Production Possibilities Curve/Frontier - Capital goods Consumer goods Law of increasing costs

Allocative efficiency: producing the particular mix of goods and services demanded by the society Impossibe to know from PPC; requires social Supply + Demand curves Changes in allocative efficiency movement of point

Shifts in the Curve Change in the quantity or quality of resources Achieved primarily through capital (physical or human) investment Adam Smith (The Wealth of Nations, 1776): capitalism a capital accumulating machine

Ireland Puerto Rico Crystal Rum Crystal Rum A B C 1 million 0 700,000 A 80,000 B 40,000 C C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Crystal Rum Crystal Rum A B C 1 million 0 700,000 30,000 0 100,000 A B C 80,000 0 40,000 40,000 0 80,000

Crystal Crystal A 1 million B 700,000 A 80,000 B 40,000 C C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Which country has the absolute advantage in the production of Crystal? In the production of Rum?

Which country has the comparative advantage in Crystal? In Rum? 1 million B 700,000 A 80,000 B 40,000 C C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Which country has the comparative advantage in Crystal? In Rum?

There are___steps in figuring out which country has Crystal Crystal A 1 million B 700,000 A 80,000 B 40,000 C C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico There are___steps in figuring out which country has the comparative advantage. 5

1. Know the definition of comparative advantage Crystal Crystal A 1 mil. B 700,000 A 80,000 B 40,000 C C 100,000 Rum 30,000 40,000 80,000 Rum Ireland Puerto Rico 1. Know the definition of comparative advantage One entity can produce something at a LOWER OPPORTUNITY COST than another entity. 2. Set up a table: Ireland Puerto Rico 1 Rum = __Crystal 1 Rum = __Crystal 1 Crystal = __ Rum 1 Crystal = __Rum 3. Go to the Xtremes (X and Y Games)

1. Know the definition of comparative advantage Crystal Crystal A 1 mil. B 700,000 A 80,000 B 40,000 C C 100,000 Rum 30,000 40,000 80,000 Rum Ireland Puerto Rico 1. Know the definition of comparative advantage Ireland Puerto Rico 1 Rum = __Crystal 1 Rum = __Crystal 1 Crystal = ____ Rum 1 Crystal = __Rum 2. Set up a table: 10 1 1/10 1 3. Go to the Xtremes (X and Y Games) 4. Fill in the blanks (starting with Puerto Rico first) 5. Circles and Arrows

We decided that Ireland should produce ALL the crystal and 1 million B 700,000 A 80,000 B 40,000 C C 100,000 Rum 30,000 40,000 80,000 Rum Ireland Puerto Rico We decided that Ireland should produce ALL the crystal and Puerto Rico should produce ALL the rum. How much crystal should Ireland produce? 1 million cases How much rum should Puerto Rico produce? 80,000 barrels Should Ireland just hold onto its cases of crystal and Puerto Rico just hold onto its barrels of rum? NO! What should each country do after specialization? Trade

Terms of trade Cost Ratio Ireland: 1 R = 10 C Puerto Rico: 1 R = 1 C Must get more than this ratio, or why trade? Actual terms depend on supply and demand

Ireland Puerto Rico IRELAND PUERTO RICO Crystal Crystal A 1 million B 700,000 A 80,000 B 40,000 C C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Consumes Consumes after specialization before Trade Produces Trades and Trade (Point B) Gain from Trade IRELAND C 1 million -175,000 R 0 +35,000 825,000 700,000 +125,000 35,000 30,000 + 5,000 PUERTO RICO C 0 R 80,000 +175,000 175,000 40,000 +135,000 -35,000 45,000 40,000 +5,000

Ireland Puerto Rico IRELAND PUERTO RICO Crystal Crystal A 1 million 175,000 D Crystal Crystal A 1 million D 825,000 700,000 A B 80,000 40,000 B 35,000 C 45,000 C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Consumes Consumes after specialization before Trade Produces Trades and Trade (Point B) Gain from Trade IRELAND Plot this column C 1 million -175,000 R 0 +35,000 825,000 700,000 +125,000 35,000 30,000 + 5,000 PUERTO RICO C 0 R 80,000 +175,000 175,000 40,000 +135,000 -35,000 45,000 40,000 +5,000

175,000 D Crystal Crystal A 1 million D 825,000 700,000 A B 80,000 40,000 B 35,000 C 45,000 C 30,000 100,000 Rum 40,000 80,000 Rum Ireland Puerto Rico Which country is obviously better off through this specialization and trade--Ireland or Puerto Rico? Both Countries are!!! Both countries are now outside their own production capabilities. Through specialization and trade all parties are better off.