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 203 502
Principles of Macroeconomics
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.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
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.
Increasing marginal opportunity costs occur because..
some workers (machines or other resources) are better suited to one
use than to another
example: ECON 203 economy
Economists expect in most situations that PPF will be bowed-outward
rather than linear (or bowed-inward)
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?
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.
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.