Unformatted text preview: 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 31 2 The Economic
Problem After studying this chapter,
you will be able to:
■ Define the production possibilities frontier and calculate
opportunity cost ■ Distinguish between production possibilities and preferences and describe an efficient allocation of resources ■ Explain how current production choices expand future
production possibilities ■ Explain how specialization and trade expand our production possibilities ■ Describe the economic institutions that coordinate
decisions Why does food cost much more today than it did a increased the cost of producing food. You will also learn how few years ago? One reason is that we now use part of our corn to assess whether it is a good idea to increase corn production crop to produce ethanol, a clean biofuel substitute for gasoline. to produce fuel; how we can expand our production possibili- Another reason is that drought in some parts of the world has ties; and how we gain by trading with others. decreased global grain production. In this chapter, you will study At the end of the chapter, in Reading Between the Lines, an economic model—the production possibilities frontier—and we’ll apply what you’ve learned to understanding why you will learn why ethanol production and drought have ethanol production is raising the cost of food. 31 9160335_CH02_p031-052.qxp 32 6/22/09 8:55 AM Page 32 CHAPTER 2 The Economic Problem ◆ Production Possibilities Production Possibilities
Frontier FIGURE 2.1 Every working day, in mines, factories, shops, and
offices and on farms and construction sites across
the United States, 138 million people produce a vast
variety of goods and services valued at $50 billion.
But the quantities of goods and services that we can
produce are limited both by our available resources
and by technology. And if we want to increase our
production of one good, we must decrease our production of something else—we face a tradeoff. You
are going to learn about the production possibilities
frontier, which describes the limit to what we can
produce and provides a neat way of thinking about
and illustrating the idea of a tradeoff.
The production possibilities frontier (PPF ) is the
boundary between those combinations of goods and
services that can be produced and those that cannot.
To illustrate the PPF, we focus on two goods at a
time and hold the quantities produced of all the
other goods and services constant. That is, we look at
a model economy in which everything remains the
same except for the production of the two goods we
Let’s look at the production possibilities frontier
for cola and pizza, which stand for any pair of goods
or services. Cola (millions of cans) and Opportunity Cost
C Unattainable 10 D Attainable E 5 Z PPF
0 1 2 3 4 5
Pizzas (millions) Pizzas Cola Possibility (millions) (millions of cans) A 0 and 15 The production possibilities frontier for cola and pizza
shows the limits to the production of these two
goods, given the total resources and technology available to produce them. Figure 2.1 shows this production possibilities frontier. The table lists some
combinations of the quantities of pizza and cola that
can be produced in a month given the resources
available. The figure graphs these combinations. The
x-axis shows the quantity of pizzas produced, and the
y-axis shows the quantity of cola produced.
The PPF illustrates scarcity because we cannot
attain the points outside the frontier. These points
describe wants that can’t be satisfied. We can produce
at any point inside the PPF or on the PPF. These
points are attainable. Suppose that in a typical
month, we produce 4 million pizzas and 5 million
cans of cola. Figure 2.1 shows this combination as
point E and as possibility E in the table. The figure 1 and 14 2 and 12 D 3 and 9 E Production Possibilities Frontier B
C 4 and 5 F 5 and 0 The table lists six production possibilities for cola and
pizzas. Row A tells us that if we produce no pizza, the
maximum quantity of cola we can produce is 15 million
cans. Points A, B, C, D, E, and F in the figure represent the
rows of the table. The curve passing through these points is
the production possibilities frontier (PPF ).
The PPF separates the attainable from the unattainable.
Production is possible at any point inside the orange area
or on the frontier. Points outside the frontier are unattainable. Points inside the frontier, such as point Z, are inefficient
because resources are wasted or misallocated. At such
points, it is possible to use the available resources to produce more of either or both goods.
animation 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 33 Production Possibilities and Opportunity Cost also shows other production possibilities. For example, we might stop producing pizza and move all the
people who produce it into producing cola. Point A
in the figure and possibility A in the table show this
case. The quantity of cola produced increases to 15
million cans, and pizza production dries up.
Alternatively, we might close the cola factories and
switch all the resources into producing pizza. In this
situation, we produce 5 million pizzas. Point F in the
figure and possibility F in the table show this case. Production Efficiency
We achieve production efficiency if we produce goods
and services at the lowest possible cost. This outcome occurs at all the points on the PPF. At points
inside the PPF, production is inefficient because we
are giving up more than necessary of one good to
produce a given quantity of the other good.
For example, at point Z in Fig. 2.1, we produce
3 million pizzas and 5 million cans of cola. But we
could produce 3 million pizzas and 9 million cans of
cola. Our pizzas cost more cola than necessary. We can
get them for a lower cost. Only when we produce on
the PPF do we incur the lowest possible cost of production.
Production is inefficient inside the PPF because
resources are either unused or misallocated or both.
Resources are unused when they are idle but could
be working. For example, we might leave some of the
factories idle or some workers unemployed.
Resources are misallocated when they are assigned
to tasks for which they are not the best match. For
example, we might assign skilled pizza chefs to work
in a cola factory and skilled cola producers to work in
a pizza shop. We could get more pizzas and more cola
from these same workers if we reassigned them to the
tasks that more closely match their skills. Tradeoff Along the PPF
Every choice along the PPF involves a tradeoff. On the
PPF in Fig. 2.1, we trade off cola for pizzas.
Tradeoffs arise in every imaginable real-world situation, and you reviewed several of them in Chapter 1.
At any given point in time, we have a fixed amount
of labor, land, capital, and entrepreneurship. By using
our available technologies, we can employ these
resources to produce goods and services, but we are
limited in what we can produce. This limit defines a 33 boundary between what we can attain and what we
cannot attain. This boundary is the real-world’s
production possibilities frontier, and it defines the
tradeoffs that we must make. On our real-world PPF,
we can produce more of any one good or service only
if we produce less of some other goods or services.
When doctors want to spend more on AIDS and
cancer research, they face a tradeoff: more medical
research for less of some other things. When Congress
wants to spend more on education and health care, it
faces a tradeoff: more education and health care for
less national defense or less private spending (because
of higher taxes). When an environmental group
argues for less logging, it is suggesting a tradeoff:
greater conservation of endangered wildlife for less
paper. When you want to study more, you face a
tradeoff: more study time for less leisure or sleep.
All tradeoffs involve a cost—an opportunity cost. Opportunity Cost
The opportunity cost of an action is the highest-valued
alternative forgone. The PPF makes this idea precise
and enables us to calculate opportunity cost. Along
the PPF, there are only two goods, so there is only
one alternative forgone: some quantity of the other
good. Given our current resources and technology,
we can produce more pizzas only if we produce less
cola. The opportunity cost of producing an additional pizza is the cola we must forgo. Similarly, the
opportunity cost of producing an additional can of
cola is the quantity of pizza we must forgo.
In Fig. 2.1, if we move from point C to point D,
we get 1 million more pizzas but 3 million fewer cans
of cola. The additional 1 million pizzas cost 3 million
cans of cola. One pizza costs 3 cans of cola.
