Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Chapter 2. Trade-offs and Comparative Advantage Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 202 504 Principles of Microeconomics Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Production Possibilities Frontiers (PPF) Factors of production economic resources used to make goods and services workers, capital, natural resources, and entrepreneurial ability Trade-off: Resources devoted to producing one product are not available for producing others. Production Possibilities Frontiers (PPF): A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Ex.1) BMW’s PPF Point A, B, C, D, E Technically efficient because the maximum output is being obtained from the available resources. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Ex.1) BMW’s PPF Point A, B, C, D, E Technically efficient because the maximum output is being obtained from the available resources. Q.1 From B to C, what is opportunity cost of producing 200 more SUV? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Ex.1) BMW’s PPF Point A, B, C, D, E Technically efficient because the maximum output is being obtained from the available resources. Q.1 From B to C, what is opportunity cost of producing 200 more SUV? Q.2 What point on PPF is best? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Ex.2) PPF for Rosie’s Boston Bakery Rosie has 5 hours. In 1 hour, Rosie can prepare 2 pies or 1 cake. Use the information given to complete the following table Draw a production possibilities frontier graph illustrating Rosies trade-offs. If Rosie is at choice D, what is her opportunity cost of making 2 more pies? ∗ for more exercise, see problem 1.9 (page 63) Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Ex.2) PPF for Rosie’s Boston Bakery Rosie has 5 hours. In 1 hour, Rosie can prepare 2 pies or 1 cake. Use the information given to complete the following table Draw a production possibilities frontier graph illustrating Rosies trade-offs. If Rosie is at choice D, what is her opportunity cost of making 2 more pies? ∗ for more exercise, see problem 1.9 (page 63) Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Increasing Marginal Opportunity Costs Suppose that all U.S. resources are devoted to producing military goods (tanks or automobiles) Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Increasing Marginal Opportunity Costs Suppose that all U.S. resources are devoted to producing military goods (tanks or automobiles) Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Increasing Marginal Opportunity Costs Suppose that all U.S. resources are devoted to producing military goods (tanks or automobiles) Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Increasing Marginal Opportunity Costs As the economy moves down the production possibilities frontier, it experiences increasing marginal opportunity costs because increasing automobile production by a given quantity requires larger and larger decreases in tank production. Economists expect in most situations that PPF will be bowed-outward rather than linear (or bowed-inward) Increasing marginal opportunity costs occur because.. intuitively, some workers are better suited to one use than to another example: ECON 202 economy Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Economic Growth So far, the total economic resources (labor, capital) available to an economy are fixed. if U.S. produce more automobiles, it must produce less of tanks Over time, however, the resources available to an economy may increase. (a) Population increase (b) Tech. change in the auto. industry Economic Growth: The ability of the economy to increase the production of goods and services. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Trade is the act of buying and selling goods and services Trade makes it possible for people to become better off by increasing both their production and their consumption To understand the great benefit of trade, we will use the ideas of production possibilities frontiers (PPF) and opportunity costs. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 1. Cody has only apple trees and Justin has only cherry trees. Would they trade? Situation 2. There are apple and cherry trees growing on both of their properties. Cody is very good at picking apples, and Justin is very good at picking cherries. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Situation 3. There are apple and cherry trees growing on both of their properties. Justin is actually better at picking both apples and cherries than Cody is Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 1. Cody has only apple trees and Justin has only cherry trees. Would they trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 1. Cody has only apple trees and Justin has only cherry trees. Would they trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 1. Cody has only apple trees and Justin has only cherry trees. Would they trade? (Before trade) 20 apples 20 cherries Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 1. Cody has only apple trees and Justin has only cherry trees. Would they trade? (Before trade) 20 apples 20 cherries (After trade) 10 apples + 10 cherries 10 apple + 10 cherries Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 2. There are apple and cherry trees growing on both of their properties. Cody is very good at picking apples, and Justin is very good at picking cherries. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 2. There are apple and cherry trees growing on both of their properties. Cody is very good at picking apples, and Justin is very good at picking cherries. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 3. There are apple and cherry trees growing on both of their properties. Justin is actually better at picking both apples and cherries than Cody is. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 3. There are apple and cherry trees growing on both of their properties. Justin is actually better at picking both apples and cherries than Cody is. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Gains from Trade Assumption. Cody and Justin both like apples and cherries. Situation 3. There are apple and cherry trees growing on both of their properties. Justin is actually better at picking both apples and cherries than Cody is. Would it make sense for Cody to concentrate on picking apples and for Justin to concentrate on picking cherries to trade? Suppose that Justin offers to trade Cody 15 pounds of his cherries for 10 pounds of Cody’s apples next week. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Absolute Advantage Surprisingly, Justin benefits from trading with Cody even though Justin is better than Cody at picking both apples and cherries. (Of course, Cody benefits from trading) Absolute advantage: The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources. Justin has an absolute advantage over Cody in producing both apples and cherries Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Specialization and Opportunity Cost Why both Cody and Justin benefit from specializing in picking only one fruit? Let’s consider the opportunity costs for Cody and Justin of picking apples and cherries. Even though Justin has an absolute advantage over Cody in picking apples, it is more costly for Justin to pick apples than it is for Cody. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Comparative Advantage Comparative Advantage: The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Apple picking: Justin has an absolute advantage over Cody, but Cody has a comparative advantage over Justin. Cherry picking: Justin has both an absolute advantage and a comparative advantage over Cody. Production Possibilities Frontiers Marginal Opportunity Costs Economic Growth Gains from Trade Abs. and Comp. Advantage Comparative Advantage The basis for trade is comparative advantage, not absolute advantage Individuals, firms, and countries are better off if they specialize in producing goods for which they have a comparative advantage and obtain the other goods by trading.