Introduction to Macroeconomics

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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

• 1. Microeconomics
• Specialization by Individuals
• 2. Macroeconomics
• Production Possibilities Curve (PPC)
• 3. Applications

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U.S. Trade in Goods, 2000(billions of dollars)
Source U.S. Bureau of Economic Analysis, Survey
of Current Business, Table 2, July 2001.
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1. Specialization by Individuals

• Division of Labor
• Opportunity Cost
• Costs of Exchange
• Comparative and Absolute Advantage

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1. Specialization by Individuals Division
of Labor

• Reasons for Specialization
• 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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1. Specialization by Individuals
Opportunity Costs

• Opportunity Cost
• The highest valued alternative foregone (given
  up) in making any choice.

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1. Specialization by Individuals
Opportunity Costs
Calculating Opportunity Costs
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1. Specialization by Individuals
Opportunity Costs
Incentive to Specialize
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1. Specialization by Individuals
Opportunity Costs
Exchange Prices
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1. Specialization by Individuals 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
NAFTA
Peso Crisis
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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1. Specialization by Individuals
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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2. Production Possibilities Curve (PPC)

• Assumptions
• Opportunity Costs
• Comparative and Absolute Advantage
• Where Should the Economy Operate?

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2. Production Possibilities Curve (PPC)
Assumptions
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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2. Production Possibilities Curve
Assumptions
B


D
C

A

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2. Production Possibilities Curve
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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2. Production Possibilities Curve
Assumptions
Increase in Resources or Technology
Improvement that benefits both products. PPC
shifts outward (to the right), from PPC1 to PPC2.
PPC1
PPC2
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2. Production Possibilities Curve
Assumptions
Increase in Specialized Resources
Improvement that benefits Food production only.
PPC1
PPC2
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2. Production Possibilities Curve
Assumptions
Increase in Specialized Resources
Improvement that benefits clothing production
only.
PPC1
PPC2
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2. Production Possibilities Curve
Opportunity Cost

• 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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2. Production Possibilities Curve
Opportunity Cost
Increasing Opportunity Cost
As you increase production of food you sacrifice
increasing quantities of clothing
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2. Production Possibilities Curve
Comparative and Absolute Advantage

• Assumptions
• 2 countries
• 2 products
• Straight-line PPCs to simplify model (constant
  opportunity cost)

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2. Production Possibilities Curve
Comparative and Absolute Advantage
PPC Country A
PPC Country B
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2. Production Possibilities Curve
Comparative and Absolute Advantage
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2. Production Possibilities Curve
Comparative and Absolute Advantage
PPC Country A
PPC Country B
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2. Production Possibilities Curve
Comparative and Absolute Advantage
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3. Applications

• Scarcity and Choice
• the cruel dilemma facing less-developed
  countries
• Opportunity Costs
• staffing professors in two departments

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3. Applications The Cruel Dilemma of the Poor
Subsistence Level
Production Possibilities Curve
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3. Applications Staffing University
Departments
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3. Applications Staffing University
Departments