Trade-offs, Comparative Advantage, and the Market System Managers at Tesla Motors Face Trade-offs Are electric cars the wave ofthe fature? Ifyou'e like most ‘rivers, you probably ik the idea of skipping the gas ta ‘ion in favor of powering up your carby plogging tanto an lectric outlet. Electric ears, though, have struggled to sc ‘ceed in the marketplace for to key reasons () The lith jum Batrie that power electri cate are cont, forcing up the prices ofthe cas, and (2) the hateriesavalable today need to be eecharged every 100 to 300 miles, making the ‘cats impractcal fa long tips ‘Tesla Motor ie an American-based automobile man facture founded in 2003 by billonaire Elon Musk, win also started the online payment system PayPal and the private space firm SpaceX. Although in 2017, the firm held only atuny 03 percent share ofthe US car marker, ts goal sto ‘become the ist fim to sell large numbers of electric cas ‘Tesa is building a naionwide network of fa-charging st tions to makes easier for drivers to make longer trips. Tes las early models were priced at over $60,000 In 2017, the company intoduced i new Model 3, with a lower price of $35,000, aimed at lring customers avay from gasoline powered cars such as the Toyota Camry and Honda Accord. Tesla manufactures sts cars in a single factory in Fremont, California. To compete i the automobile market, ‘Teal’s managers must make many strategie decisions. For ‘example, during the {ist half of 2017, Tesla sold atta of about 50,000 Model 5 sedans, with a base price of $68,000, and Mode Xs, a sport wth vehicle (SUV), with abase price 9 $85,500. With limited capacity to mansfacture eats ints ‘Fremont plant, Teslahad o decide whether it would be more profitable to produce more wnite of its Mode! S and Mode! X or tose that eapacty to produce the Model 3. Ulimately Teds plan to gin a significant share of the automobile ‘maet le its managers to decide to allocate resources to Producing the Model 3, even though doing so meant st ‘would be able to produce fewer unit of ts other models ‘Tedl'smanagersmustalsodecidehowtoselland service dts cas, Tesla has had diliculy opening company-owned ry dealerships to sell ts cars because some states have laws that equire car manufsccurets to sll through independent dealerships, which Tesla is unwilling to do. Tn thote ates, Tesla alle scare only online and relies on company cowed service centers to provide maintenance and tepait services, Some economists have questioned whether Tesla willbe able to meet its future sles goals wihout selling cas through independent dealerships as most other at companies do, Teslis managers also face other key decisions. For snscance, they intend to eventually manulieture 1 mil chiles annually. Doing so wil likely require building a Jeatt one addtional factory in which o assemble he eas a8 well at addtional factories to manufactare the barery calls tha power the cars, Like other decisions managers make, {his one involves 3 teade-oll Devoting more resources (0 building sdational factories would lave fewer reourees available for expanding prouction in its (wo existing cae and battery factories ANINSIDE LOOK on page 64 discusses the reasons ‘esa decided to builds large battery plantin Nevada, Seu: Dar “To apg Made Stay un Love SF. Sno Con” Moorawg eon eowar 22.20% and Te Hage Te [iro Mao tte Sar Gol 2016" Wat Shot Sour eee© corparoiehsertage andro, ost Seer ogy nt oaeaho revs crest © rere sys pa Economics in Your Life & Career ‘The Trade-offs When You Buy @ Car ‘Although electric cars are much in the news and are increasing in popularity, most people stil buy conven- ‘onal gasoline-powered cars. When you buy a gasaline Powered car, you probably consider factors such 35 safety and fuel efficiency To increase fuel efficiency, ‘automobile manufacturers make some cars that are ‘small and light Large cars absorb more of the impact ‘of an accident than do smal ars, so people are usually safer diving large cars. What do these facts tel us about the relationship between safety and fuel efficiency? It you were a manager at an automabile company, how ‘ight you evaluate the relationship between safety anc fuel efficiency when designing cars? As you read the chapter, uy to answer these questions. You can check your answers against those provided on page 63 at the end of this chapter. a42 CHAPTER 2 ‘iade-o%. Comparotve Advantage, end the Marie Sytem the economie resources, or factor of produton—workers, expt, natural resource, and cntreprenesrialailty—used to make goods and services. Your time is searce, which means yu face rage-of Ifyou epend an hour studying foran economics exam, yoshave fone less hour to spend studying for a psychology exam or going tothe movies IF your university deidesto use some ofits scarce budget toby new computers forthe computer labs, those fads wil not be available to buy new books fo the library orto resurface the sant packing lots. I Tels decides to devote some ofthe seatce workers and machinery in its Fremont assembly plant to producing mote Model 3, chose resources wil not be avaiable to produce more Mode Ss oustholds an firms make many oftheir decisions in markets. Trade isa key activity that cakes place makes. Trade results fom the decisions of millions of households and firms around the word By engaying in trae, people can aise her incomes. In this chapter, -we provide an overview of how the market sytem coordinates the independent decisions ofthese millions of househos and firms. We hepin our anayss ofthe economic conse- quences of scarcity and how a market system works by introducing an important economic ogee production pele oie Because the firm's tesourcer-—workere, 2 As we saw inthe chapter 0 California, where ic azzemble “Model X SUVs. jecan use simple he trade-offs Tesla faces in Graphing the Production Possibilities Frontier Figure 21 uses a production possibilities frontier to lustrate thatthe key tradeoff ‘Tesla faced in 2017 wat allocating cesources betwen st two original models (Model S and Mode! X) nd ta new Mode! 8 The numbers fom