We can also work out the opportunity cost of moving in the opposite direction. In Fig. 2.1, if we move
from point D to point C, the quantity of cola produced increases by 3 million cans and the quantity of
pizzas produced decreases by 1 million. So if we choose
point C over point D, the additional 3 million cans of
cola cost 1 million pizzas. One can of cola costs 1/3 of
Opportunity Cost Is a Ratio Opportunity cost is a ratio. It is the decrease in the quantity produced
of one good divided by the increase in the quantity
produced of another good as we move along the production possibilities frontier. 9160335_CH02_p031-052.qxp 34 6/22/09 8:55 AM Page 34 CHAPTER 2 The Economic Problem Because opportunity cost is a ratio, the opportunity
cost of producing an additional can of cola is equal to
the inverse of the opportunity cost of producing an
additional pizza. Check this proposition by returning
to the calculations we’ve just worked through. When
we move along the PPF from C to D, the opportunity
cost of a pizza is 3 cans of cola. The inverse of 3 is 1/3.
If we decrease the production of pizza and increase the
production of cola by moving from D to C, the opportunity cost of a can of cola must be 1/3 of a pizza. That
is exactly the number that we calculated for the move
from D to C.
Increasing Opportunity Cost The opportunity cost of a pizza increases as the quantity of pizzas produced
increases. The outward-bowed shape of the PPF
reflects increasing opportunity cost. When we produce
a large quantity of cola and a small quantity of pizza—
between points A and B in Fig. 2.1—the frontier has a
gentle slope. An increase in the quantity of pizzas costs
a small decrease in the quantity of cola—the opportunity cost of a pizza is a small quantity of cola. Increasing Opportunity Cost
Opportunity Cost on the Farm
Sanders Wright, a homesick Mississippi native, is
growing cotton in Iowa. But the growing season is
short and commercial success unlikely. Cotton does
not grow well in Iowa, but corn does. A farm with
irrigation can produce 300 bushels of corn per
acre—twice the U.S. average.
Ronnie Gerik, a Texas cotton farmer, has started to
grow corn. But Ronnie doesn’t have irrigation and
instead relies on rainfall. That’s not a problem for cotton, which just needs a few soakings a season. But it’s a
big problem for corn, which needs an inch of water a
week. Also, corn can’t take the heat like cotton, and if
the temperature rises too much, Ronnie will be lucky
to get 100 bushels an acre.
An Iowa corn farmer gives up almost no cotton to
produce his 300 bushels of corn per acre—corn has a
low opportunity cost. But Ronnie Gerick gives up a
huge amount of cotton to produce his 100 bushels of
corn per acre. By switching some land from cotton to
corn, Ronnie has increased the production of corn, but
the additional corn has a high opportunity cost.
“Deere worker makes ‘cotton pickin’ miracle happen,” WCFCourier.com;
and “Farmers stampede to corn,” USA Today. When we produce a large quantity of pizza and a
small quantity of cola—between points E and F in
Fig. 2.1—the frontier is steep. A given increase in the
quantity of pizzas costs a large decrease in the quantity
of cola, so the opportunity cost of a pizza is a large
quantity of cola.
The PPF is bowed outward because resources are not
all equally productive in all activities. People with many
years of experience working for PepsiCo are good at
producing cola but not very good at making pizzas. So
if we move some of these people from PepsiCo to
Domino’s, we get a small increase in the quantity of
pizzas but a large decrease in the quantity of cola.
Similarly, people who have spent years working at
Domino’s are good at producing pizzas, but they have
no idea how to produce cola. So if we move some of
these people from Domino’s to PepsiCo, we get a small
increase in the quantity of cola but a large decrease in
the quantity of pizzas. The more of either good we try
to produce, the less productive are the additional
resources we use to produce that good and the larger is
the opportunity cost of a unit of that good. Review Quiz ◆
6 How does the production possibilities frontier
How does the production possibilities frontier
illustrate production efficiency?
How does the production possibilities frontier
show that every choice involves a tradeoff?
How does the production possibilities frontier
illustrate opportunity cost?
Why is opportunity cost a ratio?
Why does the PPF for most goods bow outward so that opportunity cost increases as the
quantity produced of a good increases?
Work Study Plan 2.1
and get instant feedback. We’ve seen that what we can produce is limited
by the production possibilities frontier. We’ve also
seen that production on the PPF is efficient. But we
can produce many different quantities on the PPF.
How do we choose among them? How do we know
which point on the PPF is the best one? 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 35 Using Resources Efficiently ◆ Using Resources Efficiently 15
14 A Increasing
of a pizza ... B
C 12 D 9 E 5 F The PPF and Marginal Cost 0 1 2 2.5 3 4 5
Pizzas (millions) (a) PPF and opportunity cost Marginal cost (cans of cola per pizza) The marginal cost of a good is the opportunity cost of
producing one more unit of it. We calculate marginal
cost from the slope of the PPF. As the quantity of
pizzas produced increases, the PPF gets steeper and the
marginal cost of a pizza increases. Figure 2.2 illustrates
the calculation of the marginal cost of a pizza.
Begin by finding the opportunity cost of pizza in
blocks of 1 million pizzas. The cost of the first million pizzas is 1 million cans of cola; the cost of the
second million pizzas is 2 million cans of cola; the
cost of the third million pizzas is 3 million cans of
cola, and so on. The bars in part (a) illustrate these
The bars in part (b) show the cost of an average
pizza in each of the 1 million pizza blocks. Focus on the
third million pizzas—the move from C to D in part (a).
Over this range, because 1 million pizzas cost 3 million
cans of cola, one of these pizzas, on average, costs 3
cans of cola—the height of the bar in part (b).
Next, find the opportunity cost of each additional
pizza—the marginal cost of a pizza. The marginal cost
of a pizza increases as the quantity of pizzas produced
increases. The marginal cost at point C is less than it is
at point D. On the average over the range from C to D,
the marginal cost of a pizza is 3 cans of cola. But it
exactly equals 3 cans of cola only in the middle of the
range between C and D.
The red dot in part (b) indicates that the marginal
cost of a pizza is 3 cans of cola when 2.5 million pizzas
are produced. Each black dot in part (b) is interpreted
in the same way. The red curve that passes through
these dots, labeled MC, is the marginal cost curve. It
shows the marginal cost of a pizza at each quantity of
pizzas as we move along the PPF. The PPF and Marginal Cost FIGURE 2.2
Cola (millions of cans) We achieve production efficiency at every point on
the PPF. But which point is best? The answer is the
point on the PPF at which goods and services are
produced in the quantities that provide the greatest
possible benefit. When goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit, we
have achieved allocative efficiency.
The questions that we raised when we reviewed
the five big issues in Chapter 1 are questions about
allocative efficiency. To answer such questions, we
must measure and compare costs and benefits. 35 MC
5 4 ... means increasing
marginal cost of a
pizza 3 2 1 0 1 2 2.5 3 4 5
Pizzas (millions) (b) Marginal cost Marginal cost is calculated from the slope of the PPF. As the
quantity of pizzas produced increases, the PPF gets steeper
and the marginal cost of a pizza increases. The bars in part
(a) show the opportunity cost of pizza in blocks of 1 million
pizzas. The bars in part (b) show the cost of an average
pizza in each of these 1 million blocks. The red curve, MC,
shows the marginal cost of a pizza at each point along the
PPF. This curve passes through the center of each of the
bars in part (b).
animation 9160335_CH02_p031-052.qxp 36 6/22/09 8:55 AM Page 36 CHAPTER 2 The Economic Problem Preferences and Marginal Benefit
Willingness to pay (cans of cola per pizza) Look around your classroom and notice the wide
variety of shirts, pants, and shoes that you and your
fellow students are wearing today. Why is there such
a huge variety? Why don’t you all wear the same
styles and colors? The answer lies in what economists call preferences. Preferences are a description of
a person’s likes and dislikes.
