Exam 1- Chapter 2 Production And Trade Flashcards
The key to a global economy , according to modern economists,
Is free trade
Efficiency
Efficiency is getting the maximum output per unit of input.
Efficiency can be applied to one business or to a whole nation.
Production possibilities frontier PPF
The production possibilities frontier is an economic model of a nation’s production of goods. It allows for the production of only two goods, usually one representing in government production and the other representing in the private sector.
What does the curve on the PPF graph represent?
All possible combinations of both goods that can be produced if all the country’s resources are used as efficiently as possible.
What is the opportunity cost of each good measured by?
The opportunity cost of each good is measured by the quantity of one good that is given up to produce more of the other.
If opportunity costs are constant
The production possibilities frontier will be a straight line.
Points inside the PPF are
Inefficient
Points on the PPF are
Efficient
Points outside the PPF are
Not attainable with the present resources and technology.
When does economic growth occur
Economic growth occurs when the potential maximum output of the economy increases. This is shown on the PPF diagram by a rightward shift of the PPF curve.
What do mercantilists believe ?
They believe that nations grow and develop by selling goods to other countries while not buying goods from them. This increases the amount of money in the country available to create capital.
Theory of Comparative advantage
This theory originated with David Ricardo in the early 1800s. It argues that countries should specialize in the production of goods that they are good at producing and trade with other nations that produce different goods.
The theory of comparative advantage contends that
Both Nations are made better off by specialization and trade, compared with mercantilism which argued that one country would be made better off at the expense of the other.
When does absolute advantage occur?
Absolute advantage occurs when one country is more efficient at the production of a particular good.
When does comparative advantage occur?
- Comparative advantage occurs when we consider more than one good.
- A country has a comparative advantage in the production of a good that it is relatively better at producing compared to another country.
- Even if one country is absolutely better at producing all goods, each country will still have a relative advantage in at least one good.
Trade
Trade does not allow other countries to produce more, but it allows them to consume combinations of goods that would be unattainable without trade
Terms of trade
The rate at which one good trades for another is called the terms of trade.
Countries will only voluntarily agree to terms of trade that make it better off than it would be without trade.
Observation of the real world supports the concept that
Specialization and trade leads to increased amounts of trade and higher incomes for trading countries.
If the opportunity costs of producing a good rise as a country produces more
It has increasing opportunity costs. This is represented by a curved PPF, concave to the origin.
When will the well being of the world be maximized
When each country must be able to sell the goods and services it produces in other countries, and must be able to buy goods and services from other countries. It must be able to make these transactions at fair prices and without undue restrictions placed on it.
People go into business to make
Profit
To maximize the profits
The firm should maximize its costs, ceteris paribus.
The costs of the firm are
The payments to resources it employs, namely labor, capital, and natural resources.
The business that best maximizes cost
Will be the one that gets the most production( output) from its resources.
Efficient
An efficient business in economists terms is one that gets the maximum possible output per unit of input ( resource) it employs.
No business or country is actually efficient in the strict sense.
True. Because there is always more output that can theoretically be obtained from our resources than we actually get
We can evaluate efficiency by
Comparing two businesses or two countries, and determine which is more efficient than the other, or by looking at the country or business overtime and seeing if it becomes more or less efficient.
Profit comes from
Cost and revenue
Production possibilities frontier
It shows as the meaning and consequences of efficiency on a national scale. The PPF is based on the assumption that a country produces only two goods.
If the economy is operating at maximum efficiency, to get more of one good
We must give up production of the other.
Inefficient
It means that we are either not using all of our resources, not using them as well as possible, or both.
Economic growth occurs
When the maximum possible Output of a country increases
Economic growth can occur because
More resources are made available or
technology makes the existing resources able to produce more.
The PPF will move inward and a country’s potential output will decrease
Following major natural disasters or major economic collapses that undermine the foundation of the economy.
It is important to note that the PPF curve
Is potential output, not the actual output produced. Every country is always below its potential.
So far production possibilities analysis has been limited
To One country operating in isolation.
What are the two basic theories of international trade
Mercantilism 1300s
Theory of comparative advantage 1700-1800
Mercantilism
Believes that a country will grow stronger every time it sells a good to another country, and weaker every time it buys one from overseas.
To a mercantilist, trade always results
In a winner and a loser.
The seller wins and the buyer loses, because the seller ends up with the gold.
Economists call this a zero sum game, since the gains of one country equal the losses of the other, and if the gains and losses are summed together, the result is zero.
Mercantilism does not work if
Everyone tries to follow it. If all nations passed laws banning imports, there will be no exports as well.
Classical economists
Argued against mercantilism and in favor of free trade between nations.
Adam Smith
Author of The Wealth of Nations 1776
David Ricardo
Author of Principles of Political Economy and Taxation 1815
Classical economics argues
That a trade makes both parties to the trade better off
A mercantilist viewed grade from the perspective of the
State
A classical views trade from the perspective of
Individuals involved in the trade, and then expands this view to look at the effects on the state.
Classical theory says that to make your country strong you should
Determine which goods you are good at producing and specialize in the production of those goods .
Trade as freely as possible with other nations.
To the classical economics
Trade makes both countries better off
-Better
Better means that the cost of producing the identical goods is lower
Comparative advantage
It means advantage in comparison.
We are better at everything, we are more better than you at some things, and the most better than you at 1 thing. We find that one thing and specialize in it to both of our advantages.
Trade does not allow nations to increase their production possibilities,
It allows them to consume more than they are able to produce.
To obtain the gains from trade
Countries must specialize in the production of a good or goods
Terms of trade
The rate at which two goods trade for each other is called the terms of trade
Comparative advantage
Is that good that, compared to the other country, you are the best at producing.