the table at pleted is Ue graph ‘The nese the graph represents Tesl’s production posses frontier I Tesla uses all ltsresources to produce ts orginal models, can produce 80 per day—posot Aa one tnd ofthe production possiblities frontier If Tesla uses alt tesourees to produce ts new Mode! 3, 1 ean produce 80 per day-—point Fat the other end of the product possiblities (contr If Tesla devotes resources to producing beth is orginal mode nd the Model 3 eau be ata point ke B, where produces 60s orginal models and 20 Model 3. Allthe combinations ether onthe frontie—ike points A, B,D, and For inside the frontierike point Fate tanahe with the resources avilable. Combinations on the frontier are eset because al valle resources ae being lly tized, andtheProducton Ponbities Hort: and Opporunty Cor 48 "eas Production Chace atts oman Pant ust of nga Mode Guia oa chee | ticed urbe) romcea peta) out ot stgnatmotse edieed pray / \Sieontare fewest posible resources are being used o produce a given amount of output. Com- Dbinations inside the frontier—like point F—are ies because maximum output is not being obtained from the available recources~pethape because the aseembly line ie not operating atte capacity. Tela might lke toe beyond the frontet—at a point like G, where it would be producing 60 of i original models and 50 of ts Model 5s pr day-but point beyond the production possiblies frontier are wtainable, given the firm’scuttent resources. To produce the combination st G, Tesla would need more machines and more workers "Notice that if Tesla i producing efficiently and is on the production possbili= ties frontier, the only way to produce one more Model i to produce one lee of is ‘original models. Recall fom Chapter I that the opportunity cost of any activity isthe highest-valued alternative tha must be given up fo engage in that acy. For Tes, the opporunity cost of producing one more Model 3s the numberof original models ‘the company wll not be abe to produce because it has shifted those resources 0 pro- ‘ducing the addional Model 3. For example, i Tesla moves from point B to point the opportunity cost of producing 20 mare Model 8s per day isthe 20 fewer original models tha ican produce. "What pont on the production posites frontiers bes? We ean tll without far. ther information If consumer demand for Model Ses greater than the demand fr the ‘original modes as Tesla expected, the company likely to choose a pol closer o,f ‘demand forthe orginal models greater than the demand for Models, the company is Hey to chooses point closerto Mylab Eeonamier cone cise MyLab Economies an Figure 2.1 Totlo's Podcton Pousibites Foner Te ce + trade To bl ooe spore ty nga ode $a Mode Seay kana Bld on re of er ‘Motel The predator pester fom ikeite te abel Tea fare Combrnatoos oo the. poder fom pene fect ike pots A'B.C Dy and Beare ee becae ‘bermaxinam output bring obtsined (fom te sue ever, Coie ‘ou etd te Goose po efianbena somerset ot beng wed Cbinwions oe rok pont ean eure rte Opportunity cee The ighent ‘ale serait ste pen See44 CHAPTER 2 ‘iade-o%. Comparotve Advantage, end the Mari’ Sytem @ S0Ned Problem 2.1 lab Economia nin Drawing a Production Possibilities Frontier for Tesla Motors Suppose, for simply, chat during any given week, the Bi. Use the data in che table to draw a production ‘machinery and number of workers at Tela Motors Frement possibilities froncer graph lusteating Tesla trade- plantcannotle increased. Sothe numberof original models or ‘offbermsen sesembling orginal model and asem~ ‘Mode 3s the company can produce during the week depends bling Model 3s, Label the vertical axis “Quantity of, ‘on how many houre ate devoted to ascembling each ofthe original models produced per day” Labal the hori diferent models, Assume that Model sare more dificult to zontal axis "Quantity of Model 3s produced per assemble, 0 if Tel devoes a hour to aseblng ts orig Aig" Make sure to label the values where Tese's nalSodl Sor Mod Xt wil produce 15 vehicles bu Tesa devotes anhourto producing Modell produc caly10 ‘bikes. Assume thatthe pls can ru for hous per dy production possiilies: frontier intersects the ‘vertical and horizontal as, 6, Label the poins representing choice D and choice E Teslaisat choice D,whatisit opportunity cost of making 10 more Model 3st Solving the Problem Stop I: Review the chapter material, Thi problem is about ssing production possiblities ronvers to analyze trade-off, o you may want to review the sec- ‘Gon Graphing the Production Possblties Frontier” which Begins on page 42. Stop 2: Answer pat a) by filling in the table. I Tesla can assemble 15 original ‘modelsin I hour then with choice A, tcan acsemble 120 original models and (Model 3s, Because Tesla can assemble 10 Model 3in 1 hour, with choice B, ‘twill produce 105 original models and 10 Models. Using similar reasoning, vs can ln the remaining els in the table ae follows:Producten PosibitiesHorion ane Opporunty Coss 48 Stop 3: Answer part (b) by drawing the production possibilities frontier graph. Using the data from the blein step 2. you should draw a graph that Tooke ike thi: ora aim raerghettogas 1 Tesla devotes all hous to assembling orginal models, it will produce 120 ofthem. Therefor, Tesla's production poriiitieefonter wil ncereect the vertical axis at 120 original models produced. I Tesla devotes ll § hours to assembling Model 3,1 will produce 80 of them. Therefore, Tesas pe duction portiles frontier wil intersect the horizatal ane a 80 Mode! Sz produced ‘Step 4: Answer part () by labeling choices D and F on your graph. The points for choices D and E canbe plated using the information from the table a Co Moving from choice D to choice E increases Tes’ production of Model aby 10 but lowers ls production of original modelsby 15. Therefore, Tess opportunity cost of prodeing 10 more Medel 3s producing 15 fever orgie nal models ‘Your Tur: Forrete proces dost prot 6 on page Fhe enn Mylab Economies su in46 CHAPTER 2 ‘iade-o%, Comparotve Advantage, end the Marie’ Sytem Mylab Economies sonia Figure 2.2 Increasing Marginal ‘Opportunity Costs 2s te ce more da he po ‘deton peeblbee vai exe ces ring mage poranynt ‘teu sees sata ped ‘lm ya per cont reqes ager elle doses tn proc Toremmpl osnorn sershe po ‘coon fo 0 te Ro—merng Foe (Checomomy but ep 10k Increasing Marginal Opportunity Costs We can use the production possibilities frontier to explore issues concerning the conomy a8 3 whole, Suppose we divide al the goods and services prodvced in the economy into just two types military goods ané civilian goods. in Figure 22, tanks represent military goods and automobiles represent civilian goods. Iall the county's resources ae devoted to producing military goods, 400 tanks can be produced in one ‘yess Fall resources ate devoted to producing civilian goods, 500 ascomobile can be produced in one year Devoting resources o producing both goods results in the econ ‘my being at other points slong the production posiblies frontier Notice that this production possibilities frontier is bowed outward rather than ‘being a ssigh line. Because the curve is bowed out, the opporcunity cor of autor tebile in terme of tanks depends on svhere te economy curretiy eon te produce tion possiblities frontier For example, o increase automobile production from Oto 200-moving from point Ato point the economy hao give up only 90 tne. ut to increase sttomotile production by another 200 vehicles moving from point B to Point C—the economy hao give up 150 tanks As the economy moves dawn the production possiblities frontier. it experiences creasing marginal portant cote because increasing automobile production by a given ‘quantity requires larger and larger decreases in tank production. Increasing marginal ‘opportunity carts occur because conse workets, machines, nd other resources arcbet= ‘erated ro one we than to another. At point A, some resources that are well suited to producing sutomobiles—such as workers who have yeats of experience on automo= bile assembly linee—are now producing tanks. Shifng these resource into produce ing automobiles by moving from point A to point B allows a substantial increase in automobile production without much loss of tank production. But as the economy ‘moves down the production possiblities frontier, more and mote resources that are beter suited tank production are switched to automobile production, At ates the increases in automobile production become inteasngly stale, while the decreases in tank production become increasingly larger, We would expect in most situations thar production posibilises frontiers wil be bowed outwatd eater than leat as We assumed i the Tesi example dacussed erlier The idea of increasing marginal opportunity cose illesrates an important economic concept: The mare recurs abeady deoted toa activity, the sale the pa to eyeing anal sores to tht actin, For example: + The more hours you have already spent studying economies, the smaller the increase in your tet grade (rom each additions! hou you spené—and the greacer the opportunity cost of using the hour in that way.Producton Ponbities tortie: anc Opportnty Cor 47 + ‘Themore unde firm has devoted to research and development dering a given year, the smaller the amount of useful knowledge it receives from each addi UWonal dollar spent-and the greater the opportunity cost of wsing the funds in tatway. + The more funds the federal government spends cleaning wp toxic waste dumps uring a given year, the emaler the reduction in potion from each additional dollar spent—and, once agin, the greater the opportunity cost of using the funds inchat way. MyLab Economies crap hse Economic Growth “At any given time, the total resources avalable to any economy ae fixed. For exar- ple if che United States produces more automobile, must produce less of some- thing elee—tanks in our example. The capital stack i the amount of machinery and ‘other physical capital avaiable in an economy. Overtime, the resources avalible to fan econonyy may inrease because both the labor force and the eapital sock increase ‘When the amount of recources increases, the economy's production possible fr tier sift outward, making possible to produce both more automobile and more tanks. Panel (a of Figure 2 shows that over ime, the economy ean move fem point A topoine®, producing more tanks and more automobiles. Similarly technological change makes it posible to produce more goods with the same numberof worker and the sume amount of machinery which leo sf the pro= duction poribilies frontier outward. Technological change need not afect all sectors tqualy Panel (b) of igure 2.3 shows the results of technologieal change inthe auto= mobile industry that increases the quantity of automobiles workers can produce per {eat while laving unchanged the quantity of tanks they can produce. Outward shits in the production possibilities frontier represent economic ‘growth because they allow the economy to increase the production of goods and Services, which altimately eases the standard of livin. Inthe United States and bother high-income countries, the market system has alded the process of econ ‘growth, which over the past 200 years has greatly sncreated the welL-being of the average person, Iylab Eeonamies concise {s shining ot production pons trentar ylab Economies sane Figuro 23 teonamie Grown ‘Economic growth The bit ofthe ‘conyers the protcton Stgoodeand seree, Mylab Economies ha (Teta change nthe ateebiindsty ane show hat t more economic router become vlad technloie change secre the eanomy can more fem pot Ao eine rotecng tore tanks sé more stemobis, Patel) some {ere of technol change Inthe scomedle day hat Tacs ie quan of whe workers can produce pee pra whit vig unchanged te mason gat oft they an prodce ‘Gurrd han the production pose ener represen awh48 CHAPTER 2 ‘iade-0%, Comparotve Advantage, end the Marie Sytem We can use the concepts of the prodkction possibilities frontier and opportunity cost to understand the basic economie activity of mal, Markets are fundamentally about trade, whic isthe act of buying and sling Sometimes we trade directly, as when chile