CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE

Welcome to ECON 2301 Principles of Macroeconomics Dr. Frank Jacobson Mr. Stuckey Week 2 Class 2

Today Chapter 2 Production Possibilities Frontier Slopes of Curves

CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE

America’s Population million people million people million people million people million million 2007Estimate of 300 million Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved Industrial Development

Production Possibilities Frontier A Graph That Shows the Combinations of Output that the Economy Can Possibly Produce Given the Available Factors of Production and the Available Production Technology.

Production Possibilities Frontier ILLISTRATES AN ECONOMY’S TRADE-OFF OF PRODUCING ONE ITEM OR PRODUCT OVER ANOTHER

The Production Possibilities Curve Represents our economy at: Full employment Full production 2-20 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.

This Production Possibilities Curve shows the range of possible combinations of guns and butter extending from 15 units of butter and no guns at point A to 5 units of guns and no butter at point F 2-21 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve

2-22 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve To gain 1 unit of Guns Had to give up 1 unit of butter When you are on the curve, to get more of one thing you have to give up some of the other thing In this particular instance, the opportunity cost of gaining one unit of guns was one unit of butter

2-23 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve To gain 1 unit of Guns Had to give up 2 units of butter When you are on the curve, to get more of one thing you have to give up some of the other thing In this particular instance, the opportunity cost of gaining one unit of guns was two units of butter

2-24 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve To gain 1 unit of Guns Had to give up 3 units of butter When you are on the curve, to get more of one thing you have to give up some of the other thing In this particular instance, the opportunity cost of gaining one unit of guns was three units of butter

2-25 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve To gain 1 unit of Guns Had to give up 4 units of butter When you are on the curve, to get more of one thing you have to give up some of the other thing In this particular instance, the opportunity cost of gaining one unit of guns was four units of butter

2-26 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve To gain 1 unit of Guns Had to give up 5 units of butter When you are on the curve, to get more of one thing you have to give up some of the other thing In this particular instance, the opportunity cost of gaining one unit of guns was five units of butter

2-27 Point Units of Butter Units of Guns A 15 0 B 14 1 C 12 2 D 9 3 E 5 4 F 0 5 Hypothetical Production Schedule Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Production Possibilities Curve This is known as the “law of increasing cost.” As the output of one good expands, the opportunity cost of producing additional units of this good increases. As we shift from butter to guns, we have to give up increasing units of butter for each additional unit of guns

When you are on the curve, to get more of one thing you have to give up some of the other thing When you are at a point that is inside the line (PPF) it is possible to get more of both If you were at point G, it would be possible to move to point D or any other point on the line (PPF) and get more butter and more guns 2-28 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. G

Points Inside and Outside the Production Possibilities Curve Frontier Every point on the curve represents output at Full Employment and Full Production Every point inside the curve represents output at less than Full employment and less than Full Production 2-29 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. Where we usually are A Recession A Depression Point W represents output at more than full employment and full production and is currently unattainable

Productive Efficiency Is attained when the maximum possible output of one good is produced, given the output of other goods Productive efficiency occurs only when we are operating on the production possibilities curve Productivity efficiency means that the output of one good cannot be attained with out reducing the output of some other good 2-30 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth Best available technology Expansion of labor More or better trained labor Expansion of capital More or improved plant and equipment 2-31 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curves A move from PPC to PPC to PPC represents economic growth Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities Curves Over Time Country A Country B Country A represents slower economic growth than Country B Country A capital goods is 3.8 units Country B represents much faster economic growth than Country A Country B capital goods is 7.0 units 2-33 Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.

The Production Possibilities Frontier during World War II Copyright  2008 by Th`e McGraw-Hill Companies, Inc. All rights reserved. 2-34

Slope of a Line or Curve The Slope of a Line or Curve is a Measure of How Steep it is. The Slope of a Line is Measured by “Rise Over Run” The Change of the “y” Variable (Vertical) Between Two Points Divided By the Change in the “X” Variable (Horizontal) Between Two Points.

Figure A.3

Elastic Demand Curve A Completely Elastic Demand Curve is “Almost” Completely Flat. “Flat” Meaning Horizontal. An “Elastic” Demand Curve Means for a Small Change in Price a Very Large Quantity is Demanded.

Inelastic Demand Curve A Completely Inelastic Demand Curve is “Almost” Completely Vertical. An “Inelastic” Demand Curve Means That Regardless the Price, The Quantity Demanded Remains The Same.

Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 2-36

Barter Barter is Simply an Exchange of Goods, Services, or Goods for Services. Money is Not Involved. There is Also Almost no Way to Identify or Know How Much of it is Going on Within an Economy. It is Usually Higher in Underdeveloped Countries or When the Economy is Bad.

Circular-Flow Diagram Represents The Transactions That Take Place in an Economy by Two Kinds of Flows Around a Circle: Flows of Physical Things Such as Goods, Services, and Raw Materials in one Direction, and Flows of Money in the Opposite Direction That Pay for These Physical Things.

Circular-Flow Diagram Firms Households Markets For Factors of Production Markets For Goods and Services Factors of Production Goods and Services Sold Land, Labor And Capital Goods and Services Bought Wages, Rent and Profit (=GDP) Revenue (=GDP) Spending (= GDP) Income (=GDP) = Flow of Inputs and Outputs = Flow of Dollars

Comparative Advantage A Country Has a Comparative Advantage in Producing a Good or Service if its Opportunity Cost is Lower Than Other Countries.

Absolute Advantage A Country Has an Absolute Advantage in Producing a Good or Service if The Country Can Produce More Output Per Worker Than Other Countries.

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