4.5 End-of-Chapter Material - savingstudentsmoney.org

Key Insights
The production possibilities frontier shows the combinations of goods and services that can be produced efficiently in an economy at a point in
time.
The production possibilities frontier is downward sloping: producing more of one good requires producing less of others. The production of a
good has an opportunity cost.
As time passes, the production possibilities frontier shifts outward due to the accumulation of inputs and technological progress.
Figure 17.10 The Production Possibilities Frontier
The Main Uses of This Tool
Chapter 5 "eBay and craigslist"
Chapter 11 "Barriers to Trade and the Underground Economy"
17.13 Comparative Advantage
Comparative advantage is an idea that helps explain why individuals and countries trade with each other. Trade is at the heart of modern economies:
individuals specialize in production and generalize in consumption. To consume many goods while producing relatively few, individuals must sell what
they produce in exchange for the output of others. Countries likewise specialize in certain goods and services and import others. By so doing, they
obtain gains from trade.
Table 17.4 shows the productivity of two different countries in the production of two different goods. It shows the number of labor hours required to
produce two goods—tomatoes and beer—in two countries: Guatemala and Mexico. From these data, Mexico has an absolute advantage in the
production of both goods. Workers in Mexico are more productive at producing both tomatoes and beer in comparison to workers in Guatemala.
Table 17.4
Hours of Labor Required
Tomatoes (1 kilogram) Beer (1 liter)
Guatemala 6 3
Mexico 2 2
In Guatemala, the opportunity cost of 1 kilogram of tomatoes is 2 liters of beer. To produce an extra kilogram of tomatoes in Guatemala, 6 hours of
labor time must be taken away from beer production; 6 hours of labor time is the equivalent of 2 liters of beer. In Mexico, the opportunity cost of 1
kilogram of tomatoes is 1 liter of beer. Thus the opportunity cost of producing tomatoes is lower in Mexico than in Guatemala. This means that Mexico