Welcome to PMBA0608: Economics/Statistics Foundation Fall 2006 Sessions 3: August 26

Session 3: Production Possibilities Frontier  Shows the combination of two goods an economy can produce efficiently in a certain period of time with given amount of resources and a given technology  Assumptions Only two goods Fixed amount of factors of production Given resources & technology Efficiency (means what?)  Maximized output given what is available

Production Possibilities Frontier (PPF) Roses Guns A B C D E * I * U PPF

Remember the 10 Principles?  Does this model show Principle 1?  Does this model show Principle 2?  Any other principles?  How about Principle 8?

Production Possibilities Frontier (PPF)  Why is PPF downward sloping?  Why is PPF bowed out?  Why does the cost of producing 10 additional guns go up as we produce more guns?  What is point I?  What is point U  How can we move from I to B?  How can we shift our PPF outward?

Now we are going to jump to Chapter 3 of Mankiw Trade

Absolute Advantage  A nation has an absolute advantage in production of a good over its trade partner if it can produce one unit of that good using fewer resources than its trade partner or if, using all of its resources, it can produce more of that good than its trade partner.  Example

Comparative Advantage  A nation has a comparative advantage in production of a good if it can produce that good at a lower opportunity cost compared to its trade partner  Example

Definition  A trade benefits a nation if after trade the nation can consumes no less of any goods than before trade and more of at least one good.  Graph

In Class Assignment  PPFs  Who has absolute advantage in what? Why?  Is there going to be a trade based on absolute advantage? Why or why not?

In Class Assignment  What is the Opp. Cost of producing 1 computer in each nation  Who has comparative advantage in what? Why?  Is there going to be a trade based on comparative advantage? Why or why not?  Who should specialize in production of what? Why?

In Class Assignment  Pre-trade points of production and consumption  Terms of trade (must be mutually beneficial)  Post-trade points of production  Post-trade points of consumption  Gains from trade