Transcript Chapter 2

CHAPTER 2
ECONOMIC MODELS:
TRADE-OFFS AND TRADE
Welcome to ECON 2301
Principles of Macroeconomics
Dr. Frank Jacobson
Mr. Stuckey
Week 2 Class 2
Today

Chapter 2
Production Possibilities
Frontier
 Slopes of Curves

CHAPTER 2
ECONOMIC MODELS:
TRADE-OFFS AND TRADE
Industrial Development
America’s Population




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1789
1812
1835
1858
1915
1968
2007
4 million people
8 million people
16 million people
32 million people
100 million
200 million
Estimate of 300 million
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
1-14
Production Possibilities
Frontier
A Graph That Shows the
Combinations of Output that
the Economy Can Possibly
Produce Given the Available
Factors of Production and the
Available Production
Technology.
Production Possibilities
Frontier
ILLISTRATES AN ECONOMY’S
TRADE-OFF OF PRODUCING ONE
ITEM OR PRODUCT OVER
ANOTHER
The Production
Possibilities Curve

Represents our economy
at:
Full employment
 Full production

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-20
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
F
0
1
2
3
4
5
6
Units of guns
This Production Possibilities Curve shows the range of possible
combinations of guns and butter extending from 15 units of butter and no
guns at point A to 5 units of guns and no butter at point F
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-21
Had to give up 1 unit of butter
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
In this particular instance, the opportunity cost
of gaining one unit of guns was one unit of
butter
F
0
1
2
3
4
5
6
Units of guns
To gain 1 unit of Guns
When you are on the curve, to get more of one thing you have to give up
some of the other thing
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-22
Had to give up 2 units of butter
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
In this particular instance, the opportunity cost
of gaining one unit of guns was two units of
butter
F
0
1
2
3
4
5
6
Units of guns
To gain 1 unit of Guns
When you are on the curve, to get more of one thing you have to give up
some of the other thing
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-23
Had to give up 3 units of butter
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
In this particular instance, the opportunity cost
of gaining one unit of guns was three units of
butter
F
0
1
2
3
4
5
6
Units of guns
To gain 1 unit of Guns
When you are on the curve, to get more of one thing you have to give up
some of the other thing
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-24
Had to give up 4 units of butter
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
In this particular instance, the opportunity cost
of gaining one unit of guns was four units of
butter
F
0
1
2
3
4
5
6
Units of guns
To gain 1 unit of Guns
When you are on the curve, to get more of one thing you have to give up
some of the other thing
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-25
Had to give up 5 units of butter
Production Possibilities Curve
16
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
In this particular instance, the opportunity cost
of gaining one unit of guns was five units of
butter
F
0
1
2
3
4
5
6
Units of guns
To gain 1 unit of Guns
When you are on the curve, to get more of one thing you have to give up
some of the other thing
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-26
As we shift from butter to guns, we have to give Production Possibilities Curve
up increasing units of butter for each additional
16
unit of guns
A
B
14
Hypothetical Production Schedule
Point
Units of Butter Units of Guns
A
15
0
B
14
1
C
12
2
D
9
3
E
5
4
F
0
5
C
12
10
D
8
6
E
4
2
This is known as the “law of increasing cost.”
As the output of one good expands, the
opportunity cost of producing additional
units of this good increases.
F
0
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
1
2
3
4
5
6
Units of guns
2-27
When you are on the curve, to get more of one thing you have to give up
some of the other thing
If you were at point G, it would be possible to move to point D or any
other point on the line (PPF) and get more butter and more guns
When you are at a point that is inside the line (PPF) it is possible to get
more of both
16
A
B
14
C
12
10
D
8
6
G
E
4
2
F
0
1
2
3
4
5
6
Units of guns
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-28
Points Inside and Outside the Production Possibilities Curve Frontier
Point W represents
output at more than full
employment and full
production and is
currently unattainable
16
14
A
B
W
C
12
10
Where we usually are
A Recession
A Depression
D
X
8
Y
6
E
Z
4
2
F
0
1
2
3
4
Units of guns
5
6
Every point on the curve represents output at Full Employment and Full
Production
Every point inside the curve represents output at less than Full employment
and less than Full Production
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-29
Productive Efficiency

Is attained when the maximum
possible output of one good is
produced, given the output of
other goods
Productive efficiency occurs only
when we are operating on the
production possibilities curve
 Productivity efficiency means that the
output of one good cannot be
attained with out reducing the output
of some other good
2-30
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth
Best available technology
 Expansion of labor


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More or better trained
labor
Expansion of capital

More or improved plant
and equipment
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-31
Production Possibilities Curves
15
PPC 3
PPC 2
10
PPC 1
5
0
5
10
15
Units of guns
A move from PPC1 to PPC2 to PPC3 represents economic growth
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-32
Production Possibilities Curves Over
Time
Country B
Country A
A.
B.
25
25
20
20
15
15
PPC 2001
10
PPC 2001
10
B
5
0
PPC 1991
PPC 1991
5
A
5
10
Units of consumer goods
15
Country A represents slower
economic growth than Country B
Country A capital goods is 3.8 units
0
5
10
Units of consumer goods
15
Country B represents much faster
economic growth than Country A
Country B capital goods is 7.0 units
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-33
The Production Possibilities
Frontier during World War II
Copyright 2008 by Th`e McGraw-Hill Companies, Inc. All rights reserved.
2-34
Slope of a Line or Curve
The Slope of a Line or Curve is a
Measure of How Steep it is.
The Slope of a Line is Measured by
“Rise Over Run” The Change of the “y”
Variable (Vertical) Between Two Points
Divided By the Change in the “X”
Variable (Horizontal) Between Two
Points.
Figure A.3
Elastic Demand Curve



A Completely Elastic Demand Curve is
“Almost” Completely Flat.
“Flat” Meaning Horizontal.
An “Elastic” Demand Curve Means for a
Small Change in Price a Very Large
Quantity is Demanded.
Inelastic Demand Curve
A Completely Inelastic Demand
Curve is “Almost” Completely
Vertical.
 An “Inelastic” Demand Curve
Means That Regardless the
Price, The Quantity Demanded
Remains The Same.

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
2-36
Barter
Barter is Simply an Exchange of Goods,
Services, or Goods for Services. Money
is Not Involved. There is Also Almost
no Way to Identify or Know How Much
of it is Going on Within an Economy. It
is Usually Higher in Underdeveloped
Countries or When the Economy is Bad.
Circular-Flow Diagram
Represents The Transactions That Take
Place in an Economy by Two Kinds of
Flows Around a Circle: Flows of Physical
Things Such as Goods , Services, and
Raw Materials in one Direction, and
Flows of Money in the Opposite
Direction That Pay for These Physical
Things.
Circular-Flow Diagram
Revenue (=GDP)
Goods and
Markets For Goods
and Services
Spending
(= GDP)
Goods and
Services Sold
Services Bought
Firms
= Flow of Inputs and Outputs
= Flow of Dollars
Factors of
Production
Wages, Rent and
Profit (=GDP)
Households
Land, Labor
And Capital
Markets For Factors
of Production
Income (=GDP)
Comparative Advantage
A Country Has a Comparative
Advantage in Producing a Good
or Service if its Opportunity
Cost is Lower Than Other
Countries.
Absolute Advantage
A Country Has an Absolute
Advantage in Producing a
Good or Service if The
Country Can Produce More
Output Per Worker Than
Other Countries.
Questions
?