Managers Making Choices at BMW Learning Objectives 2.1 Use a production possibilities frontier to analyze opportunity costs and trade-offs. 2.2 Understand comparative advantage and explain how it is the basis for trade. 2.3 Explain the basic idea of how a market system works. To compete in the automobile market, the managers of BMW must make many strategic decisions, such as whether to introduce a new car model.

Trade-offs, Comparative Advantage, and the Market System Scarcity The situation in which unlimited wants exceed the limited resources available to fulfill those wants.

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Production possibilities frontier (PPF) A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology.

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Graphing the Production Possibilities Frontier FIGURE 2-1 BMW’s Production Possibilities Frontier

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Graphing the Production Possibilities Frontier Opportunity cost The highest-valued alternative that must be given up to engage in an activity.

Solved Problem 2-1 Learning Objective 2.1 Drawing a Production Possibilities Frontier for Rosie’s Boston Bakery HOURS SPENT MAKING QUANTITY MADE CHOICE CAKES PIES A 5 B 4 1 2 C 3 D 6 E 8 F 10

Trade-offs: Hurricane Katrina, Tsunami Relief, and Charitable Giving Learning Objective 2.1 Making the Connection Trade-offs: Hurricane Katrina, Tsunami Relief, and Charitable Giving More than two-thirds of Americans donated money to hurricane relief. Although these funds helped to reduce the suffering of many hurricane victims, donations to some other causes actually declined. More funds for Katrina relief meant less funds for other charities.

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Increasing Marginal Opportunity Costs FIGURE 2-2 Increasing Marginal Opportunity Cost

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Economic Growth FIGURE 2-3 Economic Growth Economic growth The ability of the economy to produce increasing quantities of goods and services.

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Trade The act of buying or selling. Specialization and Gains from Trade FIGURE 2-4 Production Possibilities for You and Your Neighbor, without Trade

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Specialization and Gains from Trade FIGURE 2-5 Gains from Trade

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Specialization and Gains from Trade TABLE 2-1 A Summary of the Gains from Trade YOU YOUR NEIGHBOR APPLES (IN POUNDS) CHERRIES (IN POUNDS) Production and consumption without trade 8 12 9 42 Production with trade 20 60 Consumption with trade 10 15 45 Gains from trade (increased consumption) 2 3 1

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Absolute Advantage versus Comparative Advantage Absolute advantage The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources Table 2-2 Opportunity Costs of Picking Apples and Cherries OPPORTUNITY COST OF PICKING 1 POUND OF APPLES OPPORTUNITY COST OF PICKING 1 POUND OF CHERRIES YOU 1 pound of cherries 1 pound of apples YOUR NEIGHBOR 2 pounds of cherries 0.5 pounds of apples

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Absolute Advantage versus Comparative Advantage Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors.

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Comparative Advantage and the Gains from Trade The basis for trade is comparative advantage, not absolute advantage. Individuals, firms, and countries are better off if they specialize in producing goods and services for which they have a comparative advantage and obtain the other goods and services they need by trading. Don’t Let This Happen to YOU! Don’t Confuse Absolute Advantage and Comparative Advantage

Solved Problem 2-2 Learning Objective 2.2 Comparative Advantage and the Gains from Trade CANADA UNITED STATES HONEY (IN TONS) MAPLE SYRUP (IN TONS) MAPLE SYRUP (IN TONS) 60 50 10 45 40 20 30 15 BEFORE TRADE AFTER TRADE HONEY (IN TONS) MAPLE SYRUP (IN TONS) MAPLE SYRUP (IN TONS) CANADA 30 15 20 UNITED STATES 10 40

Solved Problem 2-2 Learning Objective 2.2 Comparative Advantage and the Gains from Trade

Learning Objective 2.3 The Market System Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. Product markets Markets for goods—such as computers—and services—such as medical treatment. Factor markets Markets for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability. Factors of production The inputs used to make goods and services.

Learning Objective 2.3 The Market System Factors of production are divided into four broad categories: Labor includes all types of work, from the part-time labor of teenagers working at McDonald’s to the work of top managers in large corporations. Capital refers to physical capital, such as computers and machine tools, that is used to produce other goods. Natural resources include land, water, oil, iron ore, and other raw materials (or “gifts of nature”) that are used in producing goods. An entrepreneur is someone who operates a business. Entrepreneurial ability is the ability to bring together the other factors of production to successfully produce and sell goods and services.

The Market System The Circular Flow of Income Learning Objective 2.3 The Market System The Circular Flow of Income Two key groups participate in markets: A household consists of all the individuals in a home. Firms are suppliers of goods and services. Circular-flow diagram A model that illustrates how participants in markets are linked.

The Market System The Circular Flow of Income Learning Objective 2.3 FIGURE 2-6 The Circular-Flow Diagram

The Market System The Gains from Free Markets Learning Objective 2.3 The Market System The Gains from Free Markets Free market A market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed.

The Market System The Market Mechanism Learning Objective 2.3 The Market System The Market Mechanism Individuals usually act in a rational, self- interested way. Adam Smith understood that people’s motives can be complex. In a famous phrase, Smith said that firms would be led by the “invisible hand” of the market to provide consumers with what they wanted.

A Story of the Market System in Action: How Do You Make an iPod? Learning Objective 2.3 Making the Connection A Story of the Market System in Action: How Do You Make an iPod? The market coordinates the activities of the many people spread around the world who contribute to the making of an iPod.

The Market System The Role of the Entrepreneur Learning Objective 2.3 The Market System The Role of the Entrepreneur Entrepreneur Someone who operates a business, bringing together the factors of production—labor, capital, and natural resources—to produce goods and services.

The Market System The Legal Basis of a Successful Market System Learning Objective 2.3 The Market System The Legal Basis of a Successful Market System Protection of Private Property Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. Enforcement of Contracts and Property Rights If property rights are not well enforced, fewer goods and services will be produced. This reduces economic efficiency, leaving the economy inside its production possibilities frontier.

Property Rights in Cyberspace: YouTube and MySpace Learning Objective 2.3 Making the Connection Property Rights in Cyberspace: YouTube and MySpace Controlling unauthorized copying is more difficult today than it was when “copying” meant making a physical copy of a book, CD, or DVD. The popularity of YouTube and MySpace highlights the problem of unauthorized copying of videos and music. Some recording artists worry that the copyrights for their songs are not being protected on the Internet.

BMW Managers Change Production Strategy An Inside LOOK BMW Managers Change Production Strategy Redesigned X5 to lead increase; new coupe to debut in 2008

K e y T e r m s Absolute advantage Circular-flow diagram Comparative advantage Economic growth Entrepreneur Factor markets Factors of production Free market Market Opportunity cost Product markets Production possibilities frontier (PPF) Property rights Scarcity Trade