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© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
c h a p t e r
t w o
Prepared by: Fernando & Yvonn Quijano
Trade-Offs, Comparative Advantage,
and the Market System
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
2 of 21
After studying this
chapter, you
should be able to:
Use a production
possibilities frontier to
analyze opportunity
cost and trade-offs.
Understand
comparative
advantage and explain
how it is the basis for
trade.
Explain the basic idea
of how a market
system works.
Managers Making Choices at BMW
LEARNING
OBJECTIVES
1
2
3
… Over the years, BMW’s
managers have faced
strategic as well as tactical
business decisions...
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
3 of 21
Production Possibilities Frontiers and Real-world Trade-offs
LEARNING OBJECTIVE
1
Scarcity The situation in which unlimited wants
exceed the limited resources available to fulfill
those wants.
Production possibilities frontier A curve
showing all the attainable combinations of two
products that may be produced with available
resources.
Opportunity Cost The highest-valued
alternative that must be given up in order to
engage in an activity.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
4 of 21
Production Possibilities Frontiers and Real-world Trade-offs
Graphing the Production Possibilities Frontier
2 - 1
BMW’s Production Possibilities
Frontier
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
5 of 21
Drawing a Production
Possibilities Frontier for
Rosie’s Boston Bakery
2 - 1
LEARNING OBJECTIVE
1
Hours Spent Making Quantity Made
Choice Cakes Pies Cakes Pies
A 5 0 5 0
B 4 1 4 2
C 3 2 3 4
D 2 3 2 6
E 1 4 1 8
F 0 5 0 10
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
6 of 21
Production Possibilities Frontiers and Real-world Trade-offs
Increasing Marginal Opportunity Costs
2 - 2
As the economy moves down the
production possibilities frontier, it
experiences increasing marginal
opportunity costs because increasing
automobile production by a given
quantity requires larger and larger
decreases in aircraft carrier
production.
More funds for tsunami
relief meant less funds for
other charities.
Trade-offs and Tsunami Relief
2 - 1
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
7 of 21
Production Possibilities Frontiers and Real-world Trade-offs
Economic Growth
Economic Growth The ability of
the economy to produce increasing
quantities of goods and services.
2 - 3
Economic Growth
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
8 of 21
Trade
LEARNING OBJECTIVE
2
Trade The act of buying or
selling.
Specialization and Gains from Trade
2 - 4
Production Possibilities for You
and Your Neighbor, Without Trade
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
9 of 21
Trade
Specialization and Gains from Trade
2 - 5
Gains from Trade
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
10 of 21
Trade
Specialization and Gains from Trade
A Summary of the Gains from Trade
2 – 1
YOU YOUR NEIGHBOR
Apples
(in pounds)
Cherries
(in pounds)
Apples
(in pounds)
Cherries
(in pounds)
Production and
consumption without trade
8 12 9 42
Production with trade 20 0 0 60
Consumption with trade 10 15 10 45
Gains from trade
(increased consumption)
2 3 1 3
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
11 of 21
Trade
Absolute Advantage Versus Comparative Advantage
Absolute advantage The ability of an individual, firm, or
country to produce more of a good or service than competitors using
the same amount of resources.
Comparative advantage The ability of an individual, firm, or
country to produce a good or service at a lower opportunity cost than
other producers.
Opportunity cost of
picking 1 pound of apples
Opportunity cost of picking
1 pound of cherries
You 1 pound of cherries 1 pound of apples
Your neighbor 2 pounds of cherries .5 pound of apples
Don’t Confuse Absolute Advantage and Comparative Advantage
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
12 of 21
Trade
Comparative Advantage and the Gains from Trade
The basis for trade is comparative advantage,
not absolute advantage.
A country has a comparative advantage in the
production of the good for which it has a lower
opportunity cost.
To enjoy the gains from trade, a country should
specialize in the production of the good for
which it has a comparative advantage.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
13 of 21
Comparative Advantage and the Gains from Trade
2 - 2
LEARNING OBJECTIVE
2
CANADA UNITED STATES
Honey
(in tons)
Maple syrup
(in tons)
Honey
(in tons)
Maple syrup
(in tons)
0 60 0 50
10 45 10 40
20 30 20 30
30 15 30 20
40 0 40 10
50 0
BEFORE TRADE AFTER TRADE
Honey
(in tons)
Maple
syrup
(in tons)
Honey
(in tons)
Maple
syrup
(in tons)
Canada 30 15 30 20
United
States 10 40 20 40
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
14 of 21
The Market System
LEARNING OBJECTIVE
3
Market A group of buyers and sellers of a good
or service and the institution or arrangement by
which they come together to trade.
