The Production Possibility Model, Trade, and Globalization

Transcription

1 CHAPTER The Production Possibility Model, 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 010 by the McGraw-Hill Companies, Inc. All rights reserved.

2 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 into the production process to achieve an output Guns Butter

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 that uses two goods -3

4 Production Possibilities Curve The PPC is based on these assumptions: Resources are fixed All resources are fully employed (used) Only two things can be produced Technology is fixed

5 Graphing the PPC PPC runs between extremes of producing only one item or the other Data is plotted on a graph; the lines connected between the points is the PPC Shows maximum number of one item relative to other item PPC shows the opportunity cost of each choice More of one product means less of the other: tradeoff

6 Graphing the PPC Commonly, a PPC is depicted with two goods: guns and butter Guns represents military goods Butter represents consumer goods

7 Draw the Graph: PPC Showing Efficient and Inefficient Points Guns A B C A: Point of efficiency (anywhere on the curve) B: Point of inefficiency (underproducing or underutilization of resources C: Unattainable (beyond the curve) Butter -7

8 PPC Efficient and Inefficient Points An efficient point is any point along the curve Productive efficiency is achieving as much output as possible from a given amount of inputs or resources McGraw-Hill/Irwin Colander, Economics 8

9 PPC Efficient and Inefficient Points An inefficient point any point inside the curve This means resources are being underutilized or not being used efficiently An unattainable point is one beyond the curve It cannot currently be achieved unless there is an increasing in technology or additional resources become available McGraw-Hill/Irwin Colander, Economics 9

10 Why is the PPC a Curve? Law of increasing opportunity costs As production switches from one product to another, more resources are needed to increase production of second product Reasons for increasing cost of making more of one product Need new resources, machines, or factories Must retrain workers

11 Why can the PPC also be a straight line? Guns The PPC can be a straight line to represent a constant opportunity cost A B Butter -11

12 Opportunity Cost and Tradeoff Guns A B Butter What is the difference between opportunity cost and tradeoff? Tradeoff: to produce more guns, you have to produce less butter Opportunity cost: the specific number of butter you give up to produce more guns McGraw-Hill/Irwin Colander, Economics 1

13 Shifting the PPC An increase in technology or an increase in resources Technological increase for one good Guns Guns Butter More guns and butter can be produced Butter More guns can be produced based on better technology -13

14 Comparative Advantage We cannot produce everything efficiently A resource has comparative advantage if it has the ability to be better suited to the production of one good than another; it can be produced at the lowest opportunity cost Countries should specialize in the good that is cheaper for them to produce (lower opportunity cost) and trade for goods that they have a higher opportunity cost to produce -14

15 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 15

16 The Benefits from Trade When people freely enter into trade, both parties can be expected to benefit from trade Textiles (yds) 5,000 4,000 3,000 Pakistan Without trade, each country can only consume those combinations of goods along their PPCs,000 Belgium 1, Chocolate (tons) -16

17 The Benefits from Trade Textiles (yds) 5,000 If each country specializes according to comparative advantage and trades, they can consume beyond their PPCs 4,000 3,000 Pakistan,000 Belgium 1, Chocolate (tons) -17

18 Absolute and Comparative Advantage Absolute Advantage: the producer that can produce the most output Comparative Advantage: the producer with the lowest opportunity cost

19 Determining Comparative Advantage: The Output Method Output Questions: OOO=Output: Other goes Over

20 Determining Comparative Advantage The Output Method Mexico can produce 60 avocados if it uses its entire labor force. Or, Mexico can produce 15 soybeans if it uses its entire labor force. The U.S. can produce 90 avocados if it uses its entire labor force. Or, the U.S. can produce 30 soybeans if it uses its entire labor force. Let s write this in a chart format McGraw-Hill/Irwin Colander, Economics 0

21 Determining Comparative Advantage The Output Method Avocados Mexico Soybeans U.S Which country has an absolute advantage in producing avocados? Explain. U.S.: it produces more avocados than Mexico (90 vs. 60)

