Effect of International Trade and Specialization on PPC (summary)

Production possibilities analysis implies that a nation is limited to the combinations of output indicated by its production possibilities curve. But we must modify this principle when international specialization and trade exist.

An economy can avoid, through international specialization and trade, the output limits imposed by its domestic production pos­sibilities curve. International specialization means directing domestic resources to out­put that a nation is highly efficient at producing. International trade involves the exchange of these goods for goods produced abroad. Specialization and trade enable a nation to get more of a desired good at less sacrifice of some other good. Specialization and trade have the same effect as having more and better resources or discovering improved production techniques; both increase the quan­tities of capital and consumer goods available to society.

Advertisement

Important Assumptions Related to Production Possibilities Curve

Let’s now discard the first three assumptions underlying the production possibili­ties curve and see what happens.

Unemployment and Productive Inefficiency

    The first assumption was that our economy was achieving full employment and pro­ductive efficiency. Our analysis and conclusions change if some resources are idle (unemployment) or if least-cost production is not realized.Any points on PPC represent maximum outputs possible to be produced; they illustrate the combinations of goods that can be produced when the economy is operating at full capacity—with full employment and productive efficiency. With unemployment or inefficient pro­duction, the economy would produce less than each alternative shown in the table.

Graphically, we represent situations of unemployment or productive inefficiency by points inside the original production possibilities curve.  A move toward full employment and pro­ductive efficiency would yield a greater output of one or both products.

A Growing Economy

   When we drop the assumptions that the quantity and quality of resources and tech­nology are fixed, the production possibilities curve shifts positions—that is, the potential maximum output of the economy changes.

INCREASES IN RESOURCE SUPPLIES

    Although resource supplies are fixed at any specific moment, they can and do change over time. For example, a nation’s growing population will bring about increases in the supplies of labour and entrepreneurial ability. Also, labour quality usually improves over time. Historically, the economy’s stock of capital has increased at a significant, though unsteady, rate. And although we are depleting some of our energy and mineral resources, new sources are being discovered. The development of irrigation programs, for example, adds to the supply of arable land.

The net result of these increased supplies of the factors of production is the ability to produce more goods . Thus, 20 years from now, there  may be greater abundance of resources ,therefore, this will result in a greater potential output of one or both products at each alternative. Soci­ety will have achieved economic growth in the form of an expanded potential output.

But such a favourable change in the produc­tion possibilities data does not guarantee that the economy will actually operate at a point on its new production possibilities curve. Some 15 million jobs will give China full employment now, but 10 or 20 years from now its labour force will be larger, and 15 million jobs will not be sufficient for full employment. The produc­tion possibilities curve may shift, but at the future date the economy may fail to produce at a point on that new curve.

ADVANCES IN TECHNOLOGY

     Our second assumption is that we have constant, unchanging technology. In reality, technology has progressed dramatically over time. An advancing technology brings both new and better goods and improved ways of producing them. For now, let’s think of technological advances as being only improvements in capital facilities— more efficient machinery and equipment. These advances alter our previous dis­cussion of the economic problem by improving productive efficiency, thereby allowing society to produce more goods with fixed resources. As with increases in resource supplies, technological advances make possible the production of more goods.

Thus, when either supplies of resources increase or an improvement in technol­ogy occurs, the production possibilities curve shifts outward and to the right. Such an outward shift of the production possibilities curve represents growth of economic capacity or, sim­ply, economic growth: the ability to produce a larger total output. This growth is the result of (1) increases in supplies of resources, (2) improvements in resource qual­ity, and (3) technological advances.

The consequence of growth is that our full-employment economy can enjoy a greater output of goods. While a static, no-growth economy must sac­rifice some of one product in order to get more of another, a dynamic, growing economy can have larger quantities of  products.

Economic growth does not ordinarily mean proportionate increases in a nation’s capacity to produce all its products.

Terms:

ECONOMIC Growth An outward shift in the production possibil­ities curve that results from an increase in resource supplies or quality or an improvement in technology.

Allocative Efficiency

So far, we have assumed full employment and productive efficiency, both of which are necessary to realize any point on an economy’s production possibilities frontier. We now turn to allocative efficiency, which requires that the economy produce at the most valued, or optimal, point on the production possibilities curve. Of all the attainable combinations of goods which is best? That is, what specific quantities of resources should be allocated to good “A” and what quantity to good B in order to maximize satisfaction?

Our discussion of the economic perspective before puts us on the right track. Recall that economic decisions centre on comparisons of marginal benefits and mar­ginal costs. Any economic activity—for example, production or consumption— should be expanded as long as marginal benefit exceeds marginal cost and should be reduced if marginal cost exceeds marginal benefit. The optimal amount of the activity occurs where MB = MC.

We already know from the law of increasing opportunity costs that the marginal cost (MC) of additional units of good “A” will rise as more units are produced. This can be shown by an upsloping MC curve. We also know that we obtain extra or marginal benefits (MB) from additional units of good “A”. However, although material wants in the aggregate are insatiable, studies reveal that the second unit of a particular product yields less additional benefit to a person than the first. And a third provides even less MB than the second. So it is for society as a whole. We therefore can portray the marginal benefits from pizzas with a downsloping MB curve. Although total benefits rise when soci­ety consumes more good “A”, marginal benefits decline.

The optimal quantity of good “A” production is indicated by the intersection of the MB and MC curves. Why is this the optimal quantity? If less good “A” was produced, the marginal benefit of it would exceed its marginal cost. . This suggests that society would be underallocating resources to good “A” production and that more of it should be produced.

When MB = MC, the benefits of producing good “A” or alternative products with the available resources are equal. Allocative efficiency is achieved where MB = MC. The production more good “A” would represent an overallocation of resources to its production.

Generalization: Resources are being efficiently allocated to any product when the mar­ginal benefit and marginal cost of its output are equal (MB = MC).