dren trade one bascball ead for another ascbll xed, Bu often we trade indirecty- We sell ou labor services 3, say an accountant, a salesperson, oF a nurse for money. and then we use the money earned to buy goods and services. Athough in these cases trade takes place inirety ultimately the accountant, salesperson. or nurse is raing his or her services for food clothing, and otter goods and services, One of the great Benelite of trade is that makes ic possible for people to become beter off hy increasing both ‘heir production nd their consumption, Specialization and Gains trom Trade Consider the following station: You ané your neighbor both have fruit trees on your properties. Initially, suppose you have only apple tees and your neighbor has only Cherry uees. In tis sitcationifyou both ike apples and cherries there isan obvious ‘opportunity for both of you to ain from trade: You trade some of your apples for Some of your neighbor's cherries, making you both beter off But what if there are apple and cherry tees growing on both of your properties? n that cae, there can tll ‘be gens from trade. For example, your neighbor might he very good a picking apples, and you might be very good a picking cherries. It would make sense for your neigh= bor to concentrate on picking apples and for you to eancentrate on picking cherries ‘You can then trade some ofthe cherree you pick for some ofthe apples yout neighbor picks. But what if your neighbor ie actually beter at picking both applet and chervies than you ace? ‘We can ute production possibilities frontiers (FPF) to show how your neighbor can benefit from trading with you even thaugh she beter than you ae pking bot apples snd cers For szapliity, and because twill not have any eect on the conclusions We draw we wl assume thatthe PPFs inthis example are straight lines} The abe in Figure 24 shows how maay apples and how many cherries you and your neighbor can pik in ‘one meek, We can use the dat inthe table to construct PPE for you and your neighbor. Panel a shows your PP. Ifyou devote al your time to picking apples, you ean pick 20 pounds of apples per week. Ifyou devote all your time to picking cherie, you can pick 20 pounds per week Panel 9) shows thai your eighbor devotes all her Ue to picke ing apples, she can pick 30 pounds I she devotes al her cme to picking cherses she can pick 60 pounds ‘The PPFs in Figure 2.4 show how many'apples and cherries you and your neighbor «an consuine without tade, Suppose tha when you dant trade with your neighbor, you Picked eonsume 8 pounds of apples and 12 pounds of cherries per week: This combie ation of apples snd cherries it represented by point in panel (a of Figure 25. When your neighbor doesnt trade with you, she picks and consumes 9 pounds of apples and 422 pounds of cherie per week. This combination of apples and cherries represented by point Cin panel) “Alter years in which you each pick and consume your own apples and cher ries, uppose your neighbor makes the following proposal: Next week the wil trade you 15 pounds of her cherries for 10 pounds of your apples. ould you accept this proposal? As we can see in Figure 2, you should acept because you will end up with more apples snd more cherries to consume, To take advantage of her pro= posal, you should specialize in picking only apples rather than splitting your time between picking apples and picking cherries, We know specializing wil sllow yous to pick 20 pounds of apples. You can trade 10 pounds of apples to your neighbor for 15 pounds of her cherries. The result is that you wil beable to consume 10 pounds lot apples and 15 pound of cherries (pont B in panel (a of Figure 25). You are cleatlyComporaive Aevantage ond rode 49 ver ‘Your Niner ens cris holes hares abehngeenls 20pewde Opounde aopeune opainds sepicergeharosOpminds _20pourde Opounss _SOpairds erie oni oon voor sur Pe earnecraers PE fone) ipoones {s)Yourpraeucton posses renter Mylab Economies sins (You nihnorprosuctonpssiitis enter Figure 2.4 Producten Pubes for You ond Your Neighbor, without Trade {he ale hows how many pound of apples and wry poande of ‘hee outed yur neiibor an ene pk ine wk We can wt ‘Bodnar eae cnt Pf for eas oc igabor Patel (shows yar Ifyou devete your tine cing appl none te peing hei, ou cn pk 20 pound fou deo all your ine te ping eben foun ck 20 pound Panel) sows had your ether deter aber sine picky sper. se ean ek SO pou ‘Redes bertime oping cere sean pk peu foe {8 You peaicton nd consumption with ade yLab Economies nmin Figure 25 Gains tom Node fone {0 You niger produton a cannunpton wih ade ‘When you dont rade with your neighbor, you pick and coname pends of spe and 12 pounds of there pe etopit 8 in uel) When your neighbor dws trade wh eh pels and eames 9 pounds of apes and 42 pounds of chris pet west ‘oun Ci patel) yo pecan inking sper, ou can p20 ox oar nile specter a peing cei oa Pk. 0 pounds. you wade 10 pounds of your apples for 8 pounds of your ‘ighbors cherie you wilbe ale conte 30 pounds of apis ‘nd 13 pounds of chersr—poat Bin pr!) Your neighbor can econ 18 posnds apple sod 43 posed of chee —poit Bin panel Yu snd your eghbor sve boty ete of aa esl of theta50 CHAPTER 2 Tade.o%, Compareive Advantage, end he Mario® System MyLab Economies sons Table 2.1 2 Summary of he Goins ‘tom Tao Absolute advantage The by of inindindaa fire orasounty © Produce mor ofa yoodorserie Eanconpetors ing the me ‘oust ofreource, fcpsien) Production and consumption witout rae 8 wz 2 2 Production with tase 70 3 ° 0 ‘Consumption wih vade 10 5 10 5 Gain rom trae (ered carsurpton) 2 3 1 2 ewer off asa result of teading with your neighbor: You can now consume 2 more pounds of apples and 3 more pounds of cherie than yo were consuming without trading You have moved beyond your PPP Your neighbor has also benefited from the trade. By specializing in picking only cherie, she exn pick 60 pounds She Ieades 15 pounds of cherries Co You for 10 pounds of apples. She can then consume 10 pound of apples and 45 pounds of cherries point Din panel) of Figure 2.5) This combination