You’ve seen that we have a concrete way of describing the limits to production: the PPF. We need a
similarly concrete way of describing preferences. To
describe preferences, economists use the concept of
marginal benefit. The marginal benefit from a good or
service is the benefit received from consuming one
more unit of it.
We measure the marginal benefit from a good or
service by the most that people are willing to pay for
an additional unit of it. The idea is that you are willing to pay less for a good than it is worth to you but
you are not willing to pay more than it is worth. So
the most you are willing to pay for something measures its marginal benefit.
Economists illustrate preferences using the marginal
benefit curve, which is a curve that shows the relationship between the marginal benefit from a good and the
quantity consumed of that good. It is a general principle that the more we have of any good or service, the
smaller is its marginal benefit and the less we are willing to pay for an additional unit of it. This tendency is
so widespread and strong that we call it a principle—
the principle of decreasing marginal benefit.
The basic reason why marginal benefit from a
good or service decreases as we consume more of it is
that we like variety. The more we consume of any
one good or service, the more we tire of it and would
prefer to switch to something else.
Think about your willingness to pay for a pizza. If
pizza is hard to come by and you can buy only a few
slices a year, you might be willing to pay a high price
to get an additional slice. But if pizza is all you’ve
eaten for the past few days, you are willing to pay
almost nothing for another slice.
You’ve learned to think about cost as opportunity
cost, not as a dollar cost. You can think about marginal benefit and willingness to pay in the same way.
The marginal benefit, measured by what you are willing to pay for something, is the quantity of other
goods and services that you are willing to forgo. Let’s
continue with the example of cola and pizza and illustrate preferences this way. Preferences and the Marginal
Benefit Curve FIGURE 2.3 A 5 Decreasing marginal
benefit from a pizza B 4 C 3 D 2 E 1 MB
0 1 2 3 4 5
Pizzas (millions) Pizzas Willingness to pay Possibility (millions) (cans of cola per pizza) A 0.5 5 B 1.5 4 C 2.5 3 D 3.5 2 E 4.5 1 The smaller the quantity of pizzas produced, the more cola
people are willing to give up for an additional pizza. If pizza
production is 0.5 million, people are willing to pay 5 cans of
cola per pizza. But if pizza production is 4.5 million, people
are willing to pay only 1 can of cola per pizza. Willingness
to pay measures marginal benefit. A universal feature of
people’s preferences is that marginal benefit decreases.
animation Figure 2.3 illustrates preferences as the willingness
to pay for pizza in terms of cola. In row A, pizza production is 0.5 million, and at that quantity, people
are willing to pay 5 cans of cola per pizza. As the
quantity of pizzas produced increases, the amount
that people are willing to pay for a pizza falls. When
pizza production is 4.5 million, people are willing to
pay only 1 can of cola per pizza.
Let’s now use the concepts of marginal cost and
marginal benefit to describe allocative efficiency. 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 37 Using Resources Efficiently Cola (millions of cans) FIGURE 2.4 Efficient Use of Resources Too much cola 15 Allocative Efficiency Point of
efficiency A B 10 C Too many
pizzas 5 PPF
0 1.5 2.5 3.5 5
Pizzas (millions) Marginal cost and marginal benefit
(cans of cola per pizza) (a) On the PPF 5 Marginal benefit exceeds
more pizzas Marginal cost exceeds
fewer pizzas MC
quantity of pizzas 3 At any point on the PPF, we cannot produce more
of one good without giving up some other good. At
the best point on the PPF, we cannot produce more
of one good without giving up some other good
that provides greater benefit. We are producing at
the point of allocative efficiency—the point on the
PPF that we prefer above all other points.
Suppose in Fig. 2.4, we produce 1.5 million pizzas.
The marginal cost of a pizza is 2 cans of cola, and the
marginal benefit from a pizza is 4 cans of cola.
Because someone values an additional pizza more
highly than it costs to produce, we can get more value
from our resources by moving some of them out of
producing cola and into producing pizza.
Now suppose we produce 3.5 million pizzas. The
marginal cost of a pizza is now 4 cans of cola, but the
marginal benefit from a pizza is only 2 cans of cola.
Because the additional pizza costs more to produce
than anyone thinks it is worth, we can get more value
from our resources by moving some of them away
from producing pizza and into producing cola.
Suppose we produce 2.5 million pizzas. Marginal
cost and marginal benefit are now equal at 3 cans of
cola. This allocation of resources between pizza and
cola is efficient. If more pizzas are produced, the forgone cola is worth more than the additional pizzas. If
fewer pizzas are produced, the forgone pizzas are
worth more than the additional cola. Review Quiz ◆ 2 1
MB 0 37 1.5 2.5 3.5 5
Pizzas (millions) (b) Marginal benefit equals marginal cost 3 4
5 The greater the quantity of pizzas produced, the smaller is
the marginal benefit (MB) from pizza—the less cola people
are willing to give up to get an additional pizza. But the
greater the quantity of pizzas produced, the greater is the
marginal cost (MC) of a pizza—the more cola people must
give up to get an additional pizza. When marginal benefit
equals marginal cost, resources are being used efficiently.
animation What is marginal cost? How is it measured?
What is marginal benefit? How is it measured?
How does the marginal benefit from a good
change as the quantity produced of that good
What is allocative efficiency and how does it
relate to the production possibilities frontier?
What conditions must be satisfied if resources
are used efficiently?
Work Study Plan 2.2
and get instant feedback. You now understand the limits to production
and the conditions under which resources are used
efficiently. Your next task is to study the expansion of
production possibilities. 9160335_CH02_p031-052.qxp 38 6/22/09 8:55 AM Page 38 CHAPTER 2 The Economic Problem ◆ Economic Growth The Cost of Economic Growth
Economic growth comes from technological change
and capital accumulation. Technological change is the
development of new goods and of better ways of
producing goods and services. Capital accumulation is
the growth of capital resources, including human
Because of technological change and capital accumulation, we have an enormous quantity of cars that
provide us with more transportation than was available
when we had only horses and carriages; we have satellites that provide global communications on a much
larger scale than that available with the earlier cable
technology. But if we use our resources to develop new
technologies and produce capital, we must decrease
our production of consumption goods and services.
New technologies and new capital have an opportunity
cost. Let’s look at this opportunity cost.
Instead of studying the PPF of pizza and cola,
we’ll hold the quantity of cola produced constant and
examine the PPF for pizzas and pizza ovens. Figure
2.5 shows this PPF as the blue curve ABC. If we
devote no resources to producing pizza ovens, we
produce at point A. If we produce 3 million pizzas,
we can produce 6 pizza ovens at point B. If we produce no pizza, we can produce 10 ovens at point C.
