The Production Possibility Model,
Trade, and Globalization
CHAPTER
2
2
No one ever saw a dog make a fair and deliberate exchange of one bone for another with another dog .
— Adam Smith
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

The Production Possibility Model,
Trade, and Globalization
2
• Demonstrate opportunity cost with a production possibility curve
• Discuss the increasing marginal opportunity cost
• Relate the concept of comparative advantage to the production possibility curve
• Show how through comparative advantage and trade, a country can consume beyond their production possibility
• Explain how globalization and outsourcing are part of a global process guided by the law of one price
2-2

The Production Possibility Model,
Trade, and Globalization
2
History Economics
Hrs of Study Grade Hrs of Study Grade
20
18
98%
94%
0
2
40%
46%
16 90% 4 52%
14
12
10
8
6
4
2
0
86%
82%
78%
74%
70%
66%
62%
58%
6
8
10
12
14
16
18
20
58%
64%
70%
76%
82%
88%
94%
100%
What is the output?
What is the input?
2-4

The Production Possibility Model,
Trade, and Globalization
2
Econ Grade
100
16 hrs for Econ and
4 hrs for History
88
70
10 hrs for each
History and Econ
PPC
A PPC demonstrates:
• There is a limit to what you can achieve, given existing institutions, resources, and technology
• Every choice you make has an opportunity cost
40
58 66 78 100 History grade
2-6

The Production Possibility Model,
Trade, and Globalization
2
Butter
The principle of increasing marginal opportunity cost states that opportunity costs increase the more you concentrate on the activity
A
• Slope is flat at A
• This means there is a low opportunity cost to produce more guns
B
• Slope is steep at B
• This means there is a high opportunity cost to produce more guns
Guns
2-7

The Production Possibility Model,
Trade, and Globalization
2
• The reason the opportunity cost of guns increases as we produce more guns is that some resources have comparative advantage over other resources
• A resource has comparative advantage if it has the ability to be better suited to the production of one good than another
2-8

Butter
A
The Production Possibility Model,
Trade, and Globalization
2
D
C
Productive efficiency is achieving as much output as possible from a given amount of inputs or resources
• Point of efficiency
• Unattainable with given amounts of inputs
• Point of inefficiency
B
Guns
2-9

The Production Possibility Model,
Trade, and Globalization
2
Neutral technological increase or an increase in resources
A A
Biased technological increase
B B
2-10

The Production Possibility Model,
Trade, and Globalization
2
• The PPC is bowed because individuals specialize in the production of goods for which they have a comparative advantage
• For a society to produce on its PPC, individuals must produce those goods for which they have a comparative advantage and trade for other goods
• According to Adam Smith , humankind’s proclivity to trade leads to individuals using their comparative advantage
2-12

The Production Possibility Model,
Trade, and Globalization
2
• When people freely enter into trade, both parties can be expected to benefit from trade
Textiles (yds)
5,000
4,000
Without trade, each country can only consume those combinations of goods along their PPCs
3,000
Pakistan
2,000
1,000
Belgium
Chocolate (tons)
1 2 3 4 5
2-14

The Production Possibility Model,
Trade, and Globalization
2
Textiles (yds)
5,000
4,000
3,000
2,000
1,000
Pakistan
If each country specializes according to comparative advantage and trades, they can consume beyond their PPCs
Belgium
Why should Pakistan specialize in textiles and Belgium specialize in chocolates?
Chocolate (tons)
1 2 3 4 5
2-15

The Production Possibility Model,
Trade, and Globalization
2
Comparative Advantage and the Combined PPC
Combined PPC with trade
Textiles (yds)
5,000
4,000
Pakistan
3,000
Pakistan + Belgium
The slope of the combined
PPC is determined by the country with the lowest opportunity cost
2,000
1,000
Belgium
Chocolate (tons)
1 2 3 4 5
2-16

The Production Possibility Model,
Trade, and Globalization
2
• The production possibility curve embodies the opportunity cost concept
• Increasing marginal opportunity cost exists
• Trade allows people to use their comparative advantage and shifts out society’s combined production possibility curve
• Efficient, inefficient and unattainable points on the PPC
• Through specialization and trade, countries can increase consumption
2-22

The Production Possibility Model,
Trade, and Globalization
2
• The typical outward bow of the PPC is the result of comparative advantage and trade
• Because many goods are cheaper to produce in foreign countries, production of goods formerly in the U.S. is being outsourced
• Outsourcing is the product of the law of one price
• Globalization is the increasing integration of economies, cultures, and institutions across the world
2-23

The Production Possibility Model,
Trade, and Globalization
2
• Define market economy
• Compare and contrast capitalism with socialism
• Describe how businesses, households, and government interact in a market economy
• Summarize briefly the advantages and disadvantages of various types of businesses
• Explain why, even though households have the ultimate power, much of the economic decision making is done by business and government
• State six roles of government
• Explain why global policy issues differ from national policy issues
2-24