Economic models

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The production possibility frontier


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Activities

Principles of Microeconomics: "Chapter 2, Sections 1 and 2"

  • Read Sections 2.1 and 2.2 . Take a moment to read through the stated learning outcomes for this chapter, which you can find at the beginning of each section. These outcomes should be your goals as you read through the chapter. Also, attempt the "Try It" problems for each section before checking your answers. The first section of the chapter will introduce you to the four factors of production that are present in the economy: labor, capital, natural resources, and entrepreneurship. Using any two factors of production, you can then learn to construct the production possibility frontier (PPF) in a two plane model. Note the economic implications of the downward slope and the bowed-out shape of the PPF curve. Also, note the meaning of producing on the curve versus inside the curve. Lastly, think about what it means to move along the curve.

Khan Academy: "Production Possibilities Frontier"

  • Watch this video about the production possibilities frontier.

Khan Academy: "Allocative Efficiency and Marginal Benefit"

  • Watch this video about allocative efficiency and marginal benefit.

Khan Academy: "Economic Growth through Investment"

  • Watch this video about economic growth through investment.



Comparative advantage vs. absolute advantage

This model is an application of the production possibility frontier studied in the previous section, albeit in a global set-up. In this subunit, we will bring the argument for international trade, specialization, comparative advantage, and the resulting economic growth to light. The mechanics of comparative advantage will reveal why it would benefit a country to import goods it produces at home.


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Activities

Khan Academy: "Comparative Advantage Specialization and Gains from Trade"

  • Watch this video about comparative advantage specialization and gains from trade.

OpenStax College: "Principles of Microeconomics, Section 19.1: Absolute and Comparative Advantage"

  • Read this section, which covers the underlying meaning of the model of comparative advantage.

Khan Academy: "Comparative Advantage and Absolute Advantage"

  • Watch this video about comparative advantage and absolute advantage.



Analyzing advantage

Absolute and comparative advantage is a difficult topic, challenging you to use analytical reasoning to explore what absolute advantage and comparative advantage actually mean, what opportunity costs are, and the real choices that national economies have to make.

The statements "I absolutely have an advantage" and "I have an absolute advantage" have very different meanings. Likewise, consider how an economist might think differently about the statements, "Compared to me you have an advantage" and "I have a comparative advantage in producing food." For economists, the word "compare" is different in meaning from "comparative", especially when discussing advantage.

Keep these definitions handy. To define an absolute advantage among paired countries you need:

  • two producers,
  • one product, and
  • equal access to equivalent "inputs."

To define a comparative advantage among paired countires, you need:

  • two producers,
  • two products, and
  • the "price" of one product in terms of the other.

The opportunity cost of each product ought to be expressed in terms of how much of the other product is given up to produce it. You will note there is no mention of this value in terms of a currency, like the dollar, or talk about costs other than in terms of amount of input used or amount of input given up. We're not quite at the point where we're talking about money or profit.

Time, however, is always a variable in all economic considerations. Early in your exploration of economics, the best way to understaind things, bit-by-bit, is to keep time constant for now. Time is not an input. Labor is; materials are; but time is not. One last assumption requires clarification. We assumed that all available resources are dedicated to producing either food or clothing. There is no excess capacity! And to make the math easier we also assumed that their production frontiers are limited. As your study of economics continues, you will encounter ideas which complicate those assumptions!


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Activities

Saylor Academy: "Analyzing Advantage Data Tables and Graphs"

  • Review this spreadsheet, which presents a hypothetical yet conceptually realistic illustration of the choices that countries face when exploring trade and productive specialization.