Introduction to Macroeconomics Chapter 2 Opportunity Cost, Specialization, and Trade.
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Transcript of Introduction to Macroeconomics Chapter 2 Opportunity Cost, Specialization, and Trade.
Introduction to Macroeconomics
Chapter 2
Opportunity Cost, Specialization,
and Trade
Introduction to Macroeconomics
Chapter 2. Opportunity Cost, Specialization, and Trade
1. Microeconomics
– Specialization by Individuals
2. Macroeconomics
– Production Possibilities Curve (PPC)
3. Applications
Introduction to Macroeconomics
U.S. Trade in Goods, 2000(billions of dollars)
0
100
200
300
400
WesternEurope
Canada Japan Mexico China Others
Imports Exports
Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.
Introduction to Macroeconomics
1. Specialization by Individuals
• Division of Labor
• Opportunity Cost
• Costs of Exchange
• Comparative and Absolute Advantage
Introduction to Macroeconomics
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
Introduction to Macroeconomics
1. Specialization by Individuals Opportunity Costs
Opportunity Cost
The highest valued alternative foregone (given up) in making any choice.
Introduction to Macroeconomics
1. Specialization by Individuals Opportunity Costs
My Capabilities Your Capabilities
12 coconuts or 8 fish in 1 hour
14 coconuts or 7 fish in 1 hour
My Opportunity
Costs Your Opportunity
Costs 1 coconut = 2/3 fish 1 fish = 1.5 coconuts
1 coconut = 0.5 fish 1 fish = 2 coconuts
Calculating Opportunity Costs
Introduction to Macroeconomics
1. Specialization by Individuals Opportunity Costs
Production in 1 hour Me You Total Before Specialization and before Trade Coconuts 6 7 13 Fish 4 3.5 7.5 After Specialization but before Trade Coconuts 0 14 14 Fish 8 0 8 After Specialization and before Trade Coconuts 6.5 7.5 14 Fish 4.25 3.75 8
Incentive to Specialize
Introduction to Macroeconomics
1. Specialization by Individuals Opportunity Costs
Opportunity Cost
Me You Market Price
Coconuts 0.67 fish
0.5 fish
Between 0.5 and 0.67
fish
Fish 1.5
coconuts 2.0
coconuts
Between 1.5 and 2.0 coconuts
Exchange Prices
Introduction to Macroeconomics
1. Specialization by Individuals Costs of Exchange
• Negotiation costs
• Transportation costs
• Artificial barriers to trade (e.g., import tariffs)
Introduction to Macroeconomics
U.S. Trade in Goods with Mexico
0
2
4
6
8
10
12
14
16
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Per
cen
t o
f T
ota
l Im
po
rts
or
Exp
ort
s
Imports from Mexico Exports to Mexico
NAFTA
PesoCrisis
Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.
Introduction to Macroeconomics
Notes Page
Introduction to Macroeconomics
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
Introduction to Macroeconomics
2. Production Possibilities Curve (PPC)
• Assumptions
• Opportunity Costs
• Comparative and Absolute Advantage
• Where Should the Economy Operate?
Introduction to Macroeconomics
2. Production Possibilities Curve (PPC) Assumptions
Identifies all combinations of the maximum amount of any two goods or services that can be produced by a given economy.
Production Possibilities Curve (PPC)
Introduction to Macroeconomics
2. Production Possibilities Curve Assumptions
0
10
20
30
40
50
60
70
80
90
100
0 10 20 30 40 50 60 70 80 90 100
Production of Good A
Pro
du
ctio
n o
f G
oo
d B
A
B
C
D*
*
*
*
Introduction to Macroeconomics
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
Introduction to Macroeconomics
2. Production Possibilities Curve Assumptions
0
10
20
30
40
50
60
70
0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing Improvement that benefits
both products. PPC shifts outward (to the right), from PPC1 to PPC2.
PPC1 PPC2
Increase in Resources or Technology
Introduction to Macroeconomics
2. Production Possibilities Curve Assumptions
0
10
20
30
40
50
60
0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing Improvement that benefits Food production only.
PPC1 PPC2
Increase in Specialized Resources
Introduction to Macroeconomics
2. Production Possibilities Curve Assumptions
0
10
20
30
40
50
60
70
0 10 20 30 40 50 60 70
Production of Food
Pro
du
ctio
n o
f C
loth
ing
Improvement that benefits clothing production only.
PPC1 PPC2
Increase in Specialized Resources
Introduction to Macroeconomics
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
Introduction to Macroeconomics
2. Production Possibilities Curve Opportunity Cost
0
5
10
15
20
25
30
35
40
45
50
0 5 10 15 20 25 30 35 40 45 50
Production of Food
Pro
du
ctio
n o
f C
loth
ing As you increase
production of food you sacrifice increasing quantities of clothing
Increasing Opportunity Cost
Introduction to Macroeconomics
2. Production Possibilities Curve Comparative and Absolute Advantage
Assumptions:
• 2 countries
• 2 products
• Straight-line PPCs to simplify model (constant opportunity cost)
Introduction to Macroeconomics
2. Production Possibilities Curve Comparative and Absolute Advantage
0102030405060708090
100110
0 10 20 30 40 50 60 70 80 90
Production of Guns
Pro
du
ctio
n o
f B
utt
er
PPC Country A
PPC Country B
Introduction to Macroeconomics
2. Production Possibilities Curve Comparative and Absolute Advantage
Production of Guns
Production of Butter
Absolute Advantage
Country B Country A
Comparative Advantage
Country B Country A
Introduction to Macroeconomics
2. Production Possibilities Curve Comparative and Absolute Advantage
0102030405060708090
100110
0 10 20 30 40 50 60 70 80 90 100
Production of Guns
Pro
du
ctio
n o
f B
utt
er
PPC Country A
PPC Country B
Introduction to Macroeconomics
2. Production Possibilities Curve Comparative and Absolute Advantage
Production of Guns
Production of Butter
Absolute Advantage
Country A Country A
Comparative Advantage
Country A Country B
Introduction to Macroeconomics
3. Applications
• Scarcity and Choice– the “cruel dilemma” facing less-developed
countries
• Opportunity Costs– staffing professors in two departments
Introduction to Macroeconomics
3. Applications The Cruel Dilemma of the Poor
0
10
20
30
40
50
60
0 12 24 36 48
Capital Goods
Co
nsu
mp
tio
n G
oo
ds Subsistence Level
ProductionPossibilitiesCurve
Introduction to Macroeconomics
3. Applications Staffing University Departments
Economics Department Psychology Department
Number ofProfessors
Number of PagesPublished in
JournalsNumber ofProfessors
Number of PagesPublished in
Journals
0 0 5 120
1 30 4 115
2 50 3 100
3 65 2 75
4 75 1 40
5 80 0 0
Introduction to Macroeconomics
3. Applications Staffing University Departments
0
20
40
60
80
100
120
140
0 30 50 65 75 80
Economics Pages
Psy
cho
log
y P
ages