The amount by which our production possibilities expand depends on the resources we devote to
technological change and capital accumulation. If
we devote no resources to this activity (point A),
our PPF remains at ABC—the blue curve in Fig.
2.5. If we cut the current production of pizza and
produce 6 ovens (point B), then in the future, we’ll
have more capital and our PPF will rotate outward
to the position shown by the red curve. The fewer
resources we use for producing pizza and the more
resources we use for producing ovens, the greater is
the future expansion of our production possibilities. Pizza ovens During the past 30 years, production per person in
the United States has doubled. Such an expansion of
production is called economic growth. Economic
growth increases our standard of living, but it doesn’t
overcome scarcity and avoid opportunity cost. To
make our economy grow, we face a tradeoff—the
faster we make production grow, the greater is the
opportunity cost of economic growth. FIGURE 2.5 10 Economic Growth C 8 B 6 B' 4 2 PPF0 PPF1 A
0 1 2 3 4 5 A'
Pizzas (millions) PPF0 shows the limits to the production of pizza and pizza
ovens, with the production of all other goods and services
remaining the same. If we devote no resources to producing
pizza ovens and produce 5 million pizzas, our production
possibilities will remain the same PPF0. But if we decrease
pizza production to 3 million and produce 6 ovens, at point
B, our production possibilities expand. After one period, the
PPF rotates outward to PPF1 and we can produce at point
B', a point outside the original PPF0. We can rotate the PPF
outward, but we cannot avoid opportunity cost. The opportunity cost of producing more pizzas in the future is fewer
animation Economic growth is not free. To make it happen,
we use more resources to produce new ovens and
fewer resources to produce pizzas. In Fig. 2.5, we
move from A to B. There is no free lunch. The
opportunity cost of more pizzas in the future is fewer
pizzas today. Also, economic growth is no magic formula for abolishing scarcity. On the new production
possibilities frontier, we continue to face a tradeoff
and opportunity cost.
The ideas about economic growth that we have
explored in the setting of the pizza industry also
apply to nations. Hong Kong and the United States
provide an interesting case study. 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 39 Economic Growth
Hong Kong Catching Up to
the United States
In 1968, the production possibilities per person in the
United States were more than four times those in Hong
Kong (see the figure). The United States devotes one
fifth of its resources to accumulating capital and in
1968 was at point A on its PPF. Hong Kong devotes
one third of its resources to accumulating capital and in
1968, Hong Kong was at point A on its PPF.
Since 1968, both countries have experienced
economic growth, but because Hong Kong devotes a
bigger fraction of its resources to accumulating capital,
its production possibilities have expanded more quickly.
By 2008, production possibilities per person in
Hong Kong had reached 94 percent of those in the
United States. If Hong Kong continues to devote
more resources to accumulating capital than we do
(at point B on its 2008 PPF ), it will continue to
grow more rapidly. But if Hong Kong decreases capital accumulation (moving to point D on its 2008
PPF ), then its rate of economic growth will slow.
Hong Kong is typical of the fast-growing Asian
economies, which include Taiwan, Thailand, South
Korea, and China. Production possibilities expand in
these countries by between 5 and almost 10 percent a
year. A Nation’s Economic Growth
The experiences of the United States and Hong
Kong make a striking example of the effects of our
choices about consumption and capital goods on
the rate of economic growth.
If a nation devotes all its factors of production to
producing consumption goods and services and none
to advancing technology and accumulating capital,
its production possibilities in the future will be the
same as they are today.
To expand production possibilities in the future, a
nation must devote fewer resources to producing
consumption goods and services and some resources
to accumulating capital and developing new technologies. As production possibilities expand, consumption in the future can increase. The decrease in
today’s consumption is the opportunity cost of
tomorrow’s increase in consumption. Capital goods (per person) Economic Growth 39 United States
in 2008 Hong Kong
in 2008 B D Hong
in 1968 A C A 0 United States
Consumption goods (per person) Economic Growth in the United States and Hong Kong If such high economic growth rates are maintained, these other Asian countries will continue to
close the gap between themselves and the United
States, as Hong Kong is doing. Review Quiz ◆
5 What generates economic growth?
How does economic growth influence the
production possibilities frontier?
What is the opportunity cost of economic growth?
Why has Hong Kong experienced faster economic growth than the United States?
Does economic growth overcome scarcity?
Work Study Plan 2.3
and get instant feedback. Next, we’re going to study another way in which
we expand our production possibilities—the amazing
fact that both buyers and sellers gain from specialization and trade. 9160335_CH02_p031-052.qxp 40 6/22/09 8:55 AM Page 40 CHAPTER 2 The Economic Problem ◆ Gains from Trade
People can produce for themselves all the goods and
services that they consume, or they can produce one
good or a few goods and trade with others.
Producing only one good or a few goods is called
specialization. We are going to learn how people
gain by specializing in the production of the good
in which they have a comparative advantage and
trading with others. Comparative Advantage and Absolute
A person has a comparative advantage in an activity if
that person can perform the activity at a lower opportunity cost than anyone else. Differences in opportunity costs arise from differences in individual abilities
and from differences in the characteristics of other
No one excels at everything. One person is an outstanding pitcher but a poor catcher; another person is
a brilliant lawyer but a poor teacher. In almost all
human endeavors, what one person does easily, someone else finds difficult. The same applies to land and
capital. One plot of land is fertile but has no mineral
deposits; another plot of land has outstanding views
but is infertile. One machine has great precision but
is difficult to operate; another is fast but often breaks
Although no one excels at everything, some people excel and can outperform others in a large number of activities—perhaps even in all activities. A
person who is more productive than others has an
Absolute advantage involves comparing productivities—production per hour—whereas comparative
advantage involves comparing opportunity costs.
Notice that a person who has an absolute advantage does not have a comparative advantage in every
activity. John Grisham is a better lawyer and a better
author of fast-paced thrillers than most people. He
has an absolute advantage in these two activities. But
compared to others, he is a better writer than lawyer,
so his comparative advantage is in writing.
Because ability and resources vary from one person to another, people have different opportunity
costs of producing various goods. These differences
in opportunity cost are the source of comparative
advantage. Let’s explore the idea of comparative advantage by
looking at two smoothie bars: one operated by Liz
and the other operated by Joe.
Liz’s Smoothie Bar Liz produces smoothies and sal- ads. In Liz’s high-tech bar, she can turn out either a
smoothie or a salad every 2 minutes—see Table 2.1.
If Liz spends all her time making smoothies, she can
produce 30 an hour. And if she spends all her time
making salads, she can also produce 30 an hour. If
she splits her time equally between the two, she can
produce 15 smoothies and 15 salads an hour. For
each additional smoothie Liz produces, she must
decrease her production of salads by one, and for
each additional salad she produces, she must decrease
her production of smoothies by one. So
Liz’s opportunity cost of producing 1 smoothie is
1 salad, and
Liz’s opportunity cost of producing 1 salad is
1 smoothie. Liz’s customers buy smoothies and salads in equal
quantities, so she splits her time equally between the
two items and produces 15 smoothies and 15 salads
Joe’s Smoothie Bar Joe also produces smoothies and
salads, but his bar is smaller than Liz’s. Also, Joe has
only one blender, and it’s a slow, old machine. Even if
Joe uses all his resources to produce smoothies, he
can produce only 6 an hour—see Table 2.2. But Joe
is good at making salads, so if he uses all his resources
to make salads, he can produce 30 an hour.