s 1 more pound of apples and 5 more pounds of cherries than she was conriming belore trading with you She also has moved beyond her PPE. Table 21 suzamarizes the changes in production and ‘consumption hat result Irom your ade with your neighbor (in thisexample, wechose lone specific ate of tading cherries for apples—18 pounds of cherries fo 10 pounds of apples. There are, however, many other rates of trading cherries for apples that would also make you and your neighbor beter off) MyLab Economics emg Ok Absolute Advantage versus Comparative Advantage Perhaps the most remarkable sepect ofthe preceding example ie that your neighbor benefits fom trading with you even though she is better than you at picking both apples and cherries. Absolute advantage isthe ability ofan inivids, a firm, or 3 country to produce more ofa good or service than competitors, using thesame amount bof resources, Your neighbor hasan absolute advantage over you in picking both apples tnd cherries because she can pick more ofeach fruit than you can in the samne amount of time. Although it seems that your neighbor dhol pick her own apples and her own cherries, we have just seen that she is Better off specializing in picking cherties and Tesving picking apples to yo. ‘Weean coneider further why both you snd your neighbor benefit fom epecil- izing in picking only one fruit. Fist, think about the epportunity cost to eaeh of ‘you cf picking the two fruit. We saw from the PPF in Figure 2.4 that fyou devoted Il your time to picking apples, you would be able to pick 20 pounds of apples per week. At you mave down your PPF and shift time away from picking spples to pick- Ing cherries, you have to give up 1 pound of apples fer each pound of cherries you Pick (the slope of your PPF is ~1). (For a review of calculating slopes, see the appen~ dlito Chapter 1) Therefore, your opportunity cost of picking | pound of cherries ie 1 pound of apples. By te same easoning, our opportunity cost of picking | pound of apples ie 1 pound of cherries. Your neighbor's FPF has a diferent slope, so zhe faces diferent trade-off: At ste shifts time (rom picking apples to picking chet ries he has to give up 0.5 pound of apples for every 1 pound of cherries the picks (the slope of your neighbor's PPF is 0.5). A she shifs time from picking cherries to picking apples, she gives up 2 pounds of cherries for every | pound of apples she plcks. Therefore, hee opportunity cost of picking | pound of apples is 2 pounds Of cherries, and her opportunity cost of picking 1 pound of cherries is 0.3 pound of apple.Comparave Acvantage ons tede $1 Cerrr Table 2.2 ee ‘Opperuniy Coss of Peking a ‘Apples ond Cheris Yeu 1 pound ot errs pound ot apples ‘our neiehibor 2 pounds of cherres | 05 pound of sples ‘Table 2.2 summarizes the opportunity costs for you and your neighbor of pick ing apples and cherries. Note that even though your neighbor can pick more apples ina week chan you ean, the opportunity cs of picking apples is higher fr her than for you because when she picks apples, she gives up more cherries thin you do So, even though she hae an abeolte advantage over you in picking apples it more comly for Ine to pick apples than it for you. The table also shows tht her opporsumity cost ‘of picking cherries is lower than yours. Comparative advantage isthe ability of an ‘ndividval, a firm, ora country to produce a good or service ats lower opportun ‘cont than competitors In pickin ‘your neighbor has a you, while you have srher, Your neighbor has both an absolute “levantage and a comparative {rover you in picking cerves. As we hve seen, youare better off specializing in picking apples, and your neighbors beter off special ‘Ring in picking cherie, Mylab Economies cw sk ‘Comparative Advantage and the Gains from Trade ‘We have just arrived t an important economic principle: The Ba fr ales omparae tne advantage, not absolute advantage. The fastest apple pickers do act necessarily do _much apple picking. Ifthe fstst apple pickers have a compartir advantage in some ‘other activity—picking chezres, playing Major League Baseball or being industrial ‘engineers—they are better off specializing in that activity Individuals firms, and coun- tries are eter off they specialize in producing goods and services for which they have ‘comparative advantage and obtain the other goods and services they need by trade ing. We will eturn tothe impertant concept of comparauive advantage is Chapter 8, which s devoted tothe subject ofinternatona trade. MyLab Economies Cay cit MyLab Economie uP cherries but you haves comparative advantage in pick ing apples Keep het to key pons in mind 1. Tes pombe to have an abso advantage in producing a fool or sevice without having &comparstvesvastage ‘his the cae with our neighbor pking apple. eis poet have a comparative advange in produce rt geet ee nee teeter ‘Thatch case with our ling apples. Myla Economie Pr Your Tum: tty unertncngby deg ates blom 25 cnpege th athe lochCHAPTER 2 Tade-o%, Comparetve Advantage, end he Mario System Mylab Economies mn amon Solved Problem 2.2 e Comparative Advantage and the Gains from Trade ‘Suppose that Canada and the United Seats both produce maple syrup and honey, which ae gold forthe same price fn both countries. These ate the combinations ofthe twa _g00ds that each country can produce in one day, using the 2 Which country has 2 comparative advantageinpro- ducing maple syrup? Which country has a compat- tive advantage in producing honey? "ime amounts of capital and labor: be. Suppose that Canadas cutrently prodding 30 tons of honey and 15 tons of maple syrup. and the United tates is eure producing 10 tons of honey and 0 tone of maple syrup. Demons that Canada and the United States ean both be bet. ter offi they pecslinein producing ony one good sndirade forthe otber lsteate your anewerto par (bby drawing a PPE ~ {or Canada and PF forthe United Stats. Show con your Ps the combination of honey nd maple 0 frp prodvced snd consumed in each country 2 before and after ade. Solving the Problem stop 1: Stop 2: Stop 3: Review the chapter material. This problem i shout comparative advantage soyoumay want to revew the section “Absolute Advancage veress Compars= live Adeantage,” which bepins on page 50. Answer part (a) by calculating which country has a comparative advantage in each activity. Remember that a country bas comparative advantage in prodcing agoodsfitean produce the good athe lowest oppor- tunity cost, When Canada produces I more ton of honey it produces 1.5 tons less of maple syrup, When the United Sates produces | more ton of honey, produces 1 ton less of maple syrup. Therefore, forthe Unite States, the ‘pportenity cost of producing honey—1 ton of maple syrup—is lower than for Canada—15 tons of maple syrup. When Canada prodices 1 more ton of maple syrup, produces 0 67 ton ess of honey. When the United Sates pro= ddaces I more ton of maple syrup, produces 1 ton les of honey. Thereo {Canada's opportunity cos of producing maple srop—0.67 ton of honey—ie lower than tht of the United Staee—I ton of honey. We can conchae that {he United States comparative advantage inthe production of honey and (Canada hae a comparative advantage in the production of maple yrup. “Answer part (b) by showing that specialization makes Canada and the United States better off. Weknow that Canada andthe United Sates should cach specialize where hae a comparative advantage. both counties spe- ialize, Canada will produce 60 ons of maple syrup and Otons of honey, and ‘he United States wil produce 0 tons of maple syrup and 50 tone of honey. Alter both countries specialize. the United States could then trade 30 tons of hhoney to Canada for 40 tons of maple syrup. (Other mutually beneficial trades ae possible as wel) We can suramarize the resus in aa: “TheUned Sater beter off aerade because can consumethesameamount of maple syrup and 10 more tons of honey Canada better off afer rade because incan consume theme amount of honey and Smore tn of maple yr.Comporaive Aevantage ond rode 83 Slop 4: Answer part (c) by drawing the PPFs canada Pre (Phe untea sates PP ‘Your Turn: Formare prac, doreiod proms 24 and 2.7 anpage 69a the endef ta MyLab Economic uP @ APPLY the Concept Hab Economics vias, ‘Comparative Advantage, Opportunity Cost, ‘and Housework Among roommates, maried couples, and other peopl ving together, dividing up the Ihousehold chores ean bea source of tres. Traitionaly with married couples, women {id most ofthe housework, sich as preparing meals, cleaning, and doing laundry. In 1965, marvied women with children sveraged about 32 hots of housework per week, while marred men svraged only hours. Tada. women average about 15.3 hours of housework, while men average about 10 hose Housework doesn seem to be par of buying. selling. and the usual topics of busi- ‘ness and econemics. Infact, we can use basic economic concepts to analyze house- ‘work Consider first the most efiient way to dsvide up household chores. Suppose Jack and fil need to decide how they wil get the cooking and laundry done. Assume tha Jacehas an absolute advantage over Jilin beth chores, but he has abig advantage ‘over illineoocing—he takes much lees time to prepare very tasty meale—buts only a Tile faster than Jin doing aundey. In ocher words, assunsing that they have the same amount of ime available todo housework. Jack has a comparative advantage in cook- ing, while lllhas a comparative advantage in doing laundry. So rather than Jack andl Ino doing some ofthe cooking and some of the laundry, they would be heter of Jack follows his comparative advantage and docs all he cooking, while il fllows her comparative advantage and doce all the laundry ‘Economics can also provige some insight into the decline in the number of hours Whatthe most cient wy dre spent on housework since the 1960s. Combined, men and women now spend more uphourhld chore? than 30 percent fewer hours on housework, This decline has been partly driven by tech- nology, particulary improvements in household appliances, such as dishwashers and Iicromave ovens. The decline inthe number of hours women devote to housework also reflect the grester job opportunities avalable to women today than in the 1960s “The opportunity cost o.a woman of spending time on housework snd chldeare isthe ‘wage she gives up by not spending that sime in paid work f woman could work for an bour at wage of §20 but spends that hour doing household chores, the oppartusty fost ofthe time spent on chores s $20. As job opportunities for women andthe wages ‘those jobs pay have increased, so has the opportunity cost of dowg housework. So in54 CHAPTER 2. Tode.o%, Comparoive Advantage, end he Mario’ System Mylab Economics Sa a Market group ofbuyerand dale of good or serie snd the Instron or arangementby whieh they come together trade Productmarket Amucttfor foods such compete or eieertuch a neil extent, Factor market Aratket forthe [actors of production such.slabor, ‘ital tral eso. and ‘tepreneurl bty ‘ipl tral source, and ther ‘puns welt mae gednd addition to taking advantage of improved appliances, many familes have found that the com of hiring specialists in housshold chore, such as cleaning services and lien care services, is lower than the cost ofthe wile (or husband) performing those chores. [Ar women's wagce have risen relative to men's wages, the opportunity cor to ‘women of doing howsework hat ncreased more than has tae opportnty costo men Sowe wold expect tht in addition to women devoting fewer hours to housework, the ‘ap beoween the hours women and men devote would narrow In fac, while in 1965, ‘yomien devoted 28 more hours per week to housework than di men, in 2016, chey {devoted only 6 more hours. The average number ofhouts women devoted to paid work increased from § hours per week to 20 hours (Ofcourse, changes in sail atitudesalzo help explain changes in how men and women allocate thei time, But we have een that te basic economic concepts of com parative advantage and opportunity cost provide important insights into the noto- ‘wonderfal world fhousctold chores, a eae ie attra Your Tur: feuyour naortaring by dohg ated wales end 2.15 29 poper69-Toat Ihecnd otis cooper The Market System LEARNING OBJECTIVE: Explain tho basis of how a market system works ‘We have seen that households, firms, and the government face trade-offs and incur ‘opportunity coste because resources ae sarce: We have also seen that trade allows people to specialize according to thelr comparative advantage. By engaging in trade people can raise their incomes and their standard of living Of course, trade inthe ‘meer world is much more complex than the examples we have considered sla ‘Trade today involves the decisions of millons af peeple around the world. How areal ol these decisions coordinated? Inthe United States and mo other countries, tade is Carried out in markets Maske also determine the answers to the thee fendamental ‘questions diteussed in Chapter 1, What goods and service willbe produced? 