Download 2 Comparative Advantage 2 Markets, Specialization, and Growth 2

The Production Possibility Model,
Trade, and Globalization
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The Production Possibility Model,
Trade, and Globalization
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Markets, Specialization, and Growth
• Growth in per capita income during the past 2000 years
$6,000
Comparative Advantage
Income
$5,000
$4,000
$3,000
$2,000
$1,000
0
500
1000
1500
2010
Year
• What caused this growth?
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The Production Possibility Model,
Trade, and Globalization
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The Production Possibility Model,
Trade, and Globalization
Comparative Advantage
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The Benefits from Trade
• When people freely enter into trade, both parties can be
expected to benefit from trade
• The reason the opportunity cost of guns increases
as we produce more guns is that some resources
have comparative advantage over other resources
Textiles (yds)
Without trade, each
country can only consume
those combinations of
goods along their PPCs
5,000
• A resource has comparative advantage if it has
the ability to be better suited to the production of
one good than another
4,000
Pakistan
3,000
2,000
Belgium
1,000
1
2
3
4
5
Chocolate (tons)
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The Production Possibility Model,
Trade, and Globalization
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The Benefits from Trade
The Production Possibility Model,
Trade, and Globalization
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Comparative Advantage and the Combined PPC
Combined PPC with trade
Textiles (yds)
Textiles (yds)
5,000
5,000
4,000
4,000
Pakistan + Belgium
Why should Pakistan
specialize in textiles
and Belgium specialize
in chocolates?
Pakistan
3,000
2,000
Belgium
3,000
The slope of the combined
PPC is determined by the
country with the lowest
opportunity cost
Pakistan
2,000
Belgium
1,000
1,000
1
2
3
4
5
Chocolate (tons)
1
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2
3
4
5
Chocolate (tons)
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The Production Possibility Model,
Trade, and Globalization
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Application: U.S. Textile Production and Trade
The Production Possibility Model,
Trade, and Globalization
Outsourcing, Trade and Comparative Advantage
Outsourcing
• Two hundred years ago, the U.S. had a comparative
advantage in textile production
• Outsourcing is the relocation of production once done
in the United States to foreign countries
• Now, countries with cheaper labor (such as Bangladesh)
have the comparative advantage in textiles
• Outsourcing occurs because many other countries have
a comparative advantage in labor costs
• The gains from trade are higher wages for workers in
Bangladesh and lower-priced cloth for U.S. consumers
• The U.S. has comparative advantage in technology,
institutional structure, and specialized knowledge
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The Production Possibility Model,
Trade, and Globalization
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The Production Possibility Model,
Trade, and Globalization
Outsourcing, Trade and Comparative Advantage
Outsourcing, Trade and Comparative Advantage
Globalization
Exchange Rates and Comparative Advantage
• Globalization is the increasing integration of
economies, cultures, and institutions across the world
• The U.S. comparative advantage in innovation results
in higher wages in the U.S.
• A positive effect of globalization is that it provides larger
markets than the domestic economy
• As industries mature, they move to lower wage countries
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• 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
• The global economy increases the number of
competitors and this increased competition can be a
negative effect of globalization
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The Production Possibility Model,
Trade, and Globalization
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The Production Possibility Model,
Trade, and Globalization
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Chapter Summary
Outsourcing, Trade and Comparative Advantage
• The production possibility curve embodies the
opportunity cost concept
The Law of One Price
• The law of one price is the wages of equal workers in
one country will not differ significantly from the wages of
workers in another institutionally similar country
• Increasing marginal opportunity cost exists
• Trade allows people to use their comparative advantage
and shifts out society’s combined production possibility
curve
• 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
• Efficient, inefficient and unattainable points on the PPC
• Through specialization and trade, countries can increase
consumption
The reality is that the citizens in the U.S. has
been living better than it could have otherwise
because of trade and outsourcing
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The Production Possibility Model,
Trade, and Globalization
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The Production Possibility Model,
Trade, and Globalization
Preview of Chapter 3:
Chapter Summary
Economic Institutions
• The typical outward bow of the PPC is the result
of comparative advantage and trade
• Define market economy
• Compare and contrast capitalism with socialism
• Because many goods are cheaper to produce in foreign
countries, production of goods formerly in the U.S. is being
outsourced
• Describe how businesses, households, and government interact
in a market economy
• Summarize briefly the advantages and disadvantages of various
types of businesses
• Explain why, even though households have the ultimate power,
much of the economic decision making is done by business and
government
• State six roles of government
• Explain why global policy issues differ from national policy
issues
• 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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