Joe’s ability to make smoothies and salads is the
same regardless of how he splits an hour between the
two tasks. He can make a salad in 2 minutes or a
smoothie in 10 minutes. For each additional smoothie TABLE 2.1
Item Liz’s Production Possibilities
produce 1 Quantity
per hour Smoothies 2 30 Salads 2 30 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 41 Gains from Trade TABLE 2.2
Salads Joe’s Production Possibilities
produce 1 Quantity
per hour 10 6 2 30 Joe produces, he must decrease his production of salads by 5. And for each additional salad he produces,
he must decrease his production of smoothies by 1/5
of a smoothie. So
Joe’s opportunity cost of producing 1 smoothie is
5 salads, and
Joe’s opportunity cost of producing 1 salad is
1/5 of a smoothie. Joe’s customers, like Liz’s, buy smoothies and salads
in equal quantities. So Joe spends 50 minutes of each
hour making smoothies and 10 minutes of each hour
making salads. With this division of his time, Joe
produces 5 smoothies and 5 salads an hour.
Liz’s Absolute Advantage Table 2.3(a) summarizes the production of Liz and Joe. You can see that Liz
is three times as productive as Joe—her 15 smoothies and salads an hour are three times Joe’s 5. Liz has
an absolute advantage over Joe in producing both
smoothies and salads. But Liz has a comparative
advantage in only one of the activities.
Liz’s Comparative Advantage In which of the two Achieving the Gains from Trade
Liz and Joe run into each other one evening in a singles bar. After a few minutes of getting acquainted, Liz
tells Joe about her amazing smoothie business. Her
only problem, she tells Joe, is that she would like to
produce more because potential customers leave when
her lines get too long.
Joe isn’t sure whether to risk spoiling his chances by
telling Liz about his own struggling business. But he
takes the risk. When he explains to Liz that he spends
50 minutes of every hour making 5 smoothies and 10
minutes making 5 salads, Liz’s eyes pop. “Have I got a
deal for you!” she exclaims.
Here’s the deal that Liz sketches on a table napkin.
Joe stops making smoothies and allocates all his time
to producing salads. And Liz stops making salads and
allocates all her time to producing smoothies. That is,
they both specialize in producing the good in which
they have a comparative advantage. Together they produce 30 smoothies and 30 salads—see Table 2.3(b). TABLE 2.3 Liz and Joe Gain from Trade (a) Before trade Liz Joe Smoothies 15 5 Salads 15 5 (b) Specialization Liz Joe Smoothies 30 0 0 30 Liz Joe Smoothies sell 10 buy 10 Salads
(c) Trade activities does Liz have a comparative advantage?
Recall that comparative advantage is a situation in
which one person’s opportunity cost of producing a
good is lower than another person’s opportunity cost
of producing that same good. Liz has a comparative
advantage in producing smoothies. Her opportunity
cost of a smoothie is 1 salad, whereas Joe’s opportunity cost of a smoothie is 5 salads. Salads buy 20 sell 20 (d) After trade Liz Joe Smoothies 20 10 Salads 20 10 Joe’s Comparative Advantage If Liz has a compara- (e) Gains from trade Liz Joe Smoothies +5 +5 Salads +5 +5 tive advantage in producing smoothies, Joe must have
a comparative advantage in producing salads. Joe’s
opportunity cost of a salad is 1/5 of a smoothie,
whereas Liz’s opportunity cost of a salad is 1 smoothie. 41 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 42 CHAPTER 2 The Economic Problem 42 The blue PPF in part (b) shows Liz’s production possibilities. Before trade, she is producing 15 smoothies
and 15 salads an hour at point A.
Liz’s proposal is that they each specialize in producing the good in which they have a comparative advantage. Joe produces 30 salads and no smoothies at point
B on his PPF. Liz produces 30 smoothies and no salads at point B on her PPF.
Liz and Joe then trade smoothies and salads at a
price of 2 salads per smoothie or 1/2 a smoothie per
salad. Joe gets smoothies for 2 salads each, which is less
than the 5 salads it costs him to produce a smoothie.
Liz gets salads for 1/2 a smoothie each, which is less
than the 1 smoothie that it costs her to produce a
With trade, Joe has 10 smoothies and 10 salads at
point C—a gain of 5 smoothies and 5 salads. Joe
moves to a point outside his PPF. They then trade. Liz sells Joe 10 smoothies and
Joe sells Liz 20 salads—the price of a smoothie is 2
salads—see Table 2.3(c).
After the trade, Joe has 10 salads—the 30 he produces minus the 20 he sells to Liz. He also has the 10
smoothies that he buys from Liz. So Joe now has
increased the quantities of smoothies and salads that
he can sell—see Table 2.3(d).
Liz has 20 smoothies—the 30 she produces minus
the 10 she sells to Joe. She also has the 20 salads that
she buys from Joe. Liz has increased the quantities of
smoothies and salads that she can sell—see Table
2.3(d). Liz and Joe both gain 5 smoothies and 5 salads
an hour—see Table 2.3(e).
To illustrate her idea, Liz grabs a fresh napkin and
draws the graphs in Fig. 2.6. The blue PPF in part (a)
shows Joe’s production possibilities. Before trade, he is
producing 5 smoothies and 5 salads an hour at point A. 30 The Gains from Trade
Salads (per hour) Salads (per hour) FIGURE 2.6
Joe buys 10
from Liz 20 30 Liz's
PPF 25 C 20 15 A 15 C 10 Trade line
Liz buys 20
Joe 10 Trade line A 5 5 Joe's
0 5 10 15 20 25
Smoothies (per hour) (a) Joe 0 5 10 15 20 25
Smoothies (per hour) (b) Liz Joe initially produces at point A on his PPF in part (a), and
Liz initially produces at point A on her PPF in part (b). Joe’s
opportunity cost of producing a salad is less than Liz’s, so
Joe has a comparative advantage in producing salads. Liz’s
opportunity cost of producing a smoothie is less than Joe’s,
so Liz has a comparative advantage in producing smoothies.
If Joe specializes in making salads, he produces 30 salads
and no smoothies at point B on his PPF. If Liz specializes in
animation making smoothies, she produces 30 smoothies and no salads at point B on her PPF. They exchange salads for
smoothies along the red “Trade line.” Liz buys salads from
Joe for less than her opportunity cost of producing them. Joe
buys smoothies from Liz for less than his opportunity cost of
producing them. Each goes to point C—a point outside his
or her PPF. Both Joe and Liz increase production by 5
smoothies and 5 salads with no change in resources. 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 43 Gains from Trade With trade, Liz has 20 smoothies and 20 salads at
point C—a gain of 5 smoothies and 5 salads. Liz
moves to a point outside her PPF.
Despite Liz’s absolute advantage in producing
smoothies and salads, both Liz and Joe gain from specializing—producing the good in which they have a
comparative advantage—and trading.
