Download - The Production Possibility Model, Trade, And Globalization

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THE PRODUCTION THE PRODUCTION POSSIBILITY MODEL, TRADE, POSSIBILITY MODEL, TRADE,

AND GLOBALIZATIONAND GLOBALIZATION

Chapter 2Chapter 2


2-2

Today’s lecture will:Today’s lecture will:

• Demonstrate opportunity costs with a production possibilities curve.

• Discuss the principle of increasing marginal opportunity cost.

• Relate the concept of comparative advantage to the production possibilities curve.


2-3

Today’s lecture will:Today’s lecture will:

• Show how comparative advantage and trade can allow countries to consume beyond their production possibilities.

• Explain how globalization and outsourcing are part of a global process guided by the law of one price.


2-4

The Production The Production Possibilities ModelPossibilities Model

• A production possibilities curve illustrates opportunity cost by showing trade-offs among choices we make.

• It measures the maximum number of outputs that can be achieved from a given number of inputs.


2-5

6

A Production Possibilities A Production Possibilities Curve for an IndividualCurve for an Individual

Eco

no

mic

s g

rad

e

100

88

70

4640

58 66 78 94 98History grade

E: 20 hours of history,

0 hours of economics

ED

C

B

A: 20 hours of economics, 0 hours of historyA

Hours of study in history

Grade inhistory

Hours of study in economics

Grade ineconomics

20 19 18 17 16 15 14 13 12 11 10

9 8 7 6 5 4 3 2 1 0

98 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 64 62 60 58

0 1 2 3 4 5 7 8 9 10

1 1 12 13 14 15 16 17 18 19 20

40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97

100


2-6

Increasing Marginal Increasing Marginal Opportunity CostOpportunity Cost

Bu

tte

r

Slope is flat at A. Low opportunity cost of guns.

Slope is steep at B. High opportunity cost of guns.

Guns

B

A

The principle of increasing marginalopportunity cost states that opportunity costsincrease as you produce more of one product.


2-7

A Production Possibilities A Production Possibilities Table for SocietyTable for Society

% of resources devoted toproduction of guns

Number of guns

% of resources devoted toproduction of butter

Pounds of butter Row

0 20 40 60 80

100

0 4 7 9 11 12

100 80 60 40 20 0

15 14 12 9 5 0

A B C D E F


2-8

PPC for SocietyPPC for Society

1211

AB

utte

r

Guns4 7 90

1 gun

5 pounds of butter

5

9

15

3 guns

2 pounds of butter

B

C

D

E

F

14

12

4 guns

1 pound of butter


2-9

Efficiency and InefficiencyEfficiency and InefficiencyG

un

s

10

8

6

4

2

0 2 4 6 8 10

Butter

C D

A

B

Efficientpoints

Inefficientpoint

Unattainable point


2-10

Shifts in the PPCShifts in the PPC

Neutral Technological Change

Bu

tte

r

A

Guns0

Biased Technological Change

0

B

Bu

tter

Guns

C

B D

C

A


2-11

Distribution and Distribution and Production EfficiencyProduction Efficiency

• The PPC focuses on productive efficiency and ignores distribution.

• In our society, more is generally preferred to less and many policies have relatively small distributional effects.


2-12

Trade and Comparative AdvantageTrade 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.

• According to Adam Smith, humankind’s proclivity to trade leads to individuals using their comparative advantage.


2-13

Growth in the Past Two MillenniaGrowth in the Past Two Millennia

$6,000

$5,000

$4,000

$3,000

$2,000

$1,000

2010150010005000

Pe

r ca

pit

a in

co

me

(in

19

90 in

tern

ati

on

al d

olla

rs)


2-14

Gains from TradeGains from Trade

Without trade they can only consume only those combinations of goods along their PPCs, such as point A (Pakistan) and point B (Belgium).

1 2 3 4

4

3

2

1

5

Chocolate (in tons)

Te

xtile

s(i

n t

ho

us

and

s o

f y

ard

s)

Belgium

Pakistan

A

BE

D


2-15

Gains from TradeGains from Trade

If they specialize and trade, they can consume outside of their individual PPCs. Each country can consume 2,000 tons of fabric and 2 tons of chocolate (point C).

