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The Production Possibility Model, Trade, and Globalization

Learning Objectives


  1. Demonstrate opportunity cost with a production possibility curve.

  2. State the principle of increasing marginal opportunity cost.

  3. Relate the concept of comparative advantage to the production possibility curve.

  4. State how, through comparative advantage and trade, countries can consume beyond their production possibilities.

  5. Explain how globalization and outsourcing are part of a global process guided by the law of one price.

Chapter Summary

The production possibilities model shows us that we are faced with scarcity (because we are unable to have as much as we would like), that choices have to be made between different combinations of production possibilities, and that whenever a choice is made an opportunity cost is involved. In addition, when countries trade based on their comparative advantages, their combined production and consumption possibilities increase. They are able to consume more than if they produced just for themselves. This helps explain why nations are eager to participate in international trade. However, if national comparative advantages change then production shifts from one country to another and outsourcing occurs. Outsourcing is the result of the law of one price, which reflects business tendency to shift production to least-cost locations around the globe.

Globalization is the increasing integration of economies, culture, and institutions across the world. Globalization increases the number of competitors for firms. More competition creates greater specialization and increased productivity. This leads to lower costs and lower prices. Moreover, in today's global economy, incomes in low-wage countries will likely catch up with incomes in the United States and other advanced western economies over the coming decades. This convergence of wages is likely to occur through slower growth in western nominal wages, faster wage growth in foreign nominal wages, and a fall in the exchange rate of high-wage countries.

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