Economy assignment
m21q8
ECON251_M1_Fall21_Maia_Ch2.pdf
ECON251
Economic Models: Trade-offs and Trades
Chapter 2
Why models? Simplified representations of reality—play a crucial role in economics
Three simple but important models: production possibility frontier
Comparative advantage
WHAT YOU WILL LEARN IN THIS CHAPTER
I- The Production Possibility Frontier
I- The Production Possibility Frontier
• The production possibility frontier (PPF) illustrates the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for any given production of the other good.
• The PPF improves our understanding of trade-offs by considering a simplified economy that produces only two goods by showing this trade-off graphically.
• It shows well the opportunity cost, efficiency and growth principles.
I- The Production Possibility Frontier
2820 400
30
9
15
Quantity of computers
A
B
C
Quantity of phones
I-The Production Possibility Frontier
2820 400
30
9
15
Quantity of computers
A
B
D
C
Feasible and efficient
in production Not feasible
Quantity of phones
Feasible but not efficient
Question 1 If society is producing a combination of goods on its production possibilities frontier
a. it must be employing all available resources. b. it must be growing. c. it is using all the available natural resources but may not be using all available labor resources. d. Both a and b.
Production Possibilities for Two Countries
16 400
30
18
U.S. Production Possibilities
Quantity of computers
Quantity of phones
Production Possibilities for Two Countries
3060
10
8
Quantity of computers
Quantity of phones
Brazilian Production Possibilities
Comparative Advantage and Gains from Trade
16 40 0
30
18
60
8 10
(a) U.S. Production and Consumption
Quantity of computers Quantity of computers
Quantity of phonesQuantity of phones
(b) Brazilian Production and Consumption
30
Comparative Advantage and Gains from Trade
16 40 0
30
18
60
8 10
(a) U.S. Production and Consumption
Quantity of computers Quantity of computers
Quantity of phonesQuantity of phones
(b) Brazilian Production and Consumption
30
Comparative Advantage and Gains from Trade
United States and Brazilian Opportunity Costs
U.S. Opportunity Cost
Brazilian Opportunity Cost
One phone 3/4 computers > 1/3 computer
One computer 4/3 phone < 3 phones
Question 2 The slope of the production possibility frontier shows
a. how inputs must be changed to keep them fully employed. b. the technically efficient combinations of the two goods. c. how demanders are willing to trade one good for another. d. the opportunity cost of one good in terms of the other.
Specialize and Trade • Both countries are better off when they each specialize in what they
are good at and then trade.
• It’s a good idea for Brazil to make the phones for both of them, because its opportunity cost of a phone in terms of computer not made is only 1/3 of a computer, versus 3/4 computer for the United States.
• Correspondingly, it’s a good idea for the United States to make computers for both of them.
16 40 0
30
18
60
8 10
(a) U.S. Production and Consumption
Quantity of computers Quantity of computers
Quantity of phonesQuantity of phones
(b) Brazilian Production and Consumption
30
How the Two Countries Gain from Trade
Both the United States and Brazil experience gains from trade: § U.S. consumption of computers increases by two, and its consumption of
phones increases by four. § Brazilian consumption of computers increases by two, and his consumption of
phones increases by four.
Phones
Computers
Phones
Computers
Comparative vs. Absolute Advantage
• An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people.
• An individual has an absolute advantage in an activity if he or she can do it better than other people. Having an absolute advantage is not the same thing as having a comparative advantage.
U.S. vs. Brazil – Absolute vs. Comparative
• The United States has an absolute advantage in both activities: it can produce more output with a given amount of input (in this case, its time) than Brazil.
• But we’ve just seen that the United States can indeed benefit from a deal with Brazil because comparative, not absolute, advantage is the basis for mutual gain.
U.S. vs. Brazil – Absolute vs. Comparative
• So Brazil, despite its absolute disadvantage, even in phones, has a comparative advantage in phones making.
• Meanwhile the United States, which can use its time better by making computers, has a comparative disadvantage in phones making.
SUMMARY
1. Almost all economics is based on models.
An important assumption in economic models is the other things equal assumption, which allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged.
SUMMARY
2. One important economic model is the production possibility frontier. It illustrates: opportunity cost, efficiency, and economic growth.
There are two basic sources of growth: an increase in factors of production — resources such as land, labor, capital, and human capital, inputs that are not used up in production — and improved technology.
SUMMARY
3.Another important model is comparative advantage, which explains the source of gains from trade between individuals and countries. Everyone has a comparative advantage in something.
This is often confused with absolute advantage, an ability to produce a particular good or service better than anyone else.
Question 3
Trade is based on a. absolute advantage. b. comparative advantage. c. production costs. d. relative dollar prices.
Question 4
Absolute advantage is found by a. comparing opportunity costs. b. calculating the dollar cost of production. c. comparing the productivity of one nation to that of another. d. first determining which country has a comparative advantage.
Question 5
If labor in Mexico is less productive than labor in the U.S. in all areas of production,
a. neither nation can benefit from trade. b. Mexico can benefit from trade but the U.S. cannot. c. Mexico will not have a comparative advantage in any good. d. both nations can benefit from trade.
Example: Suppose Alaska each month can produce either 300 pounds of coffee and no salmon, or 500 salmon and no coffee, or any combination in between. Brazil each month can produce either 400 pounds of coffee and no salmon, or 300 salmon and no coffee, or any combination in between. a. Assume that all production possibility frontiers are straight lines. Draw one diagram showing
the monthly PPF for Alaska and another showing the monthly PPF for Brazil. Put quantity of fish on the horizontal axis.
b. Which country has the comparative advantage in coffee production? In fish production? c. Suppose Brazil adopts a new technology for catching fish that doubles the quantity of fish they
can produce each month. Using the diagram in (a), draw the new monthly PPF for Brazil. d. After the innovation, which country has the comparative advantage in coffee production? In
fish production?
Example: • In Italy, an automobile can be produced by 8 workers in one day and a
washing machine by 3 workers in one day. • I the United States, an automobile can be produced by 6 workers in one
day and a washing machine by 2 workers in one day.
a) Which country has an absolute advantage in the production of automobiles? In washing machines?
b) Which country has an comparative advantage in the production of automobiles? In washing machines?
c) What pattern of specialization results in the greatest gains from trade between two countries?
Example:
These figures illustrate the production possibilities frontiers for Robinson Crusoe and Friday with 12 hours of labor.
a. What is the opportunity cost of 1 kg fish for Robinson Crusoe? For Friday?
b. Robinson Crusoe has a comparative advantage in __________ and Friday has a comparative advantage in ___________
Example:
a. The opportunity cost of 1 bottle of perfume for Nancy is ….. b. The opportunity cost of 1 bottle of perfume for Roger is …. c. Nancy has a comparative advantage in __________ and Roger has an
absolute advantage in __________
