back start next

[start] [1] [2] [3] [ 4 ] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75]


classic case of operating inside the curve. Periods of full employment, on the other hand are associated with operadng somewhere along the production possibilities curve. Finally, because the producdon possibil-ides curve forms a boundary between attainable and non-attainable combinations of guns and butter, it is often called the production possibility frontier. Points lying outside the frontier, such as point H, are unattainable; we lack sufEcient resources to produce these outputs. But all points lying inside the curve are attainable.

Once on this frontier, society must give up some of one good to have more of another. For instance if society is at point A, and it wants a unit of butter, it has to give up 1 gun to move to point B; if it is operating at point and vrants one more unit of butter, it must now give up two guns to move to point D; at E it must give up 5 guns in order to have another unit of butter at F. hi economics all costs are opportunity costs: the opportunity cost of a good, or for that matter anything else, is the most highly valued alternative (s) that is (are) thereby forsaken in order to have the good. If nothing need be forfeited in order to consume more of the good, the opportunity cost is zero. Here the opportunity cost of an extra unit of butter is the amount of guns foregone. Between A and the opportunity cost of a unit of butter is I gun, but between E and F its 5 guns.

Once we know the opportunity cost of another unit of butter, the opportunity cost of another gun is just the reciprocal. For example, between points and D, the opportunity cost of butter is 2 guns per unit of butter, the approximate slope between these two points. Thus, reversing directions, the opportunity cost of 1 gun is 1/2 units of butter, the reciprocal of the slope between these points. Similarly, between points E and F, the opportunity cost of butter is 5 guns per unit of butter, so that the opportunity cost of a gun is 1 /5 units of butter. We can summarize all this by saying that the slope at a point (or a small region) along the production possibility curve gives the opportunity cost of the good on the horizontal axis, while the reciprocal of the slope gives the opportunity cost of the good on the vertical axis.

We see in Figure I that the opportunity cost varies: As we make more butter and less guns, we must sacrifice an increasing amount of guns to get an additional unit of butter. Liknvise, reversing directions, to have more guns, we must sacrifice an increasing amount of butter. Such sacrifices are termed trade-offs in economics; indeed the subject concerns litde else.

The opportunity cost trade-offs of Figure 1 \nry

because resources are specialized: some resourcel very good at producing butter (dairy maidy Wisconsin for example), but are less well adap producing guns. As we pull increasing numbers of farms and dairy maids out of butter production activity for which they are well suited, in order iq them for gun production, an activity for which thej poorly suited, we lose a lot of butter for the gain ofi few guns.

As another example, consider the between growing dates and artichokes. Dates desert plants that enjoy hot dry days with brilliant shine; artichokes on the other hand, dirive unden diuons of cool foggy weather. Suppose we initially icate the entire State of California to artichoke ducdon, bul now decide to grow a few dates. Ifwe to get the most dates for the sacrifice of the least chokes, that is to say, if we want to operate alo: production possibility curve and not inside it, land would we pick to grow our dates? The I answer is land where artichokes grow relatively and dates relatively well, such as the area around Springs. Since this region is poorly suited for arti cultivation, but well adapted for dates, well initial! quite a few dates for the sacrifice of very few chokes. As such, the opportunity cost of the first dates will be low. But as we continue to increase production at the forfeit of artichokes, we will in ingly have to press into service lands that are suited to dates but well adapted for artichokes, su( the region near Monterey. When such lands pressed into date cultivation, wed have to give up artichokes for the gain of very few dates. This will region of high opportunity cost along the produ* possibility curve between dates and artichokes.

If resources were not specialized, we have a linear (straight line) production possit curve such as Figure 11. Note in Figure 11 that slope is everywhere constant so that the opportul

Fig. II A Constant Opportunity Cost Production Possibility Curve



is everywhere constsmt. Here tlie trade-off is 2X . jYor what is the same thing going the other direc-jn - 1/2 Y for 1 X. The more realistic bowed out , of Figure I is said to be concave.



The actual posidon of the production possibil-Tcurve reflects the economic resources available to conomy at a certain point in time. It is somedmes /enient to break these resources down into the factors of production and the technology avail-le to an economy. Factors of production are usually ght of as comprising the inputs to the production (- the labor of various kinds; the stocks of nat-aurces or land; the stocks of capital, referring Produced goods (such as tractors and other ines) used to produce consumer goods; and to ship, the human skills required to com-these inputs effectively. Technology, on the other fers to the known methods of combining the Isof production. For example, farmers are entre-Burs who select the technology - horses or tractors for plowing fields. It is important that you use id other such jargon correcUy. Capital, for ice, never refers to money, stocks, or bonds in Bomics. Numerous similar examples of specizJized lology will follow.