2 Hove wil the goods and services be prodiced? 3. Who wil receive the goods and services produced? Recall that a market is 2 group of buyers and sees of a good of service and the insitation or arrangement by which they come together to trae, Makets take many forms: They can be physical places, such asthe pizza pariors in your city or the New York Stock Exchange, or vttal places, suchas eBay In 2 market, the buyers sre demanders of goods or services, andthe sellers are supplies of goods ar services Households and firms ineract in two types of markets product markets and fac- tor markets. Product markets are markets for goods—such as smariphones—and services—such as medical treatment. In product market, households sre éemanders nd firme ae suppliers, Factor markets are markets fr the toro production Factors fof production sre the inputs used to make goods and services, Factors of prodiction sre died into four broad categorie: 1, Labor includes all typeof work, fom the parttime labor of teenagers working a “MeDonalds to the work of senior managers in large corporations. 2. Capital refers to physical capital, such as computers, office buildings, and machine tole used to produce other goods, 3. Nanzlnscucesinchde land, water, ol ron ore, and ather raw materials or git of nature that ae used in producing goods4. Aneterenari someone who operate a bssness,Enreprenurl aii the ability to bring together the other factors of production to ssccesflly produce and sell ‘oods and services The Circular Flow of Income “Twokey groups participate in markets 1. Hous are all the incividle in s home. A houschald may consist of one person. ‘or several persons. Households are supplies of factors of production —partcalacly Iabor—employed by fies to make goods and services. Household ure te income they receive from sling the factors of production to purchase the goods and services supplied by firms. We ae farlise with household ae suppliers of labor because mort people earn mot oftheir income by going to work, meaning they are sling thet labor services o fie in the labor market. But howseholde own the othe fee tors of production ae well ether directly or indirectly, by owning the firme tha ow these resources. All iems are owned by households. Small firms, lke a nighbor- hood eestaurant, might be owned by one person. Large firms, ike Apple are owned [by millions of households that uy shazes of toc in chem. When firms pay profite tothe people who own them, the firme ace paying for using the capital and natural Fesousces tha are supplied to them by those omer. So, we can generalize by saying thatin factor markets, households ste suppliers and furs ate emanders, 2. Fimsare suppliers of goods and services Firms use the funds they recive from l= ing oode and services to buy or hire the factor of production needed to make the ‘oods and services. ‘We can ute simple economic mode called the circular-flow diagram to see how patcclpants in markets are inked. Figure 2.6 shows that in factor markets, howse~ holds supply labor and other factors of production in exchange fr wages and other ie Ai The Mater sytem 85 Girenanflow dog Amote, ‘ates wpe se nba Mylab Economics snmsin Figure 2.6 The Creulor-ow Diagram estos an rst gether Re cea owe pecicon toes Snlagentay Tete mor shor Sw he ar of roduc In eet eared ‘eepeer thi and oer cot ‘product ef nee thee ‘etre of proacion Yo ake gods nd meet hat they spit Noe iedrin poder ater Te rears tow the flow of gots aa ct ftom fins to owt The gre ra sho he a fad oor tits hua ei wage nd ‘er poets fom iron ohange foe ppg the coro roduc, Hovstols we he ges a ther formers prc pds and es From fins poder marke. ens sa gods and series hoses proc tea thy eth de { pucre th fers of production fombourtolei nor ete56 CHAPTER 2 Tade.0%, Comparcive Advantage, end he Mario’ System payments from firms. In produet markets, households us the payments they earn in Factor markets to parchase the goods and cervices supplied by firms, Firme produce these goods and Services sing the factors of production supplied by households ln the figure, the ble arrows show the ow of factors of production from howseholds ‘hough factor markets to firme, The red arows show the Mow of poode and services fom firms through product markets to hovscholds, The green arrows show the low of funds from firms through factor markets to howscholés and the ow of spending {om households through product markets to firms, Like all economie models, the eieularflow diagram is a simplified version of eal ity. Figure 26 leaves out () the important role of government in buying goods from firms and in making payments, such as Social Security or unemploymest insurance payments, o households (2) he oles playedby banks, the stock and bond markets and bother parts ofthe financial tem in aiding the low of funde from lenders to borrow ts: and (3) the fact that some goods and services purchased by domestic householés te produced in foreign couneies and some goods and services produced by domsectic firme are sold to foreign houscholds (We explore the gaverament the financial system, andthe international sector in eter chapters} Despite there simplifeatins, ce