The Production Possibility Model, Trade, and...
Transcript of 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 Possibility Model, Trade, and Globalization 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 in production process to achieve an output
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The Production Possibility Model, Trade, and Globalization 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?
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
Efficiency
• Productive efficiency is achieving as much output as possible from a given amount of inputs or resources
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The Production Possibility Model, Trade, and Globalization 2
PPC Showing Efficient and Inefficient Points
Guns
Butter
• Point of efficiency• A
• B
• Point of inefficiency
• Unattainable with given amounts of inputs
• C
• D
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The Production Possibility Model, Trade, and Globalization 2
Efficiency and Technological Change
Neutral technological increase or an increase in resources
Biased technological increase
A
B
A
B
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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Belgium
PakistanWhy should Pakistan specialize in textiles and Belgium specialize in chocolates?
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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)
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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The Production Possibility Model, Trade, and Globalization 2
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
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