CHAPTER2Trade-offs, ComparativeAdvantage, and the Market SystemChapterOutlineandLearningObjectives2.1ProductionPossibilitiesFrontiers and OpportunityTESLCosts2.2ComparativeAdvantageandTrade2.3TheMarketSystem
1 Chapter Outline and Learning Objectives 2.1 Production Possibilities Frontiers and Opportunity Costs 2.2 Comparative Advantage and Trade 2.3 The Market System CHAPTER 2 CHAPTER Trade-offs, Comparative Advantage, and the Market System
ScarcityandTrade-offsHouseholds,firms and governments continuallyface decisionsabouthowbesttousetheirscarceresources.Scarcity: a situation in which unlimited wants exceed the limitedresourcesavailabletofulfillthosewants.Scarcity requires trade-offs. Economics teaches us tools to help makegood trade-offs.Example:When deciding how to use its scarce workers andmachinery,if Teslawantstoproduce more ModelXSuVs,thoseresourceswillnotbe availabletoproduceModelSsedans.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 2 Scarcity and Trade-offs Households, firms and governments continually face decisions about how best to use their scarce resources. Scarcity: a situation in which unlimited wants exceed the limited resources available to fulfill those wants. Scarcity requires trade-offs. Economics teaches us tools to help make good trade-offs. Example: When deciding how to use its scarce workers and machinery, if Tesla wants to produce more Model X SUVs, those resources will not be available to produce Model S sedans
ProductionPossibilitiesFrontiersandOpportunityCosts2.1LEARNINGOBJECTIVEUseaproductionpossibilitiesfrontierto analyze opportunitycostsandtradeoffs.@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 3 Production Possibilities Frontiers and Opportunity Costs 2.1 Use a production possibilities frontier to analyze opportunity costs and tradeoffs
ProductionPossibilitiesFrontierAproductionpossibilities frontier(PPF)is a curve showingthemaximum attainable combinations of two products that may bepurchases with available resources and current technologyQuestion:IsthePPFapositiveornormativetool?Answer: Positive: it shows "what is", not "what should be"@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 Production Possibilities Frontier A production possibilities frontier (PPF) is a curve showing the maximum attainable combinations of two products that may be purchases with available resources and current technology. Question: Is the PPF a positive or normative tool? Answer: Positive; it shows “what is”, not “what should be
A ProductionPossibilities Frontier for TeslaTesla'sProductionChoicesat ItsFremontPlantTesla can produce sedansChoiceQuantityofSedans ProducedQuantityofSUVsProduced80A0and/or SUVs.B6020C4040D2060If it wants to produce moreE080sedans,itmustreduce theQuantityofsedansnumber of SUvS.producedper dayAcombinationthatisunattainablewitt80current resources· Points on the PPF areTesla's productionpossibilities frontierattainable for TeslaGshowingitstrade-oft60between.producingsedansandSUVsPoints belowthecurveare40inefficient3020Pointsabovethecurveareunattainablewithcurrent80010204060QuantityofSUVsproduced per dayresources.Acombinationthat isinefficientbecausenotallresourcesarebeingusedFigure 2.1Tesla's productionpossibilitiesfrontier@2015PearsonEducation,Inc.5
© 2015 Pearson Education, Inc. 5 A Production Possibilities Frontier for Tesla Tesla can produce sedans and/or SUVs. If it wants to produce more sedans, it must reduce the number of SUVS. • Points on the PPF are attainable for Tesla. • Points below the curve are inefficient. • Points above the curve are unattainable with current resources. Tesla’s production possibilities frontier Figure 2.1
TeslaCanTradeOffSedansforSUVsTesla'sProductionChoicesat ItsFremontPlantToproduce20moreSUVsChoiceQuantityofSedans ProducedQuantityofSUVsProduced80A0(e.g. moving from A to B),B6020C4040Teslamustproduce20fewerD2060E080sedans.QuantityofsedansThe20fewer sedans istheproducedper dayAcombinationthatopportunity cost ofisunattainablewitt80currentresourcesTesla's productionproducing 20moreSUVspossibilitiesfrontierGshowingitstrade-off60between.producingsedansandSUVs40Opportunity cost:The3020highest-valued alternative thatmustbe given upto engage in80an activity.010204060QuantityofSUVsproduced per dayAcombinationthat isinefficientbecausenotallresourcesarebeingusedFigure 2.1Tesla's productionpossibilitiesfrontier@2015Pearson Education,Inc.6
