the production possibility model, trade, and...

The Production Possibility Model, Trade, and Globalization 2

The Production Possibility Model,

Trade, and Globalization

No one ever saw a dog make a fair and

deliberate exchange of one bone for another

with another dog .

— Adam Smith

CHAPTER 2

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin


The Production Possibilities Model

• A production possibility table lists a choice’s opportunity cost by summarizing what alternative outputs you can achieve with your inputs

• An output is a result of an activity

• An input is what you put in production process to achieve an output

2-2


Application: A Production Possibilities Table

History Economics

Hrs of Study Grade Hrs of Study Grade

20 98% 0 40%

18 94% 2 46%

16 90% 4 52%

14 86% 6 58%

12 82% 8 64%

10 78% 10 70%

8 74% 12 76%

6 70% 14 82%

4 66% 16 88%

2 62% 18 94%

0 58% 20 100%

What is the

output?

What is the

input?

2-3


The Production Possibilities Model

• A production possibility curve (PPC) is a curve measuring the maximum combination of outputs that can be obtained from a given number of inputs

• It is a graphical representation of the opportunity cost concept

2-4


Application: A Production Possibilities Curve

History grade100

10 hrs for each History and Econ

Econ Grade

7840

58

100

88

66

70

16 hrs for Econ and 4 hrs for History

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 costPPC

2-5


Increasing Marginal Opportunity Cost

Guns

Butter

• Slope is flat at A• This means there is a low opportunity cost

to produce more guns

A

The principle of increasing marginal opportunity cost states that opportunity costs increase the

more you concentrate on the activity

B

• Slope is steep at B• This means there is a high opportunity

cost to produce more guns

2-6


Comparative Advantage

• 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

2-7


Efficiency

• Productive efficiency is achieving as much output as possible from a given amount of inputs or resources

McGraw-Hill/Irwin Colander, Economics 8


PPC Showing Efficient and Inefficient Points

Guns

Butter

• Point of efficiency• A

• B

• Point of inefficiency

• Unattainable with given amounts of inputs

• C

• D

2-9


Efficiency and Technological Change

Neutral technological increase or an increase in resources

Biased technological increase

A

B

A

B

2-10


Trade and Comparative Advantage

• 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

2-11


Trade and Comparative Advantage

• According to Adam Smith, the market guides us like an invisible hand to produce goods in which we have a comparative advantage

McGraw-Hill/Irwin Colander, Economics 12


The Benefits from Trade

Chocolate (tons)

Textiles (yds)

Without trade, each country can only consume those

combinations of goods along their PPCs

• When people freely enter into trade, both parties can be expected to benefit from trade

5,000

4,000

3,000

2,000

1,000

2 3 4 51

Belgium

Pakistan

2-13


The Benefits from Trade

Chocolate (tons)

Textiles (yds) If each country specializes according to comparative advantage and trades,

they can consume beyond their PPCs5,000

4,000

3,000

2,000

1,000

2 3 4 51

Belgium

PakistanWhy should Pakistan specialize in textiles and Belgium specialize in chocolates?

2-14


Comparative Advantage and the Combined PPC

Chocolate (tons)

Textiles (yds)

5,000

4,000

3,000

2,000

1,000

2 3 4 51

Belgium

Pakistan

Combined PPC with trade

The slope of the combined PPC is determined by the country with the lowest

opportunity cost

Pakistan + Belgium

2-15


Outsourcing, Trade, and Comparative Advantage

• Outsourcing: relocating production once done in the U.S.to foreign countries

• WHY?: Comparative advantage

• The U.S. has comparative advantage in technology, institutional structure, and specialized knowledge

2-16


Outsourcing, Trade, and Comparative Advantage

• Globalization: the integration of economies, cultures, and institutions across the world

• Provides larger markets than the domestic economy (positive)

• Increases the number of competitors (negative)

2-17


The Law of One Price

• The law of one price: states the wages of equal workers in one country will not differ significantly from the wages of workers in another similar country

• If the U.S. loses its comparative advantage based on technology and institutional structure, U.S. wages will decrease relative to wages in many other countries

• In reality, we do better due to trade and outsourcing

2-18


Chapter Summary

• 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

2-19


Chapter Summary

• 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

2-20

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