AP Macroeconomics Unit 1.2 & 1.3 - Opportunity Cost and the Production Possibilities Curve & Comparative Advantage and Gains from Trade

Unit 1.2

What is the Production Possibilities Curve?

Production Possibilities Curve (PPC): model that shows alternative ways that an economy can use scarce resources

• The line on a PPC indicates possibility:
  • Anything that’s outside the curve is unattainable
  • Anything under the curve indicates something that isn’t maximum achievement/production (inefficient)
  • When the line on a PPC moves right, it is good
  • When the line on a PPC moves left, it is bad

What are the four key assumptions of the PPC?

1. Only two goods can be produced
2. There is full employment of resources
3. There is fixed technology
4. There are fixed resources (ceteris paribus)

What does constant opportunity cost look like on a PPC graph?

• A constant slope

With increasing opportunity cost…

• As more of a particular product is produced, the opportunity cost (in terms of what must be given up of other goods) increases.

What are the three PPC shifters?

1. Changes in Resources
2. Changes in Technology
3. Changes in Trade

Relationship between Capital Goods and Future Growth:

• Countries that produce more capital goods are investing in the future and will experience more growth.
  • Capital goods: goods that make more goods
  • Growth is an outward shift of the PPC

Unit 1.3

Why do people trade?

• It’s impossible to do everything yourself
• Everyone should specialize in the production of goods and services and then trade with others

Absolute Advantage vs Comparative Advantage:

Absolute Advantage: the producer who produces more output has this advantage

Comparative Advantage: the producer with the lowest opportunity cost (or the least amount of input [resources] ) has this advantage

Specialization and Trade:

Countries should trade if they have a higher opportunity cost

Countries should specialize in the good that is costing them less resources/time to produce