The gains that we achieve from international trade
are similar to those achieved by Joe and Liz in this
example. When Americans buy T-shirts from China
and when China buys Boeing aircraft from the
United States, both countries gain. We get our shirts
at a lower cost than that at which we can produce
them, and China gets its aircraft at a lower cost than
that at which it can produce them. Review Quiz ◆
5 What gives a person a comparative advantage?
Distinguish between comparative advantage
and absolute advantage.
Why do people specialize and trade?
What are the gains from specialization and
What is the source of the gains from trade?
Work Study Plan 2.4
and get instant feedback. 43 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 44 READING BETWEEN THE LINES The Rising Opportunity Cost of Food
Fuel Choices, Food Crises, and Finger-Pointing
April 15, 2008 The idea of turning farms into fuel plants seemed, for a time, like one of the answers to high
global oil prices and supply worries. That strategy seemed to reach a high point last year
when Congress mandated a fivefold increase in the use of biofuels.
But now a reaction is building against policies in the United States and Europe to promote
ethanol and similar fuels, with political leaders from poor countries contending that these
fuels are driving up food prices and starving poor people. …
In some countries, the higher prices are leading to riots, political instability, and growing
worries about feeding the poorest people. …
Many specialists in food policy consider government mandates for biofuels to be ill advised,
agreeing that the diversion of crops like corn into fuel production has contributed to the
higher prices. But other factors have played big roles, including droughts that have limited
output and rapid global economic growth that has created higher demand for food.
That growth, much faster over the last four years than the historical norm, is lifting millions
of people out of destitution and giving them access to better diets. But farmers are having
trouble keeping up with the surge in demand.
While there is agreement that the growth of biofuels has contributed to higher food prices,
the amount is disputed. …
C. Ford Runge, an economist at the University of Minnesota, said it is “extremely difficult
to disentangle” the effect of biofuels on food costs. Nevertheless, he said there was little
that could be done to mitigate the effect of droughts and the growing appetite for protein
in developing countries.
“Ethanol is the one thing we can do something about,” he said. “It’s about the only lever we
have to pull, but none of the politicians have the courage to pull the lever.” …
Copyright 2008 The New York Times Company. Reprinted with permission. Further reproduction prohibited. Essence of the Story
■ In 2007, Congress mandated a fivefold increase in the
use of biofuels. ■ Political leaders in poor countries and specialists in
food policy say the biofuel mandate is ill advised and
the diversion of corn into fuel production has raised the
cost of food. 44 ■ Drought that has limited corn production and global
economic growth that has increased the demand for
protein have also raised the cost of food. ■ An economist at the University of Minnesota says that
while it is difficult to determine the effect of biofuels on
food costs, it is the only factor under our control. 6/22/09 8:55 AM Page 45 Economic Analysis
■ Ethanol is made from corn in the United States, so biofuel and food compete to use the same resources. ■ To produce more ethanol and meet the Congress’s
mandate, farmers increased the number of acres devoted to corn production. ■ Other goods and services 9160335_CH02_p031-052.qxp A In the United States, the
opportunity cost of corn
increased because the
area planted and
production increased In 2008, the amount of land devoted to corn production increased by 20 percent in the United States and
by 2 percent in the rest of the world.
Figure 1 shows the U.S. production possibilities frontier, PPF, for corn and other goods and services. ■ The increase in the production of corn is illustrated by
a movement along the PPF in Fig. 1 from point A in
2007 to point B in 2008. ■ In moving from point A to point B, the United States incurs a higher opportunity cost of producing corn, indicated by the greater slope of the PPF at point B. ■ In other regions of the world, despite the fact that more
land was devoted to corn production, the amount of
corn produced didn’t change. ■ The reason is that droughts in South America and Eastern Europe lowered the crop yield per acre in those regions. ■ The rotation from PPF07 to PPF08 illustrates this decrease
in production possibilities. ■ The opportunity cost of producing corn in the rest of
the world increased for two reasons: the movement
along its PPF and the inward rotation of the PPF. ■ 300
Corn (millions of metric tons) In the rest of the world,
the opportunity cost of
corn increased because ... … the area planted
increased ... With a decrease in the crop yield, production possibilities decreased and the PPF rotated inward. ■ 250 Figure 1 U.S. PPF The increase in the amount of land devoted to producing corn is illustrated by a movement along the PPF07. ■ 0 Figure 2 shows the rest of the world‘s PPF for corn and
other goods and services in 2007 and 2008. ■ PPF Other goods and services ■ B With a higher opportunity cost of producing corn, the
cost of both biofuel and food increases. … and the yield
per acre decreased
0 350 PPF08 PPF07 400 420
Corn (millions of metric tons) Figure 2 Rest of the World PPF 45 9160335_CH02_p031-052.qxp 46 6/22/09 8:55 AM Page 46 CHAPTER 2 The Economic Problem SUMMARY ◆ Key Points
Production Possibilities and Opportunity Cost ■ ■ (pp. 32–34)
■ ■ The production possibilities frontier, PPF, is the
boundary between production levels that are
attainable and those that are not attainable
when all the available resources are used to
Production efficiency occurs at points on the PPF.
Along the PPF, the opportunity cost of producing
more of one good is the amount of the other good
that must be given up.
The opportunity cost of all goods increases as the
production of the good increases. Economic Growth (pp. 38–39)
■ ■ ■ ■ Allocative efficiency occurs when goods and
services are produced at the least possible cost
and in the quantities that bring the greatest
The marginal cost of a good is the opportunity
cost of producing one more unit of it.
The marginal benefit from a good is the
benefit received from consuming one more
unit of it, measured by the willingness to pay
for it. Economic growth, which is the expansion of production possibilities, results from capital accumulation and technological change.
The opportunity cost of economic growth is
forgone current consumption. Gains from Trade (pp. 40–43)
■ Using Resources Efficiently (pp. 35–37)
■ The marginal benefit of a good decreases as the
amount of the good available increases.
Resources are used efficiently when the
marginal cost of each good is equal to its
marginal benefit. ■ ■ A person has a comparative advantage in producing a good if that person can produce the
good at a lower opportunity cost than everyone
People gain by specializing in the activity in which
they have a comparative advantage and trading
Dynamic comparative advantage arises from
learning-by-doing. 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 47 Problems and Applications PROBLEMS and APPLICATIONS 47 ◆ Work problems 1–11 in Chapter 2 Study Plan and get instant feedback.
Work problems 12–21 as Homework, a Quiz, or a Test if assigned by your instructor. Food crops
(tons per day) 70
5 a. Draw a graph of Brazil’s PPF and explain how
your graph illustrates scarcity.
b. If Brazil produces 40 barrels of ethanol a day,
how much food must it produce if it achieves
c. Why does Brazil face a tradeoff on its PPF ?
d. If Brazil increases its production of ethanol
from 40 barrels per day to 54 barrels per day,
what is the opportunity cost of the additional
e. If Brazil increases its production of food crops
from 2 tons per day to 3 tons per day, what is
the opportunity cost of the additional food?
f. What is the relationship between your answers
to d and e?
g. Does Brazil face an increasing opportunity cost
of ethanol? What feature of the PPF that you’ve
drawn illustrates increasing opportunity cost?
2. Define marginal cost and use the information
provided in the table in problem 1 to calculate
the marginal cost of producing a ton of food
when the quantity produced is 2.5 tons per day.
