Chapter 2 Economics, 8th Edition Boyes/Melvin

 Opportunity cost: the value of the highest- valued alternative that must be forgone when a choice is made. It is the evaluation of a trade- off.  Marginal benefits and costs: the benefits and opportunity costs associated with one additional unit of the good. 2 Copyright © Cengage Learning. All rights reserved.

 Principle: Decision making involves trade-offs.  A trade-off means a sacrifice--giving up one good or activity in order to obtain some other good or activity. Copyright © Cengage Learning. All rights reserved. 3

 The production possibilities curve shows the maximum quantity of goods and services that can be produced when the existing resources are used fully and efficiently. Copyright © Cengage Learning. All rights reserved. 4

Underutilized (Inefficient) Nondefense Goods B1B1 F1F1 C1C1 D1D1 Only nondefense goods produced E1E1 Only defense goods produced A1A1 Efficient Combinations Defense Goods Impossible G1G DefenseNon-defense A1A B1B C1C D1D E1E F1F G1G Copyright © Cengage Learning. All rights reserved.

 The PPC moves outward (growth occurs) as the result of:  Increased resources  Larger labor force  Change in labor force participation  Chance in labor-leisure decision  Improved technology (innovation)  Expansion of capital stock  An improvement in the rules (laws, institutions, and policies) of the economy 6 Copyright © Cengage Learning. All rights reserved.

Nondefense Goods B1B1 C1C1 D1D1 E1E1 A1A1 Defense Goods B2B A2A2 C2C2 D2D2 E2E2 F2F2 DefenseNon-defense A2A B2B C2C D2D E2E F2F Copyright © Cengage Learning. All rights reserved.

 The Production Possibilities Curve (PPC) illustrates the concept of opportunity cost. Each point on the PPC means that every other point is a forgone opportunity.  The PPC bows outward because there are ever- increasing marginal costs to the production of any good. 8 Copyright © Cengage Learning. All rights reserved.

 Opportunity Cost: This is indicated by the negative slope of the PPC. As more of one good is produced, less of the other goods are produced.  Full Employment: Producing on the PPC  Unemployment: Producing inside the PPC  Economic Growth: Indicated by an outward shift of the PPC  Investment: Indicated by a trade-off between the production of consumption goods and capital goods. Copyright © Cengage Learning. All rights reserved. 9

A. The market price that the business can obtain for a dress. B. The cost of the labor and raw materials used in making the dress C. The shirts that could have been produced with the resources used to make the dress D. The total cost of all the resources used to make one dress 10

A. A reduction in the rate of unemployment B. An increase in the size of the available labor force C. An advance in technology D. An increase in the capital stock Copyright © Cengage Learning. All rights reserved. 11

A. A decrease in unemployment B. A decrease in natural resource prices C. An increase in consumer demand D. An increase in immigration E. Negative net capital investment spending Copyright © Cengage Learning. All rights reserved. 12

A. A concave PPC has decreasing opportunity cost. B. A concave PPC has constant opportunity cost C. A concave PPC has increasing opportunity cost D. A concave PPC does not show opportunity cost E. There is no difference between the two PPC. Copyright © Cengage Learning. All rights reserved. 13

 What is the difference between absolute advantage and comparative advantage in trade? Copyright © Cengage Learning. All rights reserved. 14

 Economic agents (individuals, firms, nations) will be better off if they choose to produce those things for which they have the lowest opportunity costs, and trade for those with higher costs.  Agents do this because such choices involve giving up the least amount of other things. 15 Copyright © Cengage Learning. All rights reserved.

 Absolute Advantage: the ability of a party (individual, firm, or nation) to produce more number of a good, product, or service than competitors 16 Copyright © Cengage Learning. All rights reserved.

 Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than someone else.  Law of comparative advantage:  proposition that the joint output of trading partners will be greatest when each good is produced by the low opportunity cost producer. 17 Copyright © Cengage Learning. All rights reserved.

