1) PPF, Comparative Advantage and Trade

what is the PPF

production possibilities frontier

Shows the combinations of good production in which available resources and technology are maximized

opportunity cost

the opportunity cost of one choice is the forgone value of the next best alternative

formula for opportunity cost for choosing a specific activity

opportunity cost = monetary cost of chosen activity + net benefit of next best alternative

(net benefit = value received - monetary cost)

Efficient combinations are located (graphically)

on PPF

Attainable, but inefficient combinations are located (graphically)

inside PPF

Not attainable combinations are located (graphically

outside PPF

points on PPF are (efficient/inefficient/neither) and (attainable/unattainable)

efficient & attainable

points inside PPF are (efficient/inefficient/neither) and (attainable/unattainable)

inefficient but also attainable

points outside PPF are (efficient/inefficient/neither) and (attainable/unattainable)

neither because they are unattainable

the opportunity cost can be determined graphically by

the slope of the PPF (absolute value)

What graphically represents economic growth

shift of the PPF out

What might cause the PPF to shift out

economic growth (ie. resources increase or technology improves)

absolute advantage

an individual has an absolute advantage in an activity if he or she can produce more in the same amount of time, with the same resources.

assuming all people in the same chart are provided the same time and resources, the individual with the absolute advantage is he or she who produces a greater absolute number.

Can there be gains from trade even if one party doesn't have an absolute advantage in anything?

Yes, if each individual specializes in the activity for which he/she has a comparative advantage (can perform the activity at a lower opportunity cost)

comparative advantage

an individual has a comparative advantage if he/she can produce at a lower opportunity cost than others

Joint PPF

- what is it

- what does it look like

the curve maximizing the capabilities of both individuals

3 points:

- (y axis intercept) both specialize in producing y and produce zero x

- (x axis intercept) both specialize in producing x and produce zero y

- (kink) each specializes in the good where he has a comparative advantage

"low hanging fruit principle"

both specialize in on thing, except one split his/her time between both

Law of increasing opportunity cost

as you continue to increase production of one good, the opportunity cost of producing that next unit increases (may be observed)

determining the terms of trade in which both people benefit

Each want to get/give the slope of their PPF line

ex. Tom wants to get 3/4 coconuts for every fish caught (because he specializes in fish)

Hank wants to give up no more than 2 coconuts for every fish he receives from Tom

both benefit from trade so long as they exchange each fish for at least .75 coconuts and at most 2 coconuts