CHAPTER NO: 02

“PRODUCTION, GROWTH
AND TRADE”
By Ms. Paras Channar
Lecture outline
 The production possibility frontier.
 Economic growth.
 Gain from specialization.
 The evolution of trading arrangements.
Key Terms
 Absolute advantage: A person has an absolute
advantage in the production of the product if
he or she is more productive than another
person in the production of that product.
 Barter: The direct exchange of goods for goods
 Capital accumulation: The growth of capital
resources.
 Comparative advantage: A person has a
comparative advantage in producing a product if
he or she can produce that product at lower
opportunity cost than anyone else.
Key Terms
 Economic growth: The persistent expansion of
a country’s production possibilities.
 Human capital: The accumulated skills and
knowledge of human being. The value of
education and acquired skills.
 Money: A medium of exchange.
 Production possibility frontier: The boundary
between attainable and unattainable level of
production.
Key Terms
 Productivity: The output per unit of input.
 Property rights: the social arrangement that
govern the ownership, use and disposal of
property.
 Technological efficiency: The state in which it
is not possible to increase output without
increase input.
 Technological progress: The development of new
and better ways of producing goods and
services.
Lecture outline
 The production possibility frontier.
 Economic growth.
 Gain from specialization.
 The evolution of trading arrangements.
The production possibility frontier

 Production is conversion of Land, Labour and

Capital into goods and services.
 Labour: The time and effort that we devote to
producing goods and services.
 Land: The gifts of nature that we use to produce
goods and services.
Capital: The goods we use to produce other goods and
services.
 Includes physical capital
 interstate highways, buildings, and dams
 and human capital
 the knowledge and skill that people obtain from education
and on-the-job training
Entrepreneurship
The resource that organizes labor, land, and
capital.
Goods and Services
 There are two types of goods;
Capital Goods: are goods that are used in the
production process and can be used many time
before they eventually wear out. Like building,
computers
Consumption Goods: are goods which are used for
once like: toothpaste
 The amount that we can produce is limited
buy our resources and the technologies
available for transforming those resources into
goods and services. That limit described by
the production possibility frontier. The PPF
marks the boundary those combinations of
goods and services that can be produced and
those cannot.
Example of PPF
 Tapes Soda
 (millions (millions of bottles
 Possibility per month) per mon

a 0 and 15
b 1 and 14
c 2 and 12
d 3 and 9
e 4and 5
f 5 and 0
Graph
What is the production possibility
frontier?
 The production possibility frontier (PPF) is
the boundary between attainable and
unattainable level of production.
 Point on PPF and inside is attainable.
 Point outside the PPF is unattainable.
 A large number of production points are
feasible but not all are efficient.
 There are two concept of efficiency,
technological and economics.
Cont…
 Points on the PPF are technologically
efficient and points inside it are inefficient.
 Economic efficiency means that not only is
the output mix technologically efficient but
also consumers prefer the goods and services
in the combination.
Lecture outline
 The production possibility frontier.
 Economic growth.
 Gain from specialization.
 The evolution of trading arrangements.
Economic Growth
 The expansion of our production possibilities is
called Economic Growth.
The production possibility frontier that define the
boundary between what is attainable and what is
unattainable is not static. It is constantly changing
some times the production possibility frontier shift
inward, reducing our production possibilities. For
example extreme climatic conditions can shift the
frontier inward, at other times the frontier move
outward, for example, excellent growing and harvest
conditions have this effect. Some times frontier
shifts outward because we have new idea.
Two activities of economic growth

 Technological Progress: is the development of

new and better ways of producing Goods and
services.
 Capital Accumulation: is the growth of capital
resources.
Efficiency
 Technological Efficiency: is achieved when no
productive resources are being wasted.
 Economic efficiency: is a situation in which
production cost are as low as possible and
consumer want combination of goods and
services that is produced
Economic Growth
c
Tape-making machines (per month)
10

8
If we
b b' produce 6
6 machines
a month (b), then
the PPF rotates.
4 We will be able
to produce more
tapes in the
2 PPF0 future.
PPF 1

a a'
1 2 3 4 5 6 7
Tapes (millions per month)
Economic Growth in the
United States and Hong Kong

Since 1960, Hong Kong has grown more

rapidly than the United States.

