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Chapter 2

Chapter 2. Confronting Scarcity Choices in Production. Production Possibilities Curve. The Production Possibilities Curve is a graphical representation of the alternative combinations of goods and services an economy can produce

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Chapter 2

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  1. Chapter 2 Confronting Scarcity Choices in Production Hossain: MSMC

  2. Production Possibilities Curve • The Production Possibilities Curve is a graphical representation of the alternative combinations of goods and services an economy can produce • It describes opportunity costs and tradeoffs associated with production process Hossain: MSMC

  3. Production Possibilities Curve • To draw PPC or combination of goods an economy can produce, we need to make certain assumption • Available resource are fixed • Technology is fixed • All resources are employed • Resources are employed efficiently Hossain: MSMC

  4. Production Possibilities Curve Consider an economy with following production data: Hossain: MSMC

  5. PPC How is the O.C. of producing cars changing? Is the O.C. • Decreasing • Constant • Increasing NA 5 m 10 m 20 m 25 m 40 m Hossain: MSMC

  6. PPC Computer 100m 80m 60m 40m 20m 0 PPC Car 0 2m 4m 6m 8m 10m Hossain: MSMC

  7. PPC Computer 100m 80m 60m 40m 20m 0 PPC Car 0 2m 4m 6m 8m 10m Hossain: MSMC

  8. Consider Another Production Data Computer 100m 80m 60m 40m 20m 0 How is the O.C. changing? O.C. Remains Constant PPC O.C. 0f one car is one computer Car 0 20m 40m 60m 80m 100m Hossain: MSMC

  9. Increasing Opportunity Cost • Increasing O.C. best describes economic reality • Because, not all resources are perfectly substitutable to produce both products • When an economy produces more and more of one product (specializes in one), eventually the economy is forced to use resources that are: • Less adaptable to produce that product • More suitable to produce other products • Therefore, it must give up larger and larger amount of the other product to produce equal amounts of that product Hossain: MSMC

  10. The Law • Increasing O.C. best describes economic reality • This fact is universal enough that economists call it “The Law of Increasing O.C.” • Convex shaped PPC embodies the law of increasing O.C. • Therefore, a typical PPC often has a convex shape Hossain: MSMC

  11. The Law • The law is NOT just to say that all choice has an O.C. • Or “you must give up something in order to get something else” • It is a bit more than that • The law also says that not you must give up something, but also you must give up increasingly larger and larger quantities for equal gain in the product you specialize Hossain: MSMC

  12. Specialization and Trade Consider two economies with following production data: Hossain: MSMC

  13. PPC for USA Computer 100m 80m 60m 40m 20m 0 O.C. is Constant O.C. of 1 car = 2 comp. PPC Car O.C. of 1 comp = 1/2 car 0 10m 20m 30m 40m 50m Hossain: MSMC

  14. PPC for Canada Computer 100m 80m 60m 40m 20m 0 O.C. is Constant O.C. of 1 car = 3 comp. PPC Car O.C. of 1 comp. = 1/3 car 0 10m 20m 30m 40m 50m Hossain: MSMC

  15. Comparative Advantage • Economy with lower O.C. has Comparative Advantage over economy with higher O.C. • Which country has C.A. in Car production • Therefore, USA has C.A. in Car O.C. of 1 car = 2 comp. (USA) O.C. of 1 car = 3 comp. (Canada) Hossain: MSMC

  16. Comparative Advantage • Which country has C.A. in Computer production • Therefore, Canada has C.A. in Computer O.C. of 1 comp = 1/2 car O.C. of 1 comp. = 1/3 car Hossain: MSMC

  17. Law of Comparative Advantage • The law says economies with C.A. (or lower O.C.) should specialize in the product in which they have C.A. • If they do so, and exchange they both can do better than they can do by themselves Hossain: MSMC

  18. Law of Comparative Advantage • According to the law of C.A. • USA should specialize in CARs • Canada should specialize in Computers • If they do so, • USA will have 30 m CARs • Canada will have 45 m Computers • Note, USA can produce both products individually more than Canada • Still Specialization and Trade can be beneficial for both countries including USA Hossain: MSMC

  19. Law of Comparative Advantage • Assume that USA wants Choice C, which include both Cars and Computers • Specifically, Choice C has: • 20 m Cars and 20 m Computers • To achieve choice C, • USA must keep 20 m cars for themselves and • Trade remaining 10m Cars for Computers with Canada Hossain: MSMC

  20. Law of Comparative Advantage • How many CARs USA must demand from Canada • Well USA must demand minimum of 20 m Computers • Less than 20m computers will be unacceptable. • Because USA can produce it by giving up 10m CARS all by themselves (See production Data) • In fact, USA would like to get more than 20m computers Hossain: MSMC

  21. Law of Comparative Advantage • Now let look at Canada’s perspective. How many Computers would Canada be willing to give up in trade for 10m CARS? • Looking at Canada’s production table, we see that it must give up 30m computers to to produce 10m CARs by themselves • Therefore, Canada’s maximum willingness to give up is 30m Computers • This suggests there is an opportunity for mutually beneficial trade Hossain: MSMC

  22. Law of Comparative Advantage • Note, for 10 m Cars, • USA’s minimum Demand is 20 m Computers • Canada’s Maximum willingness to give up is 30 m Computers • Therefore, any number between 20m and 30m will be mutually beneficial • Lets assume it is • 25 m computers for 10m Cars Hossain: MSMC

  23. Law of Comparative Advantage • At this rate of exchange, • USA’s after trade consumption bundle will be, • 20m CARs and 25m COMPUTERS • A far better than their Choice C (20m, 20m) • Canada’s after trade consumption bundle will be • 10m CARS and 20m COMPUTERS • A far better than their Choice C (10m, 15m) • What explains this mutual benefit • Each country is exploiting their respective efficiencies or C.A. Hossain: MSMC

  24. Sources of Economic Growth Hossain: MSMC

  25. A comparison of Economic systems • Market capitalist economy Economy in which resources are generally owned by private individuals who have the power to make decisions about their use. • Command socialist economy (centrally planned) Economy in which government is the primary owner of capital and natural resources and has broad power to allocate the use of factors of production. • Mixed economy Economy that combines elements of market capitalist and command socialist economic systems. Hossain: MSMC

  26. A comparison of Economic systems Hossain: MSMC

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