of goods produced by other countries.
Imports : goods produced abroad and sold domestically.
Exports : goods produced domestically and sold abroad.
The Circular-Flow Diagram
Revenue Spending
Goods &
Services sold
Market for
Goods and Services
Goods &
Services bought
Firms
Households
Inputs for production
Wages, rent, and profit
Market for
Factors of Production
Labor, land, and capital
Income
