Lecture Notes: Trade-offs, Comparative Advantage, and Market Systems

Key Concepts

Scarcity and Trade-offs

• Scarcity: Unlimited wants but limited resources.
• Trade-offs: Necessary due to scarcity.
• Example: Tesla must decide between producing sedans and SUVs with limited resources.

Production Possibilities Frontier (PPF)

• PPF: A curve that shows maximum attainable combinations of products given current resources and technology.
• Positive Tool: Shows what is possible (not what should be).
• Efficiency:
  • Points on PPF: Efficient.
  • Points inside PPF: Inefficient (underutilizing resources).
  • Points outside PPF: Unattainable with current resources.
• Opportunity Cost: The highest valued alternative given up to engage in an activity.

Trade-offs Example

• Tesla Example: Moving production from sedans to SUVs involves opportunity costs.
• Linear PPF: Constant opportunity costs.
• Bowed PPF: Increasing marginal opportunity costs.
  • The more resources already devoted to an activity, the smaller the payoff to devoting additional resources to that activity.

Economic Growth and Technological Change

• Economic Growth: Expands the PPF outward, making previously unattainable points attainable.
• Technological Change: Can shift the PPF, affecting one industry (e.g., automobiles) and increasing production capacity.

Comparative Advantage

Concept

• Comparative Advantage: Ability to produce a good at a lower opportunity cost than others.
• Absolute Advantage: Ability to produce more of a good using the same resources.

Example Scenario

• You and Neighbor: Picking apples and cherries.
  • You: 20 pounds of either apples or cherries.
  • Neighbor: 30 pounds of apples or 60 pounds of cherries.
• Specialization and Trade:
  • Specialization increases consumption for both parties beyond their individual PPFs.
  • Trade Benefits: Both parties benefit from trade due to comparative advantage even if one has an absolute advantage in both goods.

Opportunity Costs

• Your Opportunity Costs:
  • 1 pound of apples = 1 pound of cherries (20:20 ratio).
• Neighbor's Opportunity Costs:
  • 1 pound of apples = 2 pounds of cherries (30:60 ratio).
  • 1 pound of cherries = 0.5 pounds of apples.

Basis for Trade

• Comparative Advantage: Drives trade.
• Specialize in goods where you have the lowest opportunity cost.

Conclusion

• Mutual Gains: Both individuals and countries can benefit from specialization and trade based on comparative advantage.
• Study Tips: Understand the PPF and opportunity cost concepts deeply to grasp comparative advantage effectively.