The document discusses production possibility frontiers and opportunity costs. It explains that a production possibility frontier shows the maximum combinations of goods that can be produced with available resources, and has a negative slope indicating more of one good requires less of another. Specialization and trade allow countries to produce goods where they have a comparative advantage, lowering overall opportunity costs. Households can also benefit from specialization between partners based on their comparative advantages in home versus market production.

1. Microeconomics
Third Edition
Chapter 2
Economic Models: Trade-offs and Trade
Copyright © 2013 by Worth Publishers
Paul Krugman and Robin Wells

2. 1.
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The production-possibility frontier
shows combinations of goods that can be produced with available
resources (labor, machinery, etc.)
simple model of production with two goods – guns and butter: if we
produce 50 guns as efficiently as possible, then,
with the workers, machines, etc., that are left, how much butter can
we make
(…and repeat for all other levels of gun/butter production)
shows outer limits of what can be produced, using available
resources as efficiently as possible;
negative slope shows that more of one good must mean less of the
other good(s) – opportunity cost!
shows that to have more of something, must make tradeoffs
at points inside the frontier, some inputs are unemployed or are not
being used efficiently;
points outside the frontier aren’t feasible (require more inputs than
are available)
as quantity of inputs grows over time, frontier will shift out could being
inside the frontier permanently shift it in?

3. 6.
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The production-possibility frontier (continued)
P-P frontier only tells us what options are available, not which option
is the right one to choose
Differences in the p-p frontiers of different countries mean that the
countries have different opportunity costs of producing the
same goods –
so a country can gain by specializing and trading – produce the good
whose opportunity cost is low,
trade it for the good it can only produce at higher opportunity cost
(which some other country will produce)
e.g., England has lower opportunity cost of cloth production, Portugal
has lower opportunity cost of wine production
So England will specialize in cloth production, Portugal will specialize
in wine production England will trade its cloth for Portugal’s wine,
and vice-versa.
The result will be: both countries become better off!

4. Figure 2.1 The Production Possibility Frontier
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers
Note: since slope of the frontier is constant,
this assumes constant opportunity cost of small jets in
terms of Dreamliners in terms of small jets: 8 more small
jets always means 6 less Dreamliners (and vice- versa).

5. Figure 2.2 Increasing Opportunity Cost
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers
Note: since slope of the frontier is increasing in
absolute value as quantity of small jets increases, this
assumes increasing opportunity cost of small jets in
terms of Dreamliners

6. Figure 2.3 Economic Growth
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers

7. USA:
Opportunity cost of 16 small jets
= 30 – 18 = 12 large jets
So opportunity cost of one small jet
= 12/16 = 0.75 large jet Opportunity
cost of 18 large jets
= 40 – 16 = 24 small jets
So opportunity cost of one large jet is
= 24/18 = 1.33 small jets
Brazil:
Opportunity cost of 6 small jets
=10 – 8 = 2 large jets
So opportunity cost of one small jet
= 2/6 = 0.33 large jet Opportunity cost
of 8 large jets
= 30 – 6 = 24 small jets
So opportunity cost of one large jet is
= 24/8 = 3 small jets
So opportunity cost of SMALL jet is lower in Brazil (0.33 large) than in US (0.75 large). And
opportunity cost of LARGE jet is lower in USA (1.33 small) than in Brazil (3 small).
So USA should specialize in producing large jets, Brazil in producing small jets.

8. Terms of trade:
USA wants to produce large jets, sell them to Brazil in exchange for small jets. It will
want to get more than 4/3 of a small jet for each large jet (which is the USA’s own
opportunity cost).
Likewise, Brazil wants to produce small jets, sell them to USA in exchange for large
jets. It will want to pay less than 3 small jets for each large jet (which is Brazil’s own
opportunity cost).
So the “price” of a large jet will be between 4/3 of a small jet and 3 small jets –
maybe 2 small jets per large jet?

9. With trade, the USA produces 30 large jets but consumes only 20. The
other 10 large jets go to Brazil, in exchange for 20 small jets.
Thus, the USA has paid a price of 10/20 or 0.50 large jets for
each of the small jets it got from Brazil.
With trade, Brazil produces 30 small jets but consumes only 10. The
other 20 small jets go to the USA, in exchange for 10 large jets.
Thus, Brazil has paid a price of 20/10 or 2 small jets for each of
the large jets it got from the USA.
So the price of a small jet is 0.50 large jets, And the price of a large jet
is 2.00 small jets.

10. Figure 2.5 Comparative Advantage and Gains from Trade
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers

11. implications for household behavior
Consider Fred and Rachel, who can each produce home output (H) and
market output (M). Their p-p frontiers look like this:
Opportunity cost of producing H (in terms of lost production of M):
Fred = 10 M lost for each 5 H gained, = 10/5 = 2 M for each H Rachel = 3 M lost
for each 11 H gained, = 3/11 M for each H
So Rachel has the lower opportunity cost of production of H. Opportunity
cost of M in terms of H = 5/10 for Fred; = 11/3 for Rachel. So Fred should
specialize in market production,
and Rachel should specialize in home production

13. Key implications of the model:
There are potential gains from trade for both partners.
Gains may be greatest for partners who are different from each other.
(“Opposites attract”)
The “traditional household” setup is not necessarily irrational, sexist,
patriarchal, etc. – could be completely rational!
Marriage/partnership could become less attractive if… women’s market
earning power increases
(reduces M productivity difference between men and women) labor-
saving appliances become more available
(reduces H productivity difference between men and women)

14. Unnumbered Figure 2.1 Pajama Republics
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers
Poor countries have
low productivity in all
industries, but not as
much in clothing
manufacture – so
they have a
comparative
advantage in
clothing
manufacture.

15. Figure 2.6 The Circular-Flow Diagram
Krugman and Wells: Microeconomics, Third Edition
Copyright © 2013 by Worth Publishers