Production and Trade Production Possibilities, Comparative and Absolute Advantage, Specialization and Trade, Circular Flow, Invisible Hand

Scarcity forces us to ask the following questions… WHAT to produce? HOW to produce? FOR WHOM to produce?

Imagine a scenario where… …we take an all-expenses-paid class trip to…

Australia!

Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island. You are in charge. Prioritize 3-5 things we’ll have to do to survive and how (and with who) we should accomplish these tasks.

Specialization Allocating resources toward production for which they are best suited.

FACTORS OF PRODUCTION Land – all gifts of nature Labor – human efforts and abilities Capital – tools, equipment, space Human Capital – Skills or knowledge gained by a worker through education, training, or experience Entrepreneurship – risk taking, ideas **The “spark” or driving force of the economy**

I have an idea…. Am I an entrepreneur?

EXAMPLES: Durable vs. Nondurable goods Durable – lasts more than 3 years Nondurable – lasts less than 3 years

Adam Smith Meat Bread Candles How do we decide to provide these? “Wealth of Nations” 1776 Invisible hand Meat Bread Candles How do we decide to provide these?

CIRCULAR FLOW

But Remember...

5 Key Economic Assumptions Society has unlimited wants and limited resources (scarcity). Due to scarcity, choices must be made. Every choice has a cost (a trade-off). Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest.” Everyone makes decisions by comparing the marginal costs and marginal benefits of every choice. Real-life situations can be explained and analyzed through simplified models and graphs. Copyright ACDC Leadership 2015

14 Copyright ACDC Leadership 2015

Production Possibilities Model Illustrate production choices Assumptions: Full employment Fixed resources Fixed technology Two goods 1-15

Production Possibilities Frontier All possible combinations of two products that can be produced when employing 100% of available resources. Guns (thousands) A 80 B 75 C 60 D 30 E 0 Butter (tons) 150 300 400 450 Let’s Graph it!

Production Possibilities Frontier How could we get to point H in the future? What does point H represent? Why is the curve bowed out from the origin? What do points F and G represent? Law of Increasing Opportunity Cost… …due to the specialization of resources Unattainable Production Unemployed Resources Economic Growth

Production Possibilities Table Production Alternatives Type of Product A B C D E Pizzas (in hundred thousands) 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 Plot Points to Create Graph… 1-19

Quick Quiz Why is the PPF bowed out from the origin? Law of increasing opportunity costs What is the marginal opportunity cost of the 2nd unit of pizza? 2 units of robots Which point(s) on the curve represent full employment of resources? All points ON the curve

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1-21

Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable C’ Industrial Robots U D’ Under or Unemployment E’ 0 1 2 3 4 5 6 7 8 9 Pizzas 1-22

How do we know where on the curve we should be? As long as the MARGINAL benefit of the next unit of a good exceeds the MARGINAL cost, we should continue to produce an additional unit of the good. We should stop producing when the marginal benefit equals the marginal cost.

Optimal Allocation of Resources MC a c 15 10 5 MB = MC e Marginal Benefit & Marginal Cost b d MB 1 2 3 **MB = Gains from additional pizza MC = Costs of foregoing additional robot Quantity of Pizza 1-24

The Future Economy Consequences of unemployment Economic growth More resources Better quality resources Technological advances 1-25

Future Possibilities Compare Two Hypothetical Economies Presentville Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville 1-26

A Budget Line $120 Budget 12 10 8 6 4 2 DVDs $20 Books $10 2 4 6 8 10 12 6 5 4 3 2 1 Income = $120 Pdvd = $20 = 6 Unattainable Quantity of DVDs Income = $120 Pb = $10 = 12 Attainable 2 4 6 8 10 12 14 Quantity of Paperback Books 1-27

Homework - Comparative Advantage Read pgs. 841-846 and complete pg. 864 #2