Welcome toPMBA0608: Economics/Statistics Foundation

Fall 2006Sessions 3: August 26

Session 3:Production Possibilities Frontier

Shows the combination of two goods an economy can produce efficiently in a certain period of time with given amount of resources and a given technology

Assumptions Only two goods Fixed amount of factors of production Given resources & technology Efficiency (means what?)

Maximized output given what is available

Production Possibilities Frontier (PPF)

Roses

Guns

100

10 20 30 400

9580

60

AB

C

D

E

* I

* U

PPF

Remember the 10 Principles?

Does this model show Principle 1?

Does this model show Principle 2?

Any other principles? How about Principle 8?

Production Possibilities Frontier (PPF)

Why is PPF downward sloping? Why is PPF bowed out? Why does the cost of producing 10

additional guns go up as we produce more guns?

What is point I? What is point U How can we move from I to B? How can we shift our PPF outward?

Now we are going to jump to Chapter 3 of Mankiw

Trade

Absolute Advantage

A nation has an absolute advantage in production of a good over its trade partner if it can produce one unit of that good using fewer resources than its trade partner or if, using all of its resources, it can produce more of that good than its trade partner.

Example

Comparative Advantage

A nation has a comparative advantage in production of a good if it can produce that good at a lower opportunity cost compared to its trade partner

Example

Definition

A trade benefits a nation if after trade the nation can consumes no less of any goods than before trade and more of at least one good.

Graph

In Class Assignment PPFs Who has absolute advantage in

what? Why? Is there going to be a trade based

on absolute advantage? Why or why not?

In Class Assignment

What is the Opp. Cost of producing 1 computer in each nation

Who has comparative advantage in what? Why?

Is there going to be a trade based on comparative advantage? Why or why not?

Who should specialize in production of what? Why?

In Class Assignment

Pre-trade points of production and consumption

Terms of trade (must be mutually beneficial)

Post-trade points of production Post-trade points of consumption Gains from trade