Introduction to Macroeconomics Chapter 2. Opportunity Cost, Specialization, and Trade

Microeconomics –Specialization by Individuals Macroeconomics –Production Possibilities Curve Applications

U.S. Trade in Goods, 2000 (billions of dollars) Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.

Specialization by Individuals and Exchange Reasons for Specialization by individuals (Division of Labor) Exchange required Costs of exchange

Reasons for Specialization (Division of Labor) Increase skill from repetition Reduce time wasted shifting between tasks Incentive to invest resources in developing specialized tools and machines Opportunity Cost

The highest valued alternative foregone (given up) in making any choice.

Calculating Opportunity Costs

Incentive to Specialize

Exchange prices

Costs of Exchange Negotiation costs Transportation costs Artificial barriers to trade (e.g., import tariffs)

U.S. Trade in Goods with Mexico NAFTA Peso Crisis Source: U.S. Bureau of Economic Analysis, Survey of Current Business, Table 2, July 2001.

Notes Page

Production Possibilities Curve (PPC) Identifies all combinations of the maximum amount of any two goods or services that can be produced by a given economy.

Production Possibilities Curve A B C D * * * *

PPC Assumptions Only 2 goods or services (or aggregates of goods or services) are produced Full and efficient use of all available resources Supplies of resources (i.e., land, labor, and capital) are fixed Technology is held constant

Increase in Available Resources or Technology Improvement that benefits both products. PPC shifts outward (to the right), from PPC 1 to PPC 2. PPC 1 PPC 2

Increase in Available Resources or Technology Improvement that benefits Food production only. PPC 1 PPC 2

Increase in Available Resources or Technology Improvement that benefits clothing production only. PPC 1 PPC 2

Opportunity Cost and the PPC Two important characteristics of the PPC: Opportunity Cost - The PPC slopes downward and to the right Increasing Opportunity Cost - The PPC is "bowed outward" (concave) from the origin

Increasing Opportunity Cost As you increase production of food you sacrifice increasing quantities of clothing

Applications Scarcity and Choice –the cruel dilemma facing less-developed countries Opportunity Costs –staffing professors in two departments Specialization –comparing 2 PPCs (comparative vs absolute advantage)

Scarcity and Choice the Cruel Dilemma of the Poor Subsistence Level Production Possibilities Curve

Staffing University Departments

PPC - Staffing University Departments

Comparative and Absolute Advantage Absolute Advantage - a person can produce a good or service with fewer resources than can another person Comparative Advantage - a person can produce a good or service with lower opportunity cost than can another person

Comparative vs Absolute Advantage Assumptions: 2 countries 2 products Straight-line PPCs to simplify model (constant opportunity cost)

Comparative vs Absolute Advantage PPC Country A PPC Country B

Comparative vs Absolute Advantage

PPC Country A PPC Country B

Comparative vs Absolute Advantage