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The Production Possibility Model, Trade, and Globalization 2 The Production Possibility Model, Trade, and Globalization 2 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? 2-2 The Production Possibility Model, Trade, and Globalization 2 The Production Possibility Model, Trade, and Globalization Comparative Advantage 2 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) 2-3 The Production Possibility Model, Trade, and Globalization 2-4 2 The Benefits from Trade The Production Possibility Model, Trade, and Globalization 2 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 2-5 2 3 4 5 Chocolate (tons) 2-6 The Production Possibility Model, Trade, and Globalization 2 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 2-7 The Production Possibility Model, Trade, and Globalization 2 2-8 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 2 • 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 2-9 The Production Possibility Model, Trade, and Globalization 2 2 2-10 The Production Possibility Model, Trade, and Globalization 2 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 2-11 2-12 The Production Possibility Model, Trade, and Globalization 2 2 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 2-13 2-14