Choice, Specialization and Trade Chapter 2
Chapter 2. What you give up to do something else. What you do not do when you choose to do something else. The economic value of your next-best.
Dec 26, 2015
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Choice, Specialization and Trade
Chapter 2
Opportunity Costs What you give up to do something else.
What you do not do when you choose to do something else.
The economic value of your next-best alternative
May be non-financial
Chapter 2 2
Direct & Opportunity Costs Direct Costs
$ that leaves your pocket
Tuition Books Gas
Opportunity Costs $ that doesn’t go into
your pocket
Wages Quality time TV
Chapter 2 3
Production Possibilities The different combinations of final goods and
services that could be produced in a given period of time with all available resources and technology.
Each point on the production possibilities curve depicts an alternative mix of output.
Chapter 2 4
Production Possibilities
Production possibilities illustrates two essential principles. Scarce resources Opportunity Costs
Chapter 2 5
Production PossibilitiesAwake Asleep
Chapter 2 6
The Production Possibilities Curve
Awake
24
20
16
12
8
4
4 8 12 16 20 24 Asleep
Chapter 2 7
Production PossibilitiesCorn Wheat
50040032026019013070200
03070
120180260360700
1000
Chapter 2 8
The Production Possibilities Curve
Wheat
1000
500 Corn
Chapter 2 9
The Production Possibilities Curve
Goods
$10T
$12T Services
Chapter 2 10
$4T
$10T
Your Back Yard 10 Acres
You can grow tomatoes or watermelon
Chapter 2 11
Your Back Yard
Tomatoes
10
5
5 10 Watermelon
Chapter 2 12
BA
C
Production Efficiency
A. On the curve - efficient B. Inside – inefficient
not using all available resources C. Outside the curve - impossible
Chapter 2 13
Economic Growth An outward shift in the Production
Possibilities curve you can & do produce more than before.
Chapter 2 14
Comparative Advantage
The ability to produce a good or service at a lower opportunity cost than someone else.
Chapter 2 15
Absolute Advantage
The ability to produce a good or service at a lower opportunity cost than everyone else.
Chapter 2 16
Comparisons: Hours to complete
Sink Repairs Tax Filing
Ashley 2 hrs. 8
Barry 8 1
Chapter 2 17
Daily Productivity
Sink repairs4
3
2
1
1 2 3 4 5 6 7 8 . Tax Filings
Chapter 2 18
Ashley
Barry
Comparative Advantages Ashley has the comparative advantage for sink
repairs. Ashley only has to give up doing ¼ of a return in order
to fix a sink, where Barry would have to give up doing 8. Barry has the comparative advantage in filing
taxes. Barry only has to give up 1/8 of a sink repair to do a tax
return. Ashley has to give up taking 4 sink repair jobs to do her taxes.
Chapter 2 19
Comparative Advantages Ashley has the comparative advantage
for sink repairs. Barry has the comparative advantage in
filing taxes.
Ashley charges $100 to fix a sink Barry charges $200 to do a tax return
Chapter 2 20
Opportunity Costs For Ashley to do her own taxes, she would
give up the opportunity to fix 4 sinks. She would give up $400 of sink jobs to keep from
paying $200 to Barry Barry would have to give up 8 tax jobs to
take the time to fix his sink. He would give up $1,600 of tax jobs to avoid
paying Ashley $100Chapter 2 21
What Should They Do? Ashley should let Barry file her taxes Barry should call Ashley for all his plumbing
needs
Even if it isn’t about the money instead of spending 8 hours doing her taxes, Ashley
could spend 2 hours repairing a sink to make more-than-enough money to pay Barry, then take the rest of the day off!
Chapter 2 22
Absolute Advantage
Cathy can do a tax return in 30 minutes, and a sink repair in 15 minutes.
She is faster than both people, for both jobs.
Chapter 2 23
Comparative Advantage For sinks:
Ashley has the comparative advantage over Cathy. Cathy has the comparative advantage over Barry.
For Taxes: Barry has the comparative advantage over
Cathy. Cathy has the comparative advantage over Ashley.
Chapter 2 24
NOT an Absolute Advantage Although faster at both jobs, Cathy
does not have an absolute advantage in either job! Cathy has to give up 2 sinks to do a tax
return. Barry only has to give up 1/8 of a sink Cathy has to give up ½ of a tax return to fix
a sink, but Ashley only has to give up ¼ of a tax return.Chapter 2 25
Absolute Advantage If Ashley, Barry, & Cathy were the only 3
people in town:
Ashley has the absolute advantage in sinks Nobody gives up less than her
Barry has the absolute advantage in taxes Nobody gives up less than him
Chapter 2 26
NOT an Absolute Advantage Cathy can do Both faster than everybody. She
can make more money than either. This is a good thing, even if it isn’t “absolute advantage”
Which should she do for a living? 16 taxes @ $200 = $3,200/day 32 sinks @ $100 = $3,200/day Which makes her happier?
Chapter 2 27
A Different Scenario
Some people find themselves washed ashore on a pacific island…
Chapter 2 28
Our Island Friends 10 Acres Can only grow coconuts & bananas Can only get 1 tree per acre
Chapter 2 29
Our Island FriendsCoconuts
10
5
5 10 Bananas
Chapter 2 30
Their Neighbors 10 Acres Can only grow coconuts & bananas They need 1 acre for each coconut tree,
or 2 acres for each banana tree they plant
Chapter 2 31
Their NeighborsCoconuts
10
5
5 10 Bananas
Chapter 2 32
4
3
Before Trade Our Friends:
Plant: 5 bananas & 5 coconuts Eat: 5 bananas & 5 coconuts
The Neighbors Plant: 3 bananas & 4 coconuts Eat: 3 bananas & 4 coconuts
Chapter 2 33
After Trade (Perhaps?)
Our Friends: Plant: 10 bananas Eat: 5 bananas & 5 coconuts Or: 6 bananas & 6 coconuts, or 6 bananas & 5 coconuts…
The Neighbors Plant: 10 coconuts Eat: 5 bananas & 5 coconuts Or: 4 bananas & 4 coconuts, or 4 bananas & 5 coconuts…
▪ Depends on how they negotiateChapter 2 34
Total Production Before Trade:
8 bananas & 9 coconuts
After Specialization & Trade: 10 bananas & 10 coconuts
Using the same 20 total acres!Chapter 2 35
Benefits of Trade Lower Prices More of each product More choice Easier work situation World peace More Efficient Better for the environment
Chapter 2 36
Costs of Trade Loss of jobs Possible loss of money if not fair Dependency on someone else Threat to national security?
Chapter 2 37
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