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MACROECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
CHAPTER 2
“Production and Trade”
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
1
Learning Objectives
1. Analyze tradeoffs facing both
individuals and countries
2. Relate the types of resources an
economy possesses.
3. Model a country’s production
possibilities, and how these possibilities
respond to technological development.
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
2
Learning Objectives
4. Describe how economies can grow faster if
they are willing to cut back on current
consumption.
5. Visualize the flow of goods and services,
resources, and money in the economy.
6. Explain how people and countries gain from
trade by specializing according to comparative
advantage.
7. (E&A) Convey how economic strength can
lead to victory, sometimes without a fight.
©2004 Prentice Hall Publishing
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2.1
SCARCITY AND CHOICE
Economics exist because resources are
scarce relative to our wants.
Scarcity means that we have to make
choices.
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Opportunity Costs
Opportunity costs.
represent the value of forgone
alternatives
All choices involve opportunity
costs!
There is no such thing as a free lunch!!!
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Resources
The four categories of resources are:
• Land
• Labor
• Entrepreneurship
• Capital
– Human capital
– Physical capital
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2.2
PRODUCTION POSSIBILITIES
A production possibility frontier is a
model that illustrates both scarcity
and choice by assuming that only two
goods may be produced.
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The Economy of Castaway Island
Data Point Fish Caught per Day Coconuts Collected per Day
A
5
0
B
4
10
C
3
16
D
2
19
E
1
21
F
0
22
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A Graph of a Production
Possibility Frontier
Coconuts
22
21
19
F
E
D
C
16
B
10
A
1
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2
3
4
5
Fish
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The Economy of Castaway Island
- The Bowed Outward PPF Data Point Fish Caught per Day
F
0
E
1
D
2
C
3
B
4
A
5
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Opportunity Cost
0
1
3
6
12
22
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Marginal Opportunity Cost
Coconuts
22
21
19
F
E
D
The marginal opportunity cost is the
additional opportunity cost of one
more fish.
C
16
B
10
A
1
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2
3
4
5
Fish
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Marginal Opportunity Cost
Coconuts
22
21
19
F
E
D
The bowed or concave slope
(shape)of the PPF curve
reflects the Principle of “the
law of increasing cost”.
C
16
B
10
A
1
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2
3
4
5
Fish
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Law of Increasing Cost
Marginal
Opportunity
Cost (change in
# of coconuts
forgone)
Data
Point
Fish caught
per day
Opportunity
Cost
# of coconuts
forgone
F
0
0
undefined*
E
1
1
1
D
2
3
2
C
3
6
3
B
4
12
6
A
5
22
10
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Technologically Efficient and
Feasible Points
Not
Feasible
All points on the PPF
are are technologically
efficient and feasible.
Feasible but
Inefficient
Good X
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Technologically Efficient and
Feasible Points
Allocative efficiency
implies a specific point
on the PPF that is the
most valuable combination
of outputs.
In general, there
will be only one
point on the PPF
that is allocatively
efficient.
Good X
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Economic Growth
Whenever the production possibility
frontier shifts outward, the economy is
said to have experienced
economic growth.
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Economic Growth
Economic growth can
be caused by an
increase in resources.
Good X
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Characteristics of the production
possibilities frontier (PPF):
• The ppf shows how much of one good can be produced
for any amount of another.
• When on the frontier, the opportunity cost of one good
is less of the other good.
• The frontier is bowed outward.
• Every point on the frontier is technologically efficient.
• Points inside the frontier imply unemployed resources.
• Points outside the frontier are unattainable.
• Shifting the frontier outward implies economic growth.
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Technological Growth
General Growth
Specialized Growth
New PPF
New PPF
Starting PPF
Starting PPF
Pretzels
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Pretzels
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Specialized Growth
• Specialized growth pivots the production
possibility frontier in the direction of more
output in the industry affected by the
technological change.
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Specialized Growth
ppf as Capital
Grows.
A
B
Sacrificing current
consumption for
capital formation
hastens economic
growth
ppf as Capital
Depreciates and
is Not Replaced.
Capital
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2.3
THE CIRCULAR FLOW MODEL
OF ECONOMIC ACTIVITY
The circular flow model depicts how markets
use the medium of money to determine what
goods and services are produced and who
gets to buy them. The model depicts both the
output market and the input market.