3. Define marginal benefit, explain how it is measured, and explain why the information provided
in the table in problem 1 does not enable you to
calculate the marginal benefit of food.
4. Distinguish between production efficiency and
allocative efficiency. Explain why many production possibilities achieve production efficiency
but only one achieves allocative efficiency.
5. Harry enjoys tennis but wants a high grade in his Grade in economics (percent) Ethanol
(barrels per day) economics course. The figure shows the limits to
what he can achieve: It is Harry’s PPF for these
70 Harry's PPF 60 50 40 2 4 6
Tennis (hours per week) The following figure shows Harry’s MB curve for
Willingness to pay (percentage points per hour) 1. Brazil produces ethanol from sugar, and the land
used to grow sugar can be used to grow food
crops. Suppose that Brazil’s production possibilities for ethanol and food crops are as follows 10
2 0 2 4 6
Tennis (hours per week) a. What is Harry’s marginal cost of tennis if he
plays for (i) 3 hours a week; (ii) 5 hours a
week; and (iii) 7 hours a week?
b. If Harry uses his time to achieve allocative efficiency, what is his economics grade and how
many hours of tennis does he play?
c. Explain why Harry would be worse off getting
a grade higher than your answer to b.
d. If Harry becomes a tennis superstar with big
earnings from tennis, what happens to his
PPF, MB curve, and efficient time allocation? 9160335_CH02_p031-052.qxp 48 6/22/09 8:55 AM Page 48 CHAPTER 2 The Economic Problem e. If Harry suddenly finds high grades in economics easier to attain, what happens to his
PPF, MB curve, and efficient time allocation?
6. A farm grows wheat and produces pork. The
marginal cost of producing each of these products increases as more of it is produced.
a. Make a graph that illustrates the farm’s PPF.
b. The farm adopts a new technology that allows
it to use fewer resources to fatten pigs. Use
your graph to illustrate the impact of the new
technology on the farm’s PPF.
c. With the farm using the new technology described in b, has the opportunity cost of producing a ton of wheat increased, decreased, or
remained the same? Explain and illustrate
d. Is the farm more efficient with the new technology than it was with the old one? Why?
7. In an hour, Sue can produce 40 caps or 4 jackets
and Tessa can produce 80 caps or 4 jackets.
a. Calculate Sue’s opportunity cost of producing
b. Calculate Tessa’s opportunity cost of producing a cap.
c. Who has a comparative advantage in producing caps?
d. If Sue and Tessa specialize in producing the
good in which each of them has a comparative
advantage, and they trade 1 jacket for 15 caps,
who gains from the specialization and trade?
8. Suppose that Tessa buys a new machine for making jackets that enables her to make 20 jackets an
hour. (She can still make only 80 caps per hour.)
a. Who now has a comparative advantage in producing jackets?
b. Can Sue and Tessa still gain from trade?
c. Would Sue and Tessa still be willing to trade
1 jacket for 15 caps? Explain your answer.
9. “America’s baby-boomers are embracing tea for
its health benefits,” said The Economist (July 8,
2005, p. 65). The article went on to say: “Even
though the climate is suitable, tea-growing [in
the United States] is simply too costly, since the
process is labor-intensive and resists automation.”
Using this information:
a. Sketch a PPF for the production of tea and
other goods and services in India.
b. Sketch a PPF for the production of tea and other goods and services in the United States.
c. Sketch a marginal cost curve for the production of tea in India.
d. Sketch a marginal cost curve for the production of tea in the United States.
e. Sketch the marginal benefit curve for tea in the
United States before and after the baby-boomers
began to appreciate the health benefits of tea.
f. Explain why the United States does not produce tea and instead imports it from India.
g. Explain how the quantity of tea that achieves
allocative efficiency has changed.
h. Does the change in preferences toward tea
affect the opportunity cost of producing tea?
10. Brazil produces ethanol from sugar at a cost of
83 cents per gallon. The United States produces
ethanol from corn at a cost of $1.14 per gallon.
Sugar grown on one acre of land produces twice
the quantity of ethanol as the corn grown on an
acre. The United States imports 5 percent of its
ethanol consumption and produces the rest itself.
Since 2003, U.S. ethanol production has more
than doubled and U.S. corn production has
increased by 45 percent.
a. Does Brazil or the United States have a comparative advantage in producing ethanol?
b. Do you expect the opportunity cost of producing ethanol in the United States to have
increased since 2003? Explain why.
c. Sketch the PPF for ethanol and other goods
and services for the United States.
d. Sketch the PPF for ethanol and other goods
and services for Brazil.
e. Sketch a figure similar to Fig. 2.6 on p. 42 to
show how both the United States and Brazil
can gain from specialization and trade.
f. Do you think the United States has achieved
production efficiency in its manufacture of
ethanol? Explain why or why not.
g. Do you think the United States has achieved
allocative efficiency in its manufacture of
ethanol? Explain why or why not.
11. For 50 years, Cuba has had a centrally planned
economy in which the government makes the big
decisions on how resources will be allocated. Why
would you expect Cuba’s production possibilities
(per person) to be smaller than those of the
United States? What are the social institutions
that help the U.S. economy achieve allocative efficiency that Cuba might lack? 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 49 Problems and Applications 12. Suppose that Yucatan’s production possibilities are
Food Sunscreen (pounds per month) (gallons per month) 300
150 a. Draw a graph of Yucatan’s PPF and explain
how your graph illustrates a tradeoff.
b. If Yucatan produces 150 pounds of food per
month, how much sunscreen must it produce
if it achieves production efficiency?
c. What is Yucatan’s opportunity cost of producing 1 pound of food?
d. What is Yucatan’s opportunity cost of producing 1 gallon of sunscreen?
e. What is the relationship between your answers
to c and d?
f. Does Yucatan face an increasing opportunity
cost of food? What feature of a PPF illustrates
increasing opportunity cost and why does the
PPF that you have drawn not have this feature?
13. What is the marginal cost of a pound of food in
Yucatan in problem 12 when the quantity produced is 150 pounds per day? What is special
about the marginal cost of food in Yucatan?
14. In Yucatan, which has the production possibilities shown in the table in problem 12, preferences are described by the following table.
Sunscreen Willingness to pay (gallons per month) (pounds of food per gallon) 25
1 a. What is the marginal benefit from sunscreen
and how it is measured?
b. What information provided in the table above
and the table in problem 12 do we need to be
able to calculate the marginal benefit from
sunscreen in Yucatan?
c. Draw a graph of Yucatan’s marginal benefit
15. “Dr. Arata Kochi, the World Health
Organization malaria chief, ... [says that] eradication is counterproductive. With enough money,
he said, current tools like nets, medicines and
DDT could drive down malaria cases 90 percent. 49 ‘But eliminating the last 10 percent is a tremendous task and very expensive,’ Dr. Kochi said.
‘Even places like South Africa should think twice
before taking this path.’”
The New York Times, March 4, 2008
a. Is Dr. Kochi talking about production efficiency
or allocative efficiency or both?
b. Make a graph with the percentage of malaria
cases eliminated on the x-axis and the marginal
cost and marginal benefit of driving down
malaria cases on the y-axis. On your graph:
(i) Draw a marginal cost curve that is consistent with Dr. Kochi’s opinion reported in the
(ii) Draw a marginal benefit curve that is consistent with Dr. Kochi’s opinion reported in
the news article.