Technological progress in both goods or in any of the four factors of production will an upward and rightward shift of the produc-dssibilities frontier as in Figure III, other things Jhtl This stands to reason. The more resources or the better were able to use existing trees, the more well be able to produce, which is the more the production possibility curve will outward. Similarly, decreases in these factors - as Sestiructive war for example - would shift the curve

"To increase its capital stock, an economy must up some ofits current consumption. For example, irder to have more autos in the future, society must labor and other resources which could have been to produce cars in the preseni and use them to S«d plants and equipment instead. Since these s are tied up building plants rather than mak-*ars, well experience reduced auto output in the Once the new capital is built and ready for lOwever, we can have more cars than previously, ly, many readers of this book are investing in

their human capital, that is, acquiring human skills useful for production. Instead of taking a job today and consuming in the present, they are foregoing consumption and investing in themselves through education in order to produce (and therefore to consume) more in later life. To that extent their production today will be lower, but their production in the future higher.

Often resources are very specific. For example, more capital such as milking machines would have no effect on the intersection along the guns axis because milking machines are useless for gun production. On the other hand, more milking machines vvould increase the maximum amount of butter that could be produced, so that we would get a shift to the dotted production possibilities curve depicted in Figure \ Note from the diagram that now, paradoxically, the economy can have more of both guns and butter. You can see this by noting that for any interior point, such as point A, it is always possible to draw a shaded area containing more of both goods following a shift of the kind depicted in the figure. How is it possible to get more guns when there has been no change in gini making capital or technology? The answer is that with more butter making capital to work with, butter makers become more productive. Hence, we can now take some butter workers (such as those Wisconsin dairy maids) out of butter productiorTandpurthem to work making guns, dhcreby having more of both goods. For example, assume one worker and one milking machine would allow us to do the work of twent\ workers without milking machines. Then as just one possibility, we could use a milking machine, transfer eighteen former butter workers into gun making, and

Fig. Ill

Butter ;

"" An Increase in

Factors or Technical

- Progress in Both Goods

. \

\ \

\ \

\ \

\ \

\ »

\ \ -

Fig. IV


An Increase in Butter ines or Improved Butter Making Technology


thereby enjoy more of both goods. Two butter workers using a milking machine will deliver more butter than before, and the eighteen new gun makers will deliver more guns.

Likewise, technological progress occurring only in butter making would shift the curve in a manner similar to Figure IV. Again we could have more butter, but the intersection along the guns axis would not be affected: The new technology is endrely irrelevant since no resources whatsoever are used for butter producdon at this point. However, we could again produce both more butter and guns everywhere else by putting resources previously dedicated to butter producdon into gun production instead.


Although its clear that people should specialize if they want to consume very much, its not immediately dear just what they should specialize in. The theory of comparative advantage is designed to answer that question. According to this theory, an economic entity, be it a person, a cit\, a region, firm, or a whole economy, should specialize in what it does relatively best, that is to say, in the good it can produce with the smallest opportunity cost. We demonstrate in Figure V that doing so allows greater production of all goods.

Consider a tivo-good world of wheat and clothing. The goods themselves are immaterial and could be wheat and oranges, A and B, or anything else. Consider further two individuals whom well call X and Y. Here again the individuals could just as well be countries, persons, regions, continents, or any other entity you might wish. Then X has a comparative advantage in whichever of two goods he has the small-

er opportunity cost compared to Y. Figure V the production possibilities curve for these twoi viduals. (You can ignore the dotted hne in the 1 for now.) We can see that X has the lower cost in wheat because his production possibjj curve has a smaller slope; consequendy we kno has a comparative advantage in wheat For ! have an extra unit of wheat, X must give up 1/2 [ of clothing, the slope of his production possibfl curve, whereas Y must give up 4 units of clothi achieve 1 unit of wheat. Looking at it another i see that Y has a comparative advantage in cl because Y gives up only 1/4 units of wheat to unit of clothing, while X must give up 2 units of \ to have another unit of clothing. Hence, becav: trade-off of clothing for wheat is lower than Ys, i lows that his reverse tiade-off, wheat for clothing, be higher than Ys. Hence, if X has a compa advantage in wheat, Y has one in clothing. In gc if one individual has the comparative advantage it good on the horizontal axis, the other has die parauve advantage in the good on the verticall because the opportunity cost of the good on the i cal axis isjust the reciprocal of the opportunity ( the good on the horizontal axis.

Now suppose that Y invests in his human ( tal so that his new production possibilities curve ( tually shifts out to the dotted line in Figure V tured below as Figure VI. Clearly, he can now more of both goods than before. On the new ] tion possibilities curve, Y will have an absolute i tage in both goods, i.e., he can have more of both ) can X. Yet his opportunity cost is constant as see his unchanged slope on the new curve, so that] comparative advante remains in clothing.

Fig. V The Production Possibiiity Curves ot individuals X & Y

Clothing ZO

\ \ \ \ \ \ \ \

\ \

12 3 4 5 vVheal

[start] [1] [2] [3] [ 4 ] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75]