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The Circular Flow Model
of Economic Activity
Goods & Services
$ Purchases
Businesses
Households
$ Incomes
Land, Labor, Capital, Entrepreneurship
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2.4
EXPANDING CONSUMPTION
POSSIBILITIES THROUGH TRADE
• For their own self interest economies engage
in trade with other economies.
• This is true for national economies,
regional economies, local economies, and
even individuals (personal economies).
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Expanding Consumption
• People specialize in their jobs according
to their interest and opportunities.
• Then they use the income they earn to
purchase goods and services.
• Countries engaged in international trade
operate the same way, first they decide
what to produce, then what to consume.
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Comparative Advantage vs.
Absolute Advantage
An economy has a comparative advantage in
producing a good if it can produce a good at
a lower opportunity cost than could other
countries.
An economy has an absolute advantage if it
is able to produce something with fewer
resources than others could.
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International Trade
 International trade is more important to
small countries than to large countries.
 Exports: Goods and services a country
sells to other countries
 Imports: Goods and services a country
buys from other countries.
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International Trade
Through trade, a country can consume a
combination of goods
and services that lies outside its
PPF, meaning that the country’s
consumption possibilities will
exceed its production possibilities.
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Exports as a Percentage of GDP
Japan
UK
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South
Korea
Ireland
80
70
60
50
40
30
20
10
0
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Specialization According to
Comparative Advantage
Country Computer Memory Chips
Japan
10 units per day
England
5 units per day
Barrels of Oil
4 per day
3 per day
Productivity per worker in
Japan and England
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Computing Opportunity Cost and
Comparative Advantage
Product Location Opportunity Cost Opportunity Cost
(C is computer chips and B
(per unit)
is Barrels of oil)
Computer chips
in Japan
Computer chips
in England
Oil in Japan
Oil in England
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10C=4B
2/5 barrel of oil
(.4B)*
5C=3B
3/5 barrel of oil
(.6B)
4B=10C
5/2 computer
chips (2.5C)
3B=5C
5/3 computer
chips (1.67C)*
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2.5 EXPLORE & APPLY
Victory Guns and Butter – From a
Strong Economy
 In World War 2, the
US was able to
quickly convert many
civilian industries to
military production
and play a pivotal
role in defeating the
both the Nazi’s and
Japan.
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 Nearly 5 decades later
it was able to defeat the
Soviet Union
“economically”,
without any shots
being fired. That’s the
best kind of victory.
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Terms along the Way
opportunity costs
land
labor
human capital
capital
entrepreneurship
technology
production possibilities
frontier
law of increasing cost
©2004 Prentice Hall Publishing
economic growth
money
barter
circular flow
output market
input market
comparative advantage
absolute advantage
Exports
imports
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Test Yourself
1. The opportunity cost of a new city police contract
is:
a.
b.
c.
d.
the amount of money it takes in order to provide the city
with the most highly qualified personnel.
the value of the other goods and services that the city and
taxpayers will be forced to give up in order to pay for the
contract.
the cost to victims of crimes that the new contract would
prevent.
the value of the opportunities that city policemen acquire
by accepting it.
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Test Yourself
2. Which of the following items is the best
example of an economic resource?
a. A stock certificate.
b. A one-hundred dollar bill.
c. A tractor.
d. A plate of spaghetti.
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Test Yourself
3. A production possibilities frontier shows
combinations of:
a. inputs that can produce a specific quantity of
output.
b. outputs that people consume.
c. outputs that can be achieved as technology
improves.
d. outputs that can be achieved in a given time
period with all available resources employed using
current technology.
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Test Yourself
4. If a Nation’s production possibilities indicates that
1,000,000 battle tanks and 6,000,000 houses could
be produced, or alternatively, 750,000 tanks and
8,000,000 houses could also be produced, the
opportunity cost of each additional house would
be:
a. 250,000 tanks.
b. 8 tanks.
c. 0.125 tanks.
d. 2,000,000 tanks.
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Test Yourself
5. As a nation develops economically, its
production possibilities frontier:
a. remains stable.
b. shifts towards the origin.
c. shifts away from the origin.
d. becomes steeper, but does not shift.
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Test Yourself
6. When a country can produce a good with
fewer resources than any other country, the
country has:
a. a comparative advantage.
b. a resource advantage.
c. an absolute advantage.
d. an unfair advantage.
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The End!
Next Chapter 3
“Demand and
Supply"
©2004 Prentice Hall Publishing
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