Introduction to Macroeconomics Chapter 2. Opportunity Cost, Specialization, and Trade.
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Transcript of Introduction to Macroeconomics Chapter 2. Opportunity Cost, Specialization, and Trade.
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Introduction to Macroeconomics
Chapter 2. Opportunity Cost, Specialization, and Trade
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Chapter 2. Opportunity Cost, Specialization, and Trade
• Microeconomics– Specialization by Individuals
• Macroeconomics– Production Possibilities Curve
• Applications
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U.S. Trade in Goods, 2000(billions of dollars)
0
100
200
300
400
WesternEurope
Canada Japan Mexico China Others
Imports Exports
Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.
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Specialization by Individuals and Exchange
• Reasons for Specialization by individuals (Division of Labor)
• Exchange required
• Costs of exchange
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Reasons for Specialization(Division of Labor)
• Increase skill from repetition• Reduce time wasted shifting between
tasks• Incentive to invest resources in developing
specialized tools and machines• Opportunity Cost
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Opportunity Cost
The highest valued alternative foregone (given up) in making any choice.
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Calculating Opportunity Costs
My Capabilities Your Capabilities
16 coconuts or 12 fish in 1 hour
14 coconuts or 7 fish in 1 hour
My Opportunity
Costs Your Opportunity
Costs
1 coconut = 0.75 fish 1 fish = 1.25 coconuts
1 coconut = 0.5 fish 1 fish = 2 coconuts
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Incentive to Specialize
Production in 1 hour Me You Total Without Specialization Coconuts 8 7 15 Fish 6 3.5 9.5 With Specialization Coconuts 0 14 14 Fish 12 0 12
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Exchange prices
Opportunity Cost
Me You Market Price
Coconuts 0.75 fish
0.5 fish
Between 0.5 and 0.75
fish
Fish 1.25 coconuts
2.0 coconuts
Between 1.25 and 2.0
coconuts
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Costs of Exchange
• Negotiation costs
• Transportation costs
• Artificial barriers to trade (e.g., import tariffs)
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U.S. Trade in Goods with Mexico
0
2
4
6
8
10
12
14
16
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Per
cen
t o
f T
ota
l Im
po
rts
or
Exp
ort
s
Imports from Mexico Exports to Mexico
NAFTA
PesoCrisis
Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.
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Notes Page
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Production Possibilities Curve(PPC)
Identifies all combinations of the maximum amount of any two goods or services that can be produced by a given economy.
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Production Possibilities Curve
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0 10 20 30 40 50 60 70 80 90 100
Production of Good A
Pro
du
ctio
n o
f G
oo
d B
A
B
C
D*
*
*
*
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PPC Assumptions
• Only 2 goods or services (or aggregates of goods or services) are produced
• Full and efficient use of all available resources
• Supplies of resources (i.e., land, labor, and capital) are fixed
• Technology is held constant
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Increase in Available Resourcesor Technology
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0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing Improvement that benefits
both products. PPC shifts outward (to the right), from PPC1 to PPC2.
PPC1 PPC2
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Increase in Available Resourcesor Technology
0
10
20
30
40
50
60
0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing Improvement that benefits
Food production only.
PPC1 PPC2
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Increase in Available Resourcesor Technology
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10
20
30
40
50
60
70
0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing
Improvement that benefits clothing production only.
PPC1 PPC2
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Opportunity Cost and the PPC
Two important characteristics of the PPC:
• Opportunity Cost - The PPC slopes downward and to the right
• Increasing Opportunity Cost - The PPC is "bowed outward" (concave) from the origin
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Increasing Opportunity Cost
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0 5 10 15 20 25 30 35 40 45 50
Production of Food
Pro
du
ctio
n o
f C
loth
ing
As you increase production of food you sacrifice increasing quantities of clothing
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Applications
• Scarcity and Choice– the “cruel dilemma” facing less-developed
countries
• Opportunity Costs– staffing professors in two departments
• Specialization– comparing 2 PPCs (comparative vs absolute
advantage)
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Scarcity and Choicethe Cruel Dilemma of the Poor
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0 12 24 36 48
Capital Goods
Co
nsu
mp
tio
n G
oo
ds Subsistence Level
ProductionPossibilitiesCurve
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Staffing University Departments
Economics Department Psychology Department
Number ofProfessors
Number of PagesPublished in
JournalsNumber ofProfessors
Number of PagesPublished in
Journals
0 0 5 120
1 30 4 115
2 50 3 100
3 65 2 75
4 75 1 40
5 80 0 0
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PPC - Staffing University Departments
0
20
40
60
80
100
120
140
0 30 50 65 75 80
Economics Pages
Psy
cho
log
y P
ages
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Comparative and Absolute Advantage
• Absolute Advantage - a person can produce a good or service with fewer resources than can another person
• Comparative Advantage - a person can produce a good or service with lower opportunity cost than can another person
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Comparative vs Absolute Advantage
Assumptions:• 2 countries• 2 products• Straight-line PPCs to simplify model
(constant opportunity cost)
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Comparative vs Absolute Advantage
0102030405060708090
100110
0 10 20 30 40 50 60 70 80 90
Production of Guns
Pro
du
ctio
n o
f B
utt
er
PPC Country A
PPC Country B
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Comparative vs Absolute Advantage
Production of Guns
Production of Butter
Absolute Advantage
Country B Country A
Comparative Advantage
Country B Country A
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Comparative vs Absolute Advantage
0102030405060708090
100110
0 10 20 30 40 50 60 70 80 90 100
Production of Guns
Pro
du
ctio
n o
f B
utt
er
PPC Country A
PPC Country B
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Comparative vs Absolute Advantage
Production of Guns
Production of Butter
Absolute Advantage
Country A Country A
Comparative Advantage
Country A Country B