1. 251FINA Chapter Three Dr. Heitham Al-Hajieh

2. From Previous Lecture
Marginal opportunity cost = the amount of another good that must be given up to produce one more unit of a good.

3. Calculating marginal opportunity cost
In the interval between points A and B, the marginal opportunity cost of 1 point on the economics exam is 1/3 of a point on the calculus exam.

4. Marginal Opportunity Cost (continued)
In the interval between points B and C, the marginal opportunity cost of one point on the economics exam equals 4/3 of a point on the calculus exam.

5. Law of increasing cost
Law of increasing cost – marginal opportunity cost rises as the level of an activity increases

6. Reasons for law of increasing cost
Law of diminishing returns
Specialized resources (heterogeneous labor, land, capital, etc.)

7. Specialized resources in farming
Some land, labor, and capital is better suited for wheat production and some is better suited for corn production

8. Unemployed or underemployed resources

9. Points outside of the PPC

10. Economic growth

11. Commodity-specific technological change

12. Specialization and trade
Adam Smith – economic growth is caused by increased specialization and division of labor.

13. Gains from specialization and division of labor
specialization in areas that match the skills and talents of workers
“learning by doing” – increase in productivity from task repetition
less time lost while switching from task to task

14. Specialization and trade
As noted by Adam Smith, specialization and trade are strongly linked.
Adam Smith and David Ricardo used this argument to support free trade among nations.

15. Absolute and comparative advantage
Absolute advantage – an individual (or country) is more productive than other individuals (or countries).
Comparative advantage – an individual (or country) may produce a good at a lower opportunity cost than can other individuals (or countries).

16. Example: U.S. and Japan
Suppose the U.S. and Japan produce only two goods: CD players and wheat.

17. Absolute advantage?
Who has an absolute advantage in producing each good?

18. Comparative advantage?
Who has a comparative advantage in producing each good?

19. Gains from trade
Opportunity cost of CD player in U.S. = 2 units of wheat
Opportunity cost of CD player in Japan = 4/3 unit of wheat
If Japan produces and trades each CD player to the U.S. for more than 4/3 of a unit of wheat but less than 2 units of wheat, both the U.S. and Japan gain from trade and can consume more goods than they could produce by themselves.

20. Gains from trade (continued)
Note that the U.S. has a comparative advantage in producing wheat.
Countries always expand their consumption possibilities by engaging in trade (since they acquire goods at a lower opportunity cost than if they produced them themselves).

21. Free trade?
If each country specializes in the production of those goods in which it possesses a comparative advantage and trades with other countries, global output and consumption in increased.