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Section 2. Production Possibility Frontier & Trade Chapter 2: pages 32-60. KEY DEFINITIONS. Production possibilities frontier is a curve showing the maximum attainable combinations of two products that may be produced with available resources. - PowerPoint PPT Presentation
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KEY DEFINITIONS
Production possibilities frontier is a curve showing the maximum 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.
Assumptions
Let’s assume there are two products (Apples and cherry).
There are two persons in our small society now: you and your neighbor.
To be or not to be...
To be self-sufficient and produce everything we need
OR To cooperate with others - TRADE
The benefit of trade is pretty obvious if you only have apple trees and your neighbor only has cherry.
Furthermore, the benefit of trade also seems obvious if you are much better in picking apples and your neighbor is better in picking cherry.
In this case you should SPRECIALIZE in apple production and your neighbor should SPECILIZE in cherry production.
And you should TRADE
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
Absolute vs. 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.
The Principle of Comparative Advantage
Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.
Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.
Should the United States trade with other countries?
As we all know Americans enjoy a lot of goods produced by other countries.
Imports: goods produced abroad and sold domestically.
Exports: goods produced domestically and sold abroad.