Product Markets Markets for good—such as
computers—and services—such as medical
treatment.
Factor markets Markets for the factors of
production, such as labor, capital, natural
resources, and entrepreneurial ability.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
15 of 21
The Market System
The Circular-Flow Diagram
2 - 6
The Circular-Flow Diagram
Households and
firms are linked
together in a
circular flow of
production, income,
and spending.
Circular-flow diagram
A model that illustrates
how participants in
markets are linked.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
16 of 21
The Market System
The Circular Flow Diagram
Two key groups participate in markets:
 A household is all the individuals in a
home.
 Firms are suppliers of goods and
services.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
17 of 21
The Market System
The Gains from Free Markets
Free market A market with few government
restrictions on how a good or service can be
produced or sold, or on how a factor of production
can be employed.
The Market Mechanism
Individuals usually act in a rational, self-interested
way. Adam Smith understood that people’s motives
can be complex.
In a famous phrase, Smith said that firms would be
led by the “invisible hand” of the market to provide
consumers with what they wanted.
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
18 of 21
The Market System
The Role of the Entrepreneur
Entrepreneur Someone who operates a business,
bringing together the factors of production—labor,
capital, and natural resources—in order to produce
goods and services.
The market coordinates the
activities of the many people
spread around the world who
contribute to the making of a
pencil.
Story of the Market System in Action: “I, Pencil”
2 - 2
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
19 of 21
The Market System
The Legal Basis of a Successful Market System
Property rights The rights individuals or firms
have to the exclusive use of their property,
including the right to buy or sell it.
PROTECTION OF PRIVATE PROPERTY
Metallica sued to stop
copyright infringement of
their songs on the Internet.
Property Right in Cyberspace: Napster, Kazaa, iTunes
2 - 3
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
20 of 21
BMW’s Net Profit Rises 2.5% as New Models Benefit Sales
© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed.
CHAPTER
2:
Trade-Offs,
Comparative
Advantage,
and
the
Market
System
21 of 21
Absolute advantage
Circular-flow diagram
Comparative advantage
Economic growth
Entrepreneur
Factor markets
Market
Opportunity cost
Production possibilities frontier
Product markets
Property rights
Scarcity
Trade

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hubbard01_instructorppt02.ppt comparativ

  • 1. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. c h a p t e r t w o Prepared by: Fernando & Yvonn Quijano Trade-Offs, Comparative Advantage, and the Market System
  • 2. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 2 of 21 After studying this chapter, you should be able to: Use a production possibilities frontier to analyze opportunity cost and trade-offs. Understand comparative advantage and explain how it is the basis for trade. Explain the basic idea of how a market system works. Managers Making Choices at BMW LEARNING OBJECTIVES 1 2 3 … Over the years, BMW’s managers have faced strategic as well as tactical business decisions...
  • 3. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 3 of 21 Production Possibilities Frontiers and Real-world Trade-offs LEARNING OBJECTIVE 1 Scarcity The situation in which unlimited wants exceed the limited resources available to fulfill those wants. Production possibilities frontier A curve showing all the attainable combinations of two products that may be produced with available resources. Opportunity Cost The highest-valued alternative that must be given up in order to engage in an activity.
