Chapter 2: Production Possibilities and Tradeoffs

Transcription

1 Chapter 2: Production Possibilities and Tradeoffs 1. Production-possibility frontier A. shows the combinations of goods that can be produced with available resources (labor, machinery, etc.) B. simple model of production with two goods (guns and butter): e.g., if we produce 50 guns, then, with the labor, machinery, etc., that are left, how much butter can we make? (repeat for all other levels of gun production, and for all other levels of butter production) C. production-possibility frontier... shows outer limits of what can be produced can be linear or concave

2 D. at points inside the frontier (like A): some inputs (labor, machines...) are unemployed or not used efficiently E. at points outside the frontier (like B): not possible (requires more inputs than are available to the economy) 2. Tradeoffs ("hard choices"): A. More of one good must mean less of the other ("guns vs. butter") 2

3 2. Tradcoffs (continued) B. Movement along the frontier: shifting output from guns to butter, or vice versa- more of one must mean less of the other (so, a tradeoff, opportunity cost) C. Negative slope of the frontier: means that if we want to produce more guns, we ll have to take labor and machinery away from butter production, thus reducing amount of butter produced (and vice-versa) 3. Linear p-p frontier A. has constant slope B. thus, assumes that opportunity cost of additional guns (in terms of butter) is constant, and (likewise) that opportunity cost of additional butter (in terms of guns) is constant

4 4. Concave p-p frontier A. Slope increases (in absolute value) as we move to the right: curve is concave B. Thus, concave p-p frontier implies that opportunity cost of additional guns (measured in terms of butter) rises as we produce more guns- i.e., increasing marginal cost of guns C. Concave p-p frontier also implies increasing marginal cost of butter in terms of guns (can you see why?)

5 5. More on the p-p frontier A. Over time, p-p frontier may shift out due to labor force growth, new machinery ("capital"), new technology (e.g., less consumption and more investment now can push p-p frontier out, allowing more consumption later) B. Reducing unemployment/inefficiency can move society closer to the frontier, allowing for more of all goods Production-possibility frontier only tells us what options are available, not what option is the right one to pick

6 Chapter 2: Com arative Advanta e and Trade 1. Trade and specialization based on com arative advanta e (note: related to o ortunit cost) o Production possibilities: simple model linear - frontier for Fred: 8 meat, or 32 potatoes, or combinations in between NOTE: Fred can have 32 potatoes if he gives up 8 meat, or 4 potatoes for each 1 meat - so "cost" of each 1 unit of meat for Fred is 4 potatoes linear - frontier for Rachel: 24 meat, or 48 potatoes, or combinations in between NOTE: Rachel can have 48 potatoes if she gives up 24 meat, or 2 potatoes for each 1 meat- so "cost" of each 1 unit of meat for Rachel is 2 potatoes

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8 So the "cost" of 1 unit of meat is: 4 potatoes for Fred 2 potatoes for Rachel So who can produce 1 unit of meat at lower cost (lower ~ cost)? Conversely, what s the "cost" of 1 potato? From the ra hs: Fred can produce 32 potatoes by giving up 8 meat, or 1 potato by giving up 8/32 = 1/4 meat So for Fred, cost of 1 potato = 1/4 meat Rachel can produce 48 potatoes by giving up 24 meat, or 1 potato by giving up 24/48 = 1/2 meat So for Rachel, cost of 1 potato = 1/2 meat Thus, Fred is the lower-cost potato producer Rachel is the lower-cost meat producer

9 3. Gains from trade, based on specialization and comparative advantage Since Rachel is the lower-cost meat producer, it makes sense for her to specialize in meat production and trade her meat for Fred s potatoes. Since Fred is the lower-cost otato ~, it makes sense for him to specialize in potato production and trade his potatoes for Rachel s meat. Since Rachel is the lower-cost meat ~, it makes sense for her to specialize in meat production and trade her meat for Fred s potatoes. (Exception: won t work if Fred wants no meat, or if Rachel wants no potatoes.) How can this work? 4

10 (A) Fred produces 16 more potatoes. (To do this, he must cut meat output by 4 units. Remember: for Fred, the cost of producing 1 more potato is 1/4 meat.) (B) Rachel produces 6 more meat. (To do this, she must cut potato output by 12. Remember: for Rachel, the cost of producing 1 more meat is 2 potatoes.) Rachel gives 5 meat to Fred. Fred gives 15 potatoes to Rachel. (D) Both Fred and Rachel have gained! Rachel has 6-5 more meat, and = 3 more potatoes Fred has = 1 more potatoes and 5-4 = 1 more meat. Note: the lower-cost meat producer produces more meat and less potatoes; the lower-cost potato producer produces more potatoes and less meat- specialization based on comparative advantage!

11 0 Comparative advantage vs. absolute advantage absolute advantage: fewer inputs are required to produce a given output a producer can have an absolute advantage in production of all goods refers to general ~ of p-p frontier (per unit of input) comparative advantage: lower opportunity cost (in terms of other ~ of producing a given output refers to slope of p-p frontier a producer can t have a comparative advantage in production of all goods different producers must have different comparative advantages unless slopes of their p-p frontiers are identical 6

12 5. Key principle: there are ~ains both parties from trade based on comparative advantage for 6. Implications for trade with other countries, "outsourcing," etc. 0 Implications for household behavior Suppose Fred has a comparative advantage in market roduction and Rachel has a comparative advantage in home roduction? Principle of comparative advantage will lead Fred to specialize in market work, Rachel to specialize in home work. (That way, they can have more market goods, and more home goods as well.) Implications for marriage: opposites attract, household specialization, etc. 7

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