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Econ101 Chapter2 Fall2022
Econ101 Chapter2 Fall2022
• A person has a comparative advantage in producing a good or service if the opportunity cost of
their production is lower than someone else. Liz has a comparative advantage in producing
smoothies, but Joe has a comparative advantage in producing salads. ACOMPARATIVE
PERSON WHOS OPP COST IS LESS HAS THE
ADVANTAGE
• A person who has an absolute advantage in an activity, does not necessarily have a comparative
advantage in that activity.
Gains from trade
• Gains from trade can be achieved if factors of production (land, labour, capital,
entrepreneurship) specialize in the production of the goods and services in which they have a
comparative advantage.
Gains from trade
• The gains from trade from specialization are 5 smoothies and 5 salads for both Liz and Joe.
The Joe-Liz economy and its PPF
• Through specialization, Joe and Liz can expand
their combined PPF.
• When Canada’s millions of workers, acres of
land, machines and entrepreneurs are put to the
uses in which they have a comparative
advantage, Canada’s productive capacity can
reach its full potential. In other words, its PPF
can expand outwards as much as possible.
• Although Joe and Liz have linear individual PPFs,
their combined PPF is bowed outward. In a
country with millions of factors of production
specializing, the economy’s PPF is smoothly
outward-bowed.
Economic growth
• Economic growth comes from technological
change and capital accumulation.
• Technological change is the development of
new goods and services and more efficient
ways of producing existing goods and
resources using available resources.
• Capital accumulation is the growth of capital
resources, including human capital (the skills
of people).
• By foregoing pizzas today to produce more
pizza ovens, we can expand our PPF outward
in the future.
Hong Kong overtakes Canada
• In 1996, production possibilities per person
were three times bigger in Canada than in
Hong Kong. Canada was devoting one-fifth of
national production to capital goods and
Hong Kong one-third. They were both at A.
• Because Hong Kong invested more in capital
accumulation, by 2016 its production
possibilities per person had overtaken
Canada’s. Hong Kong went from A to B, while
Canada went from A to C.
• If Hong Kong decreases its capital
accumulation (moves to point D), its
economic growth will slow.
Economic growth and what we produce (1)
• When a country is very poor, people’s
marginal benefit of food is extremely high, so
production is highly concentrated in
agriculture.
• As countries invest in capital and technology,
its PPF expands and they can easily satisfy
the food demands of its population, so
growth in production is concentrated in
industry (manufactured goods).
• In China, where production per person is 7
times that of Ethiopia, agriculture is only 9
percent of total production, compared to 36
in Ethiopia.
Economic growth and what we produce (2)
• As China continues to invest in capital and
technology, its PPF will approach that of
Canada, where production per person is 4
times its level in China.
• As society’s needs for manufactured goods
are satisfied, labour is released from industry
to service production. The share of production
in agriculture now drops to only 29%.
• The shift from manufacturing to service jobs
creates hardship for many workers who lack
the skills needed for the new jobs.
Economic coordination
• For 7.5 billion people in the world to specialize and produce millions of different goods in a
socially efficient way, their productive activities must somehow be coordinated. Who is
responsible for this coordination?
• Coordination in a capitalist market economy relies on four complementary social institutions:
1. Firms: an economic unit that employs factors of production to produce goods and services.
2. Markets: any arrangement that allows buyers and sellers to get information and do business
with each other.
3. Property rights: regulations which govern the ownership, use and disposal of the good,
services and resources that people value.
4. Money: any commodity or token that is accepted as a means of payment.
Circular flows through the economy
• Households and firms make choices and
markets coordinate their choices.
• Households make two types of choices:
1. How much labour, land, capital, and
entrepreneurship to sell to firms.
2. What and how many goods and
services to consume.
• Firms also make two types of choices:
1. How much labour, land, capital, and
entrepreneurship to employ; and
2. What and how many goods and services
to produce.
• The green flows are the payments for the red
flows. Markets coordinate these exchanges
through price adjustments.