Production Possibilities Absolute and Comparative Advantage

1. Production PossibilitiesAbsolute and Comparative Advantage

2. Macro Production Possibilities • Macro Economists graph the trade-off between a society’s present consumption and investment. • Societies which have large investments in capital goods, forego present consumption for larger future growth. • Societies which have larger current consumption and smaller amounts of investments have smaller future growth.

3. Points off the curve • If a point is inside the production possibilities curve then resources are not being used efficiently. A business or society is not making full utilization of its resources. • A point outside the production possibilities curve is unattainable in the short run, since resources are not sufficient to support this level of production. Increased technology and efficiency may make it possible in the future.

4. Curving vs.. Straight Production Possibility Curves • Why do most production possibility curves actually curve? • The main reason is increasing costs associated with moving to higher levels of a certain choice. • When moving resources between two options is not completely efficient, there is the straight line curves or bows.

5. Production Possibility Frontiers • These main shift in or out depending on two factors: • 1. Changes in the amount of productive resources in an economy (e.g increases or decreases in land, labor, or capital) • 2. Changes in technology and productivity

6. Adam Smith and the Division of Labor • Adam Smith is the father of classical economics. • In his book The Wealth of Nations he argued that the division of labor was key to creating a wealthy society. • He also believed in free trade. He argued nations benefited by specializing in producing goods and trading for those items that they were less efficient in producing.

7. Smith continued • Smith also believed that government should leave business alone. This is the concept of laissez faire. • He believed that each person pursuing his or her self interest would lead to a richer society, and one with social harmony.

8. Absolute Advantage • Economists look at the amount of labor hours that it takes to produce a product. • A society which can produce an equal amount of a product with fewer resources has absolute advantageover another nation. • Absolute advantage may be the result of superior natural resources, a more efficient labor force, or advanced technology, allowing a nation to produce a product with fewer labor hours.

9. David Ricardo and Comparative Advantage • Economists David Ricardo asked the question, why should nations with absolute advantage trade at all, if they can produce many goods more efficiently than other nations? • His theory of comparative advantage showed that even nations with absolute advantage benefited from trade. • Both nations would benefit from trade if they specialized in producing items in which they had the lowest opportunity costs.

10. Responding to the theory • What do you think of Ricardo’s argument that nations should specialize and trade for maximum efficiency? • Which groups within a country might oppose the argument for specialization and free trade? • How might less economically developed nations benefit or be hurt by this theory?