1 2 3 4

4

3

2

1

5

Chocolate (in tons)

Te

xtile

s(i

n t

ho

us

and

s o

f y

ard

s)

Belgium

Pakistan

A

B

C

E

D


2-16

Summary of TradeSummary of Trade

For Pakistan the opportunity cost of one ton of chocolateis 4000 yards of textiles.

For Belgium the opportunity cost of one ton of chocolateis 250 yards of textiles.

Belgium has the comparative advantage in chocolateand specializes producing 4 tons (point E). Pakistan has the comparative advantage in textiles and specializes producing 4000 yards (point D).

1 2 3 4

4

3

2

1

5

Chocolate (in tons)

Te

xtile

s(i

n t

ho

us

and

s o

f y

ard

s)

Belgium

Pakistan

A

B

C

E

D

If both countries divide what is jointlyproduced evenly, they will both be consuming at point C, beyond both countries’ PPC.


2-17

Comparative Advantage and Comparative Advantage and the Combined PPCthe Combined PPC

1 2 3 4 5

4

3

2

1

5

Chocolate (in tons)

Te

xtile

s(i

n t

ho

us

and

s o

f y

ard

s)

Belgium

Pakistan

H

F

G

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

The combined PPC is the curve connecting points F, H, and G.


2-18

U.S. Textile U.S. Textile Production and TradeProduction and Trade

• Two hundred years ago, the U.S. had a comparative advantage in textile production.

• Now countries with cheaper labor, such as Bangladesh, have the comparative advantage in textiles.

• The gains from trade are higher wages for workers in Bangladesh and lower-priced cloth for U.S. consumers.


2-19

Outsourcing and GlobalizationOutsourcing and Globalization

• Outsourcing is the relocation of production once done in the U.S. to foreign countries.

• Outsourcing occurs because many other countries have a comparative advantage in labor costs.

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


2-20

GlobalizationGlobalization

• Globalization is the increasing integration of economies, cultures, and institutions across the world.

• The positive effect of globalization is that it provides larger markets than the domestic economy.

• Increased competition can be a negative effect of globalization.


2-21

Exchange Rates and Exchange Rates and Comparative AdvantageComparative Advantage

• The U.S. comparative advantage in innovation results in higher wages in the U.S.

• As industries mature, they move to lower wage countries.

• In order to regain our comparative advantage, the U.S. exchange rate will decline and foreign wages will increase to make U.S. exports cheaper and imports to the U.S. more expensive.


2-22

Law of One PriceLaw of One Price

• The law of one price – the wages of equal workers in one country will not differ significantly from the wages of workers in another institutionally 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.


2-23

SummarySummary• The production possibilities curve (PPC)

measures the maximum combination of outputs that can be obtained from a given number of inputs.

• According to the principle of increasing marginal opportunity cost, as production of one good increases, we must give up ever-increasing quantities of something else.

• Points inside the PPC are inefficient, points along the PPC are efficient, and points outside the PPC are unattainable.


2-24

SummarySummary• The rise of markets, specialization, trade, and

competition have contributed to significant increases in output.

• By specializing in producing those goods for which one has a comparative advantage (lowest opportunity cost) one can produce the greatest amount of goods with which to trade.

• Specialization and trade shift the PPC out.

• We live in an ever-increasingly global economy. Both outsourcing and insourcing occur, based on comparative advantage.


2-25

Review Question 2-1

Given the following PPC

A B C D E

Computers 0 1 2 3 4

Books 100 90 70 40 0

What is the marginal opportunity cost of the third computer?

To produce the third computer, production moves fromalternative C to D. The marginal opportunity cost of the third computer is 70 – 40 = 30 books.


2-26

Review Question 2-2

Suppose that the U.S. can produce 80 computer chipsor 80 video games in one hour. Japan can produce 40computer chips or 80 video games in one hour. What is the opportunity cost of computer chips in each country? In which product should each country specialize?

In the U.S. the cost of 1 computer chip is 80/80 = 1 video game.In Japan the cost of 1 computer chip is 80/40 = 2 video games.The U.S. should specialize in computer chips and Japan should specialize in video games.

Download - The Production Possibility Model, Trade, And Globalization

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