(iii) Identify the quantity of malaria eradicated
that achieves allocative efficiency.
16. Capital accumulation and technological change
bring economic growth, which means that the
PPF keeps shifting outward: Production that was
unattainable yesterday becomes attainable today;
and production that is unattainable today will
become attainable tomorrow. Why doesn’t this
process of economic growth mean that scarcity is
being defeated and will one day be gone?
17. “Inexpensive broadband access has done far more
for online video than enable the success of services like YouTube and iTunes. By unchaining
video watchers from their TV sets, it has opened
the floodgates to a generation of TV producers
for whom the Internet is their native medium.”
The New York Times, December 2, 2007
a. How has inexpensive broadband changed the
production possibilities of video entertainment and other goods and services?
b. Sketch a PPF for video entertainment and
other goods and services before broadband.
c. Show how the arrival of inexpensive broadband has changed the PPF.
d. Sketch a marginal benefit curve for video
e. Show how opening the “floodgates to a generation of TV producers for whom the Internet is
their native medium” might have changed the
marginal benefit from video entertainment.
f. Explain how the quantity of video entertainment that achieves allocative efficiency has
changed. 9160335_CH02_p031-052.qxp 50 6/22/09 8:55 AM Page 50 CHAPTER 2 The Economic Problem 18. Kim can produce 40 pies an hour or 400 cookies
an hour. Liam can produce 100 pies an hour or
200 cookies an hour.
a. Calculate Kim’s opportunity cost of producing
b. Calculate Liam’s opportunity cost of producing a pie.
c. Who has a comparative advantage in producing pies?
d. If Kim and Liam spend 30 minutes of each
hour producing pies and 30 minutes producing cookies, how many pies and cookies does
each of them produce?
e. Suppose that Kim and Liam increase the time
they spend producing the good in which they
have a comparative advantage by 15 minutes.
What will be the increase in the total number
of pies and cookies they produce?
f. What is the highest price of a pie at which
Kim and Liam would agree to trade pies and
g. If Kim and Liam specialize and trade, what are
the gains from trade?
19. Before the Civil War, the South traded with the
North and with England. The South sold cotton
and bought manufactured goods and food.
During the war, one of President Lincoln’s first
actions was to blockade the ports, which prevented this trade. The South had to increase its
production of munitions and food.
a. In what did the South have a comparative
b. Draw a graph to illustrate production, consumption, and trade in the South before the
c. Was the South consuming inside, on, or outside its PPF ? Explain your answer.
d. Draw a graph to show the effects of the Civil
War on consumption and production in the
e. Did the Civil War change any opportunity
costs in the South? Did the opportunity cost
of everything rise? Did any items cost less?
f. Illustrate your answer to e with appropriate
20. “A two-time N.B.A. All-Star, Barron Davis has
quietly been moonlighting as a [movie] producer since 2005, when he and a high school buddy,
Cash Warren, formed a production company
called Verso Entertainment.
In January, Verso's first feature-length effort,
“Made in America,” a gang-life documentary
directed by Stacy Peralta, had its premiere to
good reviews at Sundance Film Festival and is
being courted by distributors.”
The New York Times, February 24, 2008
a. Does Barron Davis have an absolute advantage
in basketball and movie directing and is this
the reason for his success in both activities?
b. Does Barron Davis have a comparative advantage in basketball or movie directing or both
and is this the reason for his success in both
c. Sketch a PPF between playing basketball and
producing other goods and services for Barron
Davis and for yourself.
d. How do you (and people like you) and Barron
Davis (and people like him) gain from specialization and trade?
21. After you have studied Reading Between the Lines
on pp. 46–47, answer the following questions:
a. How has an Act of the United States Congress
increased U.S. production of corn?
b. Why would you expect an increase in the
quantity of corn produced to raise the opportunity cost of corn?
c. Why did the cost of producing corn increase
in the rest of the world?
d. Is it possible that the increased quantity of
corn produced, despite the higher cost of production, moves the United States closer to
22. Use the links on MyEconLab (Textbook Resources,
Chapter 2, Weblinks) to obtain data on the tuition
and other costs of enrolling in the MBA program
at a school that interests you.
a. Draw a PPF that shows the tradeoff that you
would face if you decided to enroll in the
b. Do you think your marginal benefit of an
MBA exceeds your marginal cost?
c. Based on your answer to b, do you plan to enroll in an MBA program? Is your answer to
this question consistent with using your time
to achieve your self-interest? 9160335_CH02_p031-052.qxp 6/22/09 8:55 AM Page 51 PA RT ONE
UNDERSTANDING THE SCOPE OF ECONOMICS Your Economic Revolution
Three periods in human history stand out as ones of economic revolution. The first,
the Agricultural Revolution, occurred 10,000 years ago. In what is today Iraq, people
learned to domesticate animals and plant crops. People stopped roaming in search
of food and settled in villages, towns, and cities where they specialized in the activities in which they had a comparative advantage and developed markets in which to
exchange their products. Wealth increased enormously.
You are studying economics at a time that future historians will call the Information
Revolution. Over the entire world, people are embracing new information technologies and prospering on an unprecedented scale.
Economics was born during the Industrial Revolution, which began in England
during the 1760s. For the first time, people began to apply science and create new
technologies for the manufacture of textiles and iron, to create steam engines, and
to boost the output of farms.
During all three economic revolutions, many have prospered but many have
been left behind. It is the range of human progress that poses the greatest question
for economics and the one that Adam Smith addressed in the first work of economic science: What causes the differences in wealth among nations? Many people had written about economics before Adam
Smith, but he made economics a science. Born in 1723
in Kirkcaldy, a small fishing town near Edinburgh, Scotland, Smith was the only child of the town’s customs officer. Lured from his professorship (he was a full professor at
28) by a wealthy Scottish duke who gave him a pension of
£300 a year—ten times the average income at that
time—Smith devoted ten years to writing his masterpiece:
An Inquiry into the Nature and Causes of the Wealth
of Nations, published in 1776.
Why, Adam Smith asked , are some nations wealthy
while others are poor? He was pondering these questions at
the height of the Industrial Revolution, and he answered
by emphasizing the role of the division of labor and free
To illustrate his argument, Adam Smith described two
pin factories. In the first, one person, using the hand tools
available in the 1770s, could make 20 pins a day. In the
other, by using those same hand tools but breaking the
process into a number of individually small operations in
which people specialize—by the division of labor—ten
people could make a staggering 48,000 pins a day. One “It is not from the benevolence of the butcher, the
brewer, or the baker that
we expect our dinner, but
from their regard to their
The Wealth of Nations draws out the wire, another
straightens it, a third cuts it, a
fourth points it, a fifth grinds
it. Three specialists make the
head, and a fourth attaches it.
Finally, the pin is polished and
But a large market is needed to support the division of
labor: One factory employing ten workers would need to
sell more than 15 million pins a year to stay in business!
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This note was uploaded on 02/07/2010 for the course ECON 251 taught by Professor Blanchard during the Fall '08 term at Purdue.
- Fall '08