Chapter 2 Review Session. PPC, CPC, Absolute Advantage, Comparative Advantage

Transcription

1 Chapter 2 Review Session PPC, CPC, Absolute Advantage, Comparative Advantage

2 PPC & the three types of points The Production Possibilities Curve (PPC): a curve showing the maximum attainable combinations of products that may be produced with available resources and current technology. Efficient, inefficient, and unattainable (on, below, and beyond the PPC)

3 Example: Page 57 Problems #3 Consider a society consisting only of Helen, who allocates her time between sewing dresses and baking bread. Each hour she devotes to sewing dresses yields 4 dresses and each hour she devotes to baking bread yields 8 loaves of bread. a. If Helen works a total of 8 hours per day, graph her production possibilities curve. b. Using your graph, which of the points listed below are attainable and/or efficient? 28 dresses per day, 16 loaves per day. 16 dresses per day, 32 loaves per day. 18 dresses per day, 24 loaves per day.

4 Absolute vs. Comparative Advantage Absolute Advantage: whoever requires less time to produce a unit of output. Opportunity Cost: The value of the next best alternative that must be foregone in order to undertake an activity. Comparative Advantage: whoever has a lower opportunity cost in producing a unit of output.

5 Example: Page 57 Problems #1 Ted can wax a car in 20 minutes or wash a car in 60 minutes. Tom can wax a car in 15 minutes or wash a car in 30 minutes. What is each man s opportunity cost of washing a car? Who has a comparative advantage in washing cars?

6 Example: Ch2 PS Table 3-1 Labor hrs needed to make 1 pound Prod. In 40 hrs in lbs Meat Potatoes Meat Potatoes Farmer Rancher

7 CA/AA and PPC Absolute value of slope of PPC: opportunity cost of good X. Reciprocal of absolute value of slope of PPC: opportunity cost of good Y. The person with a flatter PPC has comparative advantage in good X. The other person would have comparative advantage in good Y. In general, one person cannot have comparative advantage in both goods but it is possible for one person to have absolute advantage in both goods

8 Example: Ch2 PS Figure 3-2

9 CPC vs. PPC The Consumption Possibilities Curve (CPC): a curve showing the maximum attainable combinations of products that may be consumed. It is also the boundary between possible consumption combinations and impossible consumption combinations. The Production Possibilities Curve (PPC): a curve showing the maximum attainable combinations of products that may be produced with available resources and current technology. It is also the boundary between possible production combinations and impossible production combinations

10 Example: Ch2 PS SA #8 You have been asked to go before Congress and provide a simple explanation of the benefits of free trade between the United States and Brazil. Use what you have learned so far in this class to explain why the United States and Brazil can benefit from trade with each other. To make the problem more concrete, consider the production of coffee and petroleum. Let the monthly PPC for the US be P=12-2C, and let the monthly PPC for Brazil be P=5-(1/3)C, where P is the number of barrels of petroleum (in thousands), and C is the number of bushels of coffee (in thousands).

11 monthly PPC for the US be P=12-2C, monthly PPC for Brazil be P=5-(1/3)C On the same graph, plot Brazil s and the United States PPCs. Put P on the y-axis and C on the x-axis. For each PPC, label the x-intercept, the y-intercept and the slope. Find O.C. of producing coffee for Brazil and the US. Find O.C. of producing petroleum for Brazil and the US. In which good does each country have a comparative advantage? If each country specializes in the good it has comparative advantage in, what range is the trading price of petroleum in terms of coffee (i.e., how many bushels of coffee for each barrel of petroleum) both countries would be willing to accept?

12

13 Suppose each country only produces the good it has comparative advantage in and the final trading price they agree on is 2 bushels of coffee for each barrel of petroleum, what are equations for the consumption possibilities curves of the two countries (Let the consumption of coffee in thousands of bushels be x and the consumption of petroleum in thousands of barrels be y)? What are the slopes of the consumption possibilities curves? What is the maximum amount of petroleum that Brazil can consume? What is the maximum amount of coffee that US can consume? Are both countries better off if they trade with each other? Please explain.

14 7.5 US s CPC slope =1/2 (15,4.5)