 Lebron can mow his lawn in two hours. He can also film a Nike commercial in two hours and make $10,000  What is his opportunity cost of mowing his lawn?  Scotty the teenager can mow LeBron’s lawn in four hours. He could also work at McDonald’s for four hours at $8 an hour.  What is Scotty’s opportunity cost of mowing Lebron’s yard? Copyright © Cengage Learning. All rights reserved. 18

 Who has absolute advantage in mowing the lawn?  Who has comparative advantage in mowing the lawn?  Would Lebron benefit from the trade? Would Scotty? Copyright © Cengage Learning. All rights reserved. 19

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 How do natural disasters and terrorist attacks affect international trade and economic growth?  A report from the World Trade Organization (WTO) says while the immediate effect on particular industries can be notable, the economy-wide impact these events have on trade and growth is short-term and generally minimal. 21 Copyright © Cengage Learning. All rights reserved.

 Private property rights are necessary for a market economy to develop. If no one owns something, no one has the incentive to take care of it. 22 Copyright © Cengage Learning. All rights reserved.

 We give up  If We Make Copyright © Cengage Learning. All rights reserved. 23

 Chris can bake either 8 pies or 4 loaves of bread per hour. For Chris, what is the opportunity cost of baking an extra pie? Copyright © Cengage Learning. All rights reserved. 24

 What you give up  What you gain  4 = 1  8 2 bread Copyright © Cengage Learning. All rights reserved. 25

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Copyright © Cengage Learning. All rights reserved. 30 StateApplesTimberOpp. Cost of 1 Timber = Opp. Cost of 1 Apple + Oregon1040 Washington4010 Absolute Advantage in Timber: Absolute Advantage in Apples: Comparative Advantage in Timber: Comparative Advantage in Apples: Draw these PPF’s. Assume each is producing (and consuming) at the midpoint.

Copyright © Cengage Learning. All rights reserved. 31 StateApplesTimberOpp. Cost of 1 Timber = Opp. Cost of 1 Apple + Oregon Apple4 Timber Washington40104 Apple.25 Timber Absolute Advantage in Timber: Oregon Absolute Advantage in Apples: Washington Comparative Advantage in Timber: Oregon Comparative Advantage in Apples: Washington

Copyright © Cengage Learning. All rights reserved. 32 Hours to produce 1 unit of Donuts Hours to produce 1 unit of Coffee Producing 1 unit of donuts costs Producing 1 unit of coffee costs Springfield84 Shelbyville248 Absolute Advantage in Donuts: Springfield Absolute Advantage in Coffee: Springfield Comparative Advantage in Donuts : Comparative Advantage in Coffee:

Copyright © Cengage Learning. All rights reserved. 33 Hours to produce 1 unit of Donuts Hours to produce 1 unit of Coffee Producing 1 unit of donuts costs Producing 1 unit of coffee costs Springfield842 units of coffee ½ unit of donuts Shelbyville2483 units of coffee 1/3 unit of donuts Absolute Advantage in Donuts: Springfield Absolute Advantage in Coffee: Springfield Comparative Advantage in Donuts : Springfield Comparative Advantage in Coffee: Shelbyville

 A. 10 hours working; $50 income  B. No. 0.0 – 1.0 =$50 oc  1.0 – 2.0 = $100 oc  C. 10 hours studying; 1.0 GPA Copyright © Cengage Learning. All rights reserved. 34

 B. No one can have a comparative advantage in both activities because it is the “comparative” opportunity costs  C. 4. OC of GPA: $300/4.0 = 75  OC of Income: 4.0/$300 =.013  5. OC of GPA: $360/4.0 = 90  OC of Income: $4.0/$360 =.011  4 should study and 5 should work Copyright © Cengage Learning. All rights reserved. 35

 a. A-B: 10 units; B-C: 20 units; C-D: 30 units; D-E: 40 units  b. All other combinations  C. 1. OC of HC: 100G/100HC = 1  OC of OG: 100HC/100OG = 1  2. OC of HC: 50/65 =.77  OC of OG: 65/50 = 1.3  Nation 1 should specialize in All Other Goods and Nation 2 should specialize in Health Care Copyright © Cengage Learning. All rights reserved. 36