AP_Macro_Unit_1_Activity_2 - UNIT 1 Macroeconomics LESSON 1 I ACTIVITY 2 Opportunity Cost and Comparative Advantage People who dont know much about

AP_Macro_Unit_1_Activity_2 - UNIT 1 Macroeconomics LESSON 1...

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Advanced Placement Economics Macroeconomics: Student Activities© National Council on Economic Education, New York, N.Y.91MacroeconomicsLESSON 1ACTIVITY 2UNITPeople who dont know much about economics often dismiss economics as being little more thancost/benefit analysis. While it is true that this is a very important concept, economics is not that sim-ple. In fact, one of the most difficult concepts in economics is understanding the opportunity cost ofchoosing a particular action.We have seen that economic entities such as countries often face increasingopportunity costs as they tryto increase production. For instance, when a country finds itself at war and needs to increase its pro-duction of armaments, at first it finds that increasing military production comes at a relatively low oppor-tunity cost, as the first factories converted to military use are generally well-suited for such an event.As the war goes on, however, we see factories that are not at all well-suited to producing weaponsbeing converted to military use, at a very high opportunity cost. Little is added to the output of arma-ments, and a great deal is sacrificed in terms of consumer goods.The notion of increasing opportunity costs is manifested in a production possibilities curve that isconcave towards the origin. In Figure 2.1, we can see that as we increase the production of military goods,each additional unit of output costs more in terms of civilian goods. When the government initiallyOpportunity Cost and Comparative AdvantageCIVILIAN GOODS IN BILLIONS OF DOLLARSMILITARY GOODS IN BILLIONS OF DOLLARS450500550600500100150200250300350400650700660201030405060708090Figure 2.1Production Possibilities Curve: Military and Civilian GoodsActivity written by Ike Brannon, Joint Economic Committee, U.S. Senate, Washington, D.C.
10Advanced Placement Economics Macroeconomics: Student Activities© National Council on Economic Education, New York, N.Y.1MacroeconomicsLESSON 1 ACTIVITY 2 (continued)UNITincreases the output of military goods from $20 billion to $30 billion, the opportunity cost (in terms ofcivilian goods forgone) is small: only $10 billion of military goods ($660 billion minus $650 billion).However, when the country is already producing a lot of military goods and wants to produce evenmore, the cost is much higher. If the country is producing $70 billion and wants to produce $80 bil-lion, the opportunity cost is now $200 billion, or $600 billion minus $400 billion.Opportunity cost also explains the incredible amount of trade that goes on among individuals, firmsand countries. Today, of course, few of us produce our own goods and services; we rely on others to dothis while we use our time earning money at a job. Instead of making our goods, we buy them. Com-puter manufacturers actually produce few of their own parts, but instead buy parts from suppliers.

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