© 2015 Pearson Education, Inc. 6 Tesla Can Trade Off Sedans for SUVs To produce 20 more SUVs (e.g. moving from A to B), Tesla must produce 20 fewer sedans. • The 20 fewer sedans is the opportunity cost of producing 20 more SUVs. Opportunity cost: The highest-valued alternative that must be given up to engage in an activity. Tesla’s production possibilities frontier Figure 2.1
IncreasingMarginal OpportunityCostsOn the previous slide,Increasingautomobileproductionby200here.opportunity costs wereTanksconstant..onlyreducestankproductionby50IncreasingautomobileBut opportunity costs areAproduction by200 here.400often increasingB350.reducestankproductionby150Why? Some resources are200bettersuitedtoonetaskthananother.The first resources to"switch"aretheonebest0200400500Automobilessuited to switchingFigure 2.2Increasing marginalopportunity costsThemore resourcesalready devotedto an activity,the smallerthe payoff to devoting additional resources to thatactivity@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 7 Increasing Marginal Opportunity Costs On the previous slide, opportunity costs were constant. But opportunity costs are often increasing. Why? Some resources are better suited to one task than another. The first resources to “switch” are the one best suited to switching. The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity. Increasing marginal opportunity costs Figure 2.2
EconomicGrowthonthePPFAs moreeconomic resourcesTanksbecome available,the500economycanmovefrompoint400A to point B, producing more300tanks and more automobiles200Shifts in the production0400450500625Automobilespossibilities frontier represent(a)Shiftingouttheproductionpossibilitiesfrontiereconomic growthFigure2.3aEconomicgrowthEconomic growth: the ability of the economyto increase theproductionofgoodsand services.@2015PearsonEducation,Inc8
© 2015 Pearson Education, Inc. 8 Economic Growth on the PPF As more economic resources become available, the economy can move from point A to point B, producing more tanks and more automobiles. Shifts in the production possibilities frontier represent economic growth. Economic growth: the ability of the economy to increase the production of goods and services. Figure 2.3a Economic growth
Technological Change inOne IndustryThis panel showsTankstechnological improvement inthe automobile industry400The quantity of tanks that canbeproducedremainsunchanged.500800QAutomobiles(b)Technological change in theautomobile industryAs in the previous slide, manypreviously unattainableFigure2.3bEconomicgrowthcombinations arenowattainable.O@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 9 Technological Change in One Industry This panel shows technological improvement in the automobile industry. The quantity of tanks that can be produced remains unchanged. As in the previous slide, many previously unattainable combinations are now attainable. Figure 2.3b Economic growth
MakingAPPFforExamGradestheConnectionSuppose you have a limited amount of time to study for twoexams, Economics and Accounting.What would the production possibilities curve for the examgradeslooklike?A straight line, like the PPF for sedans and SUVsorAbowed-outwardcurve,likethePPFfortanksandautomobiles?Why? The first hour spent studying Economicsis much more valuable than the lasthour...10@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 10 Making the Connection A PPF for Exam Grades Suppose you have a limited amount of time to study for two exams, Economics and Accounting. What would the production possibilities curve for the exam grades look like? A straight line, like the PPF for sedans and SUVs or A bowed-outward curve, like the PPF for tanks and automobiles? Why? The first hour spent studying Economics is much more valuable than the last hour