Chapter 2 Flashcards
What is Production Possibilities Frontier (PPF)?
A curve representing all possible production combinations of two goods.
Assume 2 million Canadians can produce either:
2 bushels of wheat/day (4 Million bushels/day)
OR
1 shirt/day (2 Million shirts/day)
PPF Graph shows any point on the line shows the production possibilities for any combination of the two products
Production Possibilities
4M wheat and 0 shirt
3M wheat and 0.5M shirts
2M wheat and 1M shirts
1M wheat and 1.5M shirts
0 wheat and 2M shirts
What are PPF trade-offs?
A situation where someone gives up something to gain another thing.
There may be a situation where everyone grows wheat or everyone makes shirts (grow wheat – no shirts or make shirts – no wheat).
As seen in the diagram, production of one suffers to the advantage of the other, there are trade-offs.
PPF Trade off Chart curving down from top left to bottom right
Point C1 -all produce wheat
Point C4 –all produce T-shirts
Moving from C1 – C2 shows a loss of 1 m bushels of wheat and a 1 m gain in shirt
Slope of the PPF steeper from C2to C3, and again from C3to C4
What are the Factors that shift the PPF?
1) Increase in resources causes the PP to grow
2) Increase in working population means more can be produced at the same rate as before
3) Improvement in technology: causes the PP to
An increase in PP causes the PPF to shift outward
What are Absolute and Comparative Advantage?
Absolute Advantage:
Producer can generate more output than others with a given amount of resources
Comparative Advantage:
Producer can make a good at a lower opportunity cost than other producers, it has a comparative advantage producing that good
What is Absolute Advantage?
Example:
Product Shirts — Canadian Worker produces 50 shirts — Chinese worker produces 25 shirts
Product Bushels of Wheat — Canadian Worker produces 200 bushels — Chinese worker produces 50
The Canadian worker can produce twice as many shirts or four times as much wheat than the Chinese worker. So Canada has an absolute advantage in both production
Comparative Advantage Equation
The opportunity cost of one shirt in Canada is 4 (200/50) bushels of wheat.
So the formula is opportunity cost = product of 2nd best choice / product we want(first choice)
The opportunity cost of one bushel of wheat in Canada is 0.25 (50/200) shirt.
The opportunity cost of one shirt in China is 2 (50/25) bushels of wheat.
The opportunity cost of one bushel of wheat in China is 0.5 (25/50) shirt.
Canada has comparative advantage in wheat and China has comparative advantage in shirts (lower number is better, Canada gives up .25 less shirt for each bushel of wheat, China gives up 2 less bushels of wheat for each shirt)
Comparative Advantage Without Specialization
Product Shirts — Canadian Workers (30 million) produces 50 shirts — Chinese workers (100 million) produces 25 shirts
Product Bushels of Wheat — Canadian Workers (30 million) produces 200 bushels — Chinese workers (100 million) produces 50
Assuming 30 workers in Canada are divided into producing Shirts and Bushels of wheat, there will be 15 workers in each field of production.
Shirts — 50 * 15 million (workers) = 0.75 billion shirts — Bushels of Wheat — 200 * 15 million (workers) = 3 billion
Assuming 100 workers in China are divided into producing Shirts and Bushels of wheat, there will be 50 workers in each field of production.
Shirts — 25 * 50 million (workers) = 1.25 billion shirts — Bushels of Wheat — 50 * 50 million (workers) = 2.5 billion
Comparative Advantage With Specialization
Product Shirts — Canadian Workers (30 million) produces 50 shirts — Chinese workers (100 million) produces 25 shirts
Product Bushels of Wheat — Canadian Workers (30 million) produces 200 bushels — Chinese workers (100 million) produces 50
Assuming 30 million workers in Canada are working only on Wheat than:
Bushels of Wheat — 200 * 30 million (workers) = 6 billion
Assuming 100 million workers in China are working only on shirts than:
Shirts — 25 * 100 million (workers) = 2.5 billion shirts
Specialization makes Canada produce only wheat (lowest opportunity cost)
Specialization makes China produce only shirt (lowest opportunity cost).
Trade improves the total production of each product by 0.5 b
What is specialization?
Specialization - practice of focusing resources to produce a particular good
Due to comparative advantage.
Total production increases while using the same number of workers and the same technology
Allows trading countries to produce more product than before
If Canada and China agreed to trade 2.75 billion bushels of wheat for 1 billion of shirt, each will gain 0.25 billions of both products
