Production Possibilities Absolute Comparative Advantage Production Possibilities Curve

Production Possibilities, Absolute & Comparative Advantage

Production Possibilities Curve

Production Possibilities Curve • Any point on the curve represents an efficient use of resources • Any point inside the curve represents an inefficient use of resources (unemployment) • Any point outside the curve is not possible • The curve can shift inward or outward when there are changes in costs or productive capacity

Absolute & Comparative Advantage

Why Nations Trade • Nations have different natural, human and capital resources • Nations are not equally efficient at producing the goods and services demanded by their residents • Production of any good has an opportunity cost • Nations should specialize in production of goods with the lowest opportunity costs

Assumptions • Two nations • Two goods • Producers in both nations can produce both goods • Consumers in both nations want both goods • Resources are perfectly interchangeable between production of both goods

Absolute Advantage • Given equal resources, one nation (or individual) can produce more of a good than another nation (or individual). • But even if one country has absolute advantages in the production of both goods, specialization and trade will usually benefit both countries.

Comparative Advantage • One nation (or individual) can produce a good at a lower opportunity cost than another nation (or individual). • Examples of Comparative Advantage: – Economics professor and secretary – Auto mechanic and doctor – Accountant and painter

Terms of Trade • Good terms of trade – To benefit both nations, the terms must fall between the two nations’ opportunity costs