Production Possibilities Curve
The PPC illustrates which two economic concepts?
Scarcity and trade-offs
True or false: A country can have absolute advantage in both goods but still benefit from trade. Explain your reasoning.
True. The country still benefits from trade because of comparative advantage, focusing resources on what it's relatively best at (lowest opportunity cost) and trading for other goods. Specialization and trade allow a country to consume outside its own production possibilities.
Country X can make 20 bikes or 5 computers.
What is the opportunity cost of 1 bike?
1/4 computers (.25)
The law of demand states what relationship between price and quantity demanded?
Inverse relationship.
What is the “invisible hand” according to Adam Smith?
Individuals acting in their own self-interest unintentionally benefit society.
A point inside the PPC represents what?
Inefficient use of resources / unemployment.
Specialization leads to what benefit when countries trade?
More total output / increased efficiency.
Country A produces 40 apples or 20 oranges.
Country B produces 30 apples or 30 oranges.
Who has the absolute advantage in oranges? Why?
Country B (30 > 20).
What causes a movement along the demand curve?
A change in price.
Two questions: What is the term for the total monetary amount of goods and services produced in an economy in 1 year? Why do economists use this measurement?
What two things can shift a PPC outward?
Increased quantity or quality of resources or better technology.
Trade is beneficial when each party produces the good for which it has what?
Comparative advantage (lowest opportunity cost).
Country A: 12 laptops or 24 shoes
Country B: 6 laptops or 18 shoes
Who has the comparative advantage in shoes?
A: 1 shoe costs 1/2 (0.5) laptops
B: 1 shoe costs 1/3 (0.33) laptops
Answer: Country B.
Name one determinant that shifts supply AND provide a scenario.
Input costs, technology, number of sellers, expectations, or taxes/subsidies.
The circular flow model illustrates the interaction between which two markets?
The product market and the resource (factor) market.
If a PPC is bowed out, what does that indicate about opportunity cost? Why?
Opportunity cost is increasing due to specialized resources (as you produce more of one good, you must give up increasingly larger amounts of the other good
Country A’s OC of 1 pen = 2 pencils.
Country B’s OC of 1 pen = 4 pencils.
Give an acceptable terms of trade for 1 pen.
Between 2 and 4 pencils (e.g., 1 pen for 3 pencils).
You already calculated:
Country A’s opportunity cost of 1 shoe = 1/2 (0.5) laptops
Country B’s opportunity cost of 1 shoe = 1/3 (0.33) laptops
Based on the opportunity costs above, what would be an acceptable terms of trade (TOT) for 1 shoe that benefits both countries?
Give a range and an example of a specific trade ratio that would work.
To benefit both:
The price must be higher than B’s OC (0.33 laptops)
And lower than A’s OC (0.5 laptops)
So:
Acceptable Terms of Trade Range:
1 shoe = between 0.33 and 0.5 laptops
Example of acceptable trade:
1 shoe for 0.4 laptops (benefits both countries)
How does a decrease in input costs affects supply?
Supply increases (shifts right).
Name two characteristics of a free-market economy.
Competition, private property, voluntary exchange, or self-interest.
The U.S.A. can produce 30 tons of wheat or 10 tons of sugar. What is the opportunity cost of 1 ton of wheat?
1 ton of wheat costs 1/3 of sugar.
If a country refuses to specialize despite having comparative advantage, what is the main economic consequence?
It produces inside its potential consumption possibilities—lost efficiency and lower total output.
Country D: 30 cookies or 15 cakes
Country E: 20 cookies or 10 cakes
Q: Who has the comparative advantage in cakes?
D: 1 cake costs 2 cookies
E: 1 cake costs 2 cookies
Answer: Neither—same OC.
If demand increases and supply decreases, what happens to equilibrium price and quantity?
Price increases and quantity is indeterminate.
What is the term for an economy where the price of a good is less than the equilibrium price AND what will this economy need to do to resolve this issue?
Shortage, price will need to increase to eliminate the shortage and restore equilibrium.