Hong Kong has devoted a bigger fraction of

its resources to accumulating capital.
Economic Growth in the
United States and Hong Kong

Capital goods (per person) United States

and Hong Kong
United States in 1998
in 1960
b

Hong Kong
in 1960
c
a a

0 Consumption goods (per person)

What are the costs of economic
growth?
 Economic growth result from technological
changes and capital accumulation.
 The opportunity cost of faster economic
growth is a decrease in current consumption.
 By producing fewer consumption goods and
services we can devote more resources to
development new technologies and to
accumulating capital.
Lecture outline
 The production possibility frontier.
 Economic growth.
 Gain from specialization.
 The evolution of trading arrangements.
Gains from Trade

Comparative Advantage
A person or nation has a comparative
advantage in an activity if one/it can perform
an activity at a lower opportunity cost than
others.
Why is there a difference?
 Differences in abilities
 Differences in resource characteristics
Comparative Advantage
Tom’s Factory
Can produce 4,000 lengths of tape/hour or
Can produce 1,333 cases/hour

Opportunity Cost
To produce 1 case, he must decrease tape
production by 3 lengths — opportunity cost.
To produce 1 length of tape, he must decrease
case production by 0.333 case — opportunity
cost.
Comparative Advantage
Nancy’s Factory
Can produce 1,333 lengths of tape/hour or
Can produce 4,000 cases/hour

Opportunity Cost
To produce 1 case, she must decrease tape
production by 0.333 lengths — opportunity cost.
To produce 1 length of tape, she must decrease
case production by 3 cases — opportunity cost.
Why do people specialize and how
can they gain from trade?
 Production can be increased if people specialize
in the activity in which they have a comparative
advantage.
 A person has a comparative advantage in
producing a good if that persons opportunity cost
of producing the good is lower than anyone else.
 Difference in opportunity cost are the source of
gain from specialization and trade.
 If a person can produce all goods with fewer
input than some one else, that is, is more
productive,, that person has an absolute advantage.
Cont..
 Even people with an absolute advantage gain
by specializing in the activities in which they
have a comparative advantage.
 Countries also possess comparative advantage
in different activities, and their presence is
the basis of international exchange of goods
and services.
Lecture outline
 The production possibility frontier.
 Economic growth.
 Gain from specialization.
 The evolution of trading arrangements.
Absolute Advantage

 An absolute advantage exists when a person

or nation can produce more of a good than
another.
 Individuals and nations can have absolute
advantages in any or all goods.
 However, it is not possible to have a
comparative advantage in everything.
Dynamic Comparative Advantage

 People or nations can become more

productive simply by repetition --learning-
by-doing.
 Dynamic Comparative Advantage results from
learning-by-doing.
 Examples: Hong Kong, South Korea, Taiwan
The Market Economy

Two key social institutions organize trade

among nations.
Property rights:
 Real
 Financial
 Intellectual
The Market Economy

Two key social institutions organize trade

among nations.
Markets
A market is any arrangement that
enables buyers and sellers to get
information and to do business with
each other.
Circular Flows in the
Market Economy
The Market Economy

Coordinating Decisions
Markets coordinate individual decisions
through price adjustments.
Why do trading arrangement evolve?

 There are gain from trade and specialization, but

trade requires the development of property
rights.
 In a world without property rights, the gain from
specialization and exchange would be much
reduced.
 To overcome these problems. Property rights have
evolved.
 Exchange via barter does occur, but it is in
efficient money has evolved as a more efficient
alternative medium of exchange.
The End