  • 4. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 4 of 21 Production Possibilities Frontiers and Real-world Trade-offs Graphing the Production Possibilities Frontier 2 - 1 BMW’s Production Possibilities Frontier
  • 5. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 5 of 21 Drawing a Production Possibilities Frontier for Rosie’s Boston Bakery 2 - 1 LEARNING OBJECTIVE 1 Hours Spent Making Quantity Made Choice Cakes Pies Cakes Pies A 5 0 5 0 B 4 1 4 2 C 3 2 3 4 D 2 3 2 6 E 1 4 1 8 F 0 5 0 10
  • 6. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 6 of 21 Production Possibilities Frontiers and Real-world Trade-offs Increasing Marginal Opportunity Costs 2 - 2 As the economy moves down the production possibilities frontier, it experiences increasing marginal opportunity costs because increasing automobile production by a given quantity requires larger and larger decreases in aircraft carrier production. More funds for tsunami relief meant less funds for other charities. Trade-offs and Tsunami Relief 2 - 1
  • 7. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 7 of 21 Production Possibilities Frontiers and Real-world Trade-offs Economic Growth Economic Growth The ability of the economy to produce increasing quantities of goods and services. 2 - 3 Economic Growth
  • 8. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 8 of 21 Trade LEARNING OBJECTIVE 2 Trade The act of buying or selling. Specialization and Gains from Trade 2 - 4 Production Possibilities for You and Your Neighbor, Without Trade
  • 9. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 9 of 21 Trade Specialization and Gains from Trade 2 - 5 Gains from Trade
  • 10. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 10 of 21 Trade Specialization and Gains from Trade A Summary of the Gains from Trade 2 – 1 YOU YOUR NEIGHBOR Apples (in pounds) Cherries (in pounds) Apples (in pounds) Cherries (in pounds) Production and consumption without trade 8 12 9 42 Production with trade 20 0 0 60 Consumption with trade 10 15 10 45 Gains from trade (increased consumption) 2 3 1 3
  • 11. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 11 of 21 Trade Absolute Advantage Versus Comparative Advantage Absolute advantage The ability of an individual, firm, or country to produce more of a good or service than competitors using the same amount of resources. Comparative advantage The ability of an individual, firm, or country to produce a good or service at a lower opportunity cost than other producers. Opportunity cost of picking 1 pound of apples Opportunity cost of picking 1 pound of cherries You 1 pound of cherries 1 pound of apples Your neighbor 2 pounds of cherries .5 pound of apples Don’t Confuse Absolute Advantage and Comparative Advantage
  • 12. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 12 of 21 Trade Comparative Advantage and the Gains from Trade The basis for trade is comparative advantage, not absolute advantage. A country has a comparative advantage in the production of the good for which it has a lower opportunity cost. To enjoy the gains from trade, a country should specialize in the production of the good for which it has a comparative advantage.
  • 13. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 13 of 21 Comparative Advantage and the Gains from Trade 2 - 2 LEARNING OBJECTIVE 2 CANADA UNITED STATES Honey (in tons) Maple syrup (in tons) Honey (in tons) Maple syrup (in tons) 0 60 0 50 10 45 10 40 20 30 20 30 30 15 30 20 40 0 40 10 50 0 BEFORE TRADE AFTER TRADE Honey (in tons) Maple syrup (in tons) Honey (in tons) Maple syrup (in tons) Canada 30 15 30 20 United States 10 40 20 40
  • 14. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 14 of 21 The Market System LEARNING OBJECTIVE 3 Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. Product Markets Markets for good—such as computers—and services—such as medical treatment. Factor markets Markets for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability.
  • 15. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 15 of 21 The Market System The Circular-Flow Diagram 2 - 6 The Circular-Flow Diagram Households and firms are linked together in a circular flow of production, income, and spending. Circular-flow diagram A model that illustrates how participants in markets are linked.
  • 16. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 16 of 21 The Market System The Circular Flow Diagram Two key groups participate in markets:  A household is all the individuals in a home.  Firms are suppliers of goods and services.
  • 17. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 17 of 21 The Market System The Gains from Free Markets Free market A market with few government restrictions on how a good or service can be produced or sold, or on how a factor of production can be employed. The Market Mechanism Individuals usually act in a rational, self-interested way. Adam Smith understood that people’s motives can be complex. In a famous phrase, Smith said that firms would be led by the “invisible hand” of the market to provide consumers with what they wanted.
  • 18. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 18 of 21 The Market System The Role of the Entrepreneur Entrepreneur Someone who operates a business, bringing together the factors of production—labor, capital, and natural resources—in order to produce goods and services. The market coordinates the activities of the many people spread around the world who contribute to the making of a pencil. Story of the Market System in Action: “I, Pencil” 2 - 2
  • 19. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 19 of 21 The Market System The Legal Basis of a Successful Market System Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. PROTECTION OF PRIVATE PROPERTY Metallica sued to stop copyright infringement of their songs on the Internet. Property Right in Cyberspace: Napster, Kazaa, iTunes 2 - 3
  • 20. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 20 of 21 BMW’s Net Profit Rises 2.5% as New Models Benefit Sales
  • 21. © 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1st ed. CHAPTER 2: Trade-Offs, Comparative Advantage, and the Market System 21 of 21 Absolute advantage Circular-flow diagram Comparative advantage Economic growth Entrepreneur Factor markets Market Opportunity cost Production possibilities frontier Product markets Property rights Scarcity Trade