22 Determining Comparative Advantage The Output Method Avocados Mexico Soybeans U.S Which country has an absolute advantage in producing soybeans? Explain. U.S.: it produces more soybeans than Mexico (30 vs. 15)

23 Determining Comparative Advantage The Output Method Avocados Soybeans Mexico 60 1A=1/4S 15 1S=4A U.S. 90 1A=1/3S 30 1S=3A 3. Which country has a comparative advantage in producing avocados? Explain. Mexico; it can produce them at a lower opportunity cost, 1/4 soybean for Mexico vs. 1/3 soybean for the U.S.

24 Determining Comparative Advantage The Output Method Avocados Soybeans Mexico 60 1A=1/4S 15 1S=4A U.S. 90 1A=1/3S 30 1S=3A 4. Which country has a comparative advantage in producing soybeans? Explain. The U.S.; it can produce them at a lower opportunity cost; 3 avocados for the U.S. vs. 4 for Mexico.

25 Terms of Trade Avocados Soybeans Mexico 60 1A=1/4S 15 1S=4A U.S. 90 1A=1/3S 30 1S=3A Terms of trade refers to trade that is mutually beneficially to both countries. The U.S. has a comparative advantage in soybeans. It would specialize in soybeans if it could get more than 3 avocados through trade. Mexico has a comparative advantage in avocados. It would specialize in avocados if it could get one soybean for less than 4 avocados through trade.

26 Terms of Trade Avocados Soybeans Mexico 60 1A=1/4S 15 1S=4A U.S. 90 1A=1/3S 30 1S=3A What would be an acceptable term of trade for soybeans? Anywhere between 3 and 4 avocados 1 soybean for 3.5 avocados: this would allow the U.S. to get 3.5 avocados from Mexico by sending 1 soybean to Mexico. This would allow Mexico to obtain 1 ton of soybeans for 3.5 avocados, a lower opportunity cost (on their own it they would have to give up 4 avocados to produce 1 soybean)

27 Determining Comparative Advantage: The Input Method Input Questions IOU= Input: Other goes Under Usually the amount of hours (or labor) to produce something

28 Determining Comparative Advantage: The Input Method Car (in hours) Machines (in hours) Mexico 4 U.S Which country has an absolute advantage in producing cars? Explain. Mexico; it can produce 4 cars while the U.S. can produce

29 Determining Comparative Advantage: The Input Method Car (in hours) Machines (in hours) Mexico 4 U.S. 6. Which country has an absolute advantage in producing machines? The U.S.; it can produce 6 machines while Mexico can produce

30 Determining Comparative Advantage: The Input Method Car (in hours) Machines (in hours) Mexico 4 1C=M 1M=1/C U.S. 1C=1/3M 6 1M=3C 3. Which country has a comparative advantage in producing cars? Explain. The U.S. has a comparative advantage in cars because it can produce them with a lower opportunity cost (1/3 machine for the U.S. vs. machines for Mexico).

31 Determining Comparative Advantage: The Input Method Car (in hours) Machines (in hours) Mexico 4 1C=M 1M=1/C U.S. 1C=1/3M 6 1M=3C 4. Which country has a comparative advantage in producing machines? Mexico has a comparative advantage in machines because it can produce them with a lower opportunity cost (1/ car for Mexico vs. 3 cars for the U.S.).

32 Terms of Trade Car (in hours) Machines (in hours) Mexico 4 1C=M 1M=1/C U.S. 1C=1/3M 6 1M=3C 5. What would be terms of trade for machines? Anywhere between ½ car and 3 cars. Mexico has the comparative advantage in machines. It would specialize in machines if it could get more than ½ car through trade. The U.S. has the comparative advantage in cars. It would specialize in cars if it could get one machine for less than 3 cars through trade.

33 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 -33

34 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) -34

35 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 -35

36 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 -36

37 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 -37