citeulate flow diagram in Figure 26 helps u se how product markets, factor markets, and thir prtelpant ae linked together. One ofthe gest wonders ofthe market system fe that FRmanages to succesfully coordinate the independent activities of o many households and firms yLab Eeonames en: cu The Gains trom Free Markets A free market exists when the government place few restrictions on how goods and services can be produced or sld or on how factors of production can be employed Governments in all modern economies intervene more than is consistent with a fully fee market, In that senge, we can chink ofthe free market as being a benchmark against which we can judge actual economies, There are relatively few government restrce [ons on economic activites in the United States, Canada, Western Europe, Hong Kong Singapore, and Estonia. So these countries come clot to dhe fee market benchmark. ln countries such at Cubs and North Korea, the fre make system has been rejected in favor of centrally planned economies with extensive government control ver prod= tet and factor markets. Contees hat come closest tothe free market benchmark have heen more successful than counties with centrally planned economies fs proving their people wth rising living standards “The Scottish philosopher Adam Smiths considered the father of modern econom- ice because his hook, An Inyo the Nature ar Cerf the Weath of Nations, published in 1776, was a early and very influential argument forthe free market system, Smith was ‘riking at atime when extensive government restrictions on markets were common: In ‘many parts of Europ, the guild pte prevailed. Under this system, goveraments would ve guilds, or organizations af prodaers, the authority to contol the production of 3 good. For example the shoemaker guild controlled who was allowed t produce shoes, ow many shoes they could proce, and wha price they could charge n France, the cloth makers’ guid even dicated the number of thread inthe weave of the cloth, ‘Smith argued that sch restriction edeed the income and wealth of seountryand its people by restriting the quantity of goods produced. Some people a the time sported the ratritions of te guild system because was in thei financial interes to doe yo were amember of gull the restrictions served to reduce the competition yu faced. But tothe people believed thatthe cltenative tothe guld system was economic disorder. Sith rgued the these people were wrong and thi a country could enjoys smoothly fnetion- ing economic system if im were feed Srom rescitions placed on their operations clther by guilds or dtectiy by governments. Mylab Economies eins Ok ‘The Market Mechanism In Smith’ day, defenders of resvictions on how firms operate argued that for exam- ple, the shoemakers guild did not control shoe production, ete: too many of oo few $hoet would be produced, in contrat Smith maintained tht prices would do a beetjb of coordinating the activites of buyers and sles than the guilds could. A key to “understanding Smith's argument isthe assurmption that individuals usually ati aration, sere In particular, individuals take the ations that ae most key o make themselves better off financially. This assumption of rational selfnterested behavior ‘underlies nearly all economic analyse In fact, economics can be distinguished from ‘other disciplines that study human behavior—nich a¢rocology and peyehology—by its emphais on the aeumption of elf-iterested behavior. Adam Smith understood— 4 economirts today understand that people's motives can be complex, But when We ‘analyze people in the ac of buying and selling, the motivation of financial reward uei- Ally provies the best explanation forthe actione people tke, For example, suppose that significant namer of consume switch fom buying ‘conventional gsoline-powered cars to buying either gasoline|lectric-powered hybrid ‘art, such asthe Toyota Pius, or allelecric cate, such ae the Tesla Model 3. Fim wal find chat they can charge relatively higher price for hybrid care and electric care than ‘they can for gasoline-powered cars. The eleinterest of these firms wil lad them to respond to consumers wishes by producing more hybrid and electric cars and fewer ‘gasolin-powered ears. Or suppose that consumers decide that they want feat lees ‘bead, pasts, and other foods that contain gluten Then the pices firms can charge for slutenire bread and paca wil increate. The sel(interestof firms wil lad them to [produce more gluten-free bread and pasta snd lest regulat bread and pats, which, in {act is wiat has happened over the past 10 years. "Note tha forthe market mechanism to work in response to changes in consumers wants, prices mt he fel Te relate price ithe price of one good or service relative to the prices of other goods or services, Changes in reatve prices provide informa tios, ofa sigal, to both consumers and firms. For example, consumers worldwide have increased their demand for estle and poultry. Because corn is fed to cate and pole, prices for corn have increased eative to prices for other crops Many farmers Inthe Unsced States ceived this price signal and responded by increasing the amount ‘ot comn they planted and decreasing the mount of soybeans and wheat. One Kansas farmer was quoted a taying, "I seemed to me there was $100 to $150 per are more money inthe com than there was in th beans. Thats he kind of math that aloof guys ‘were sing "In recent years, the United States has experienced record corn eros. Simic Tal falling prices for DVDs and music CDs were signal to move studios and record companies to devote fewer resources to these products and mote resources to making raves and musi avaiable ta sream online In he United States today governments a the federal, state, and local level set or regulate the prices of only about 10 to 20 percent of goods and services The prices of other goods and sevice are free to change a6 consumer preferences change and as costs of production change Inthe ease where consumers want more ofa prouct, and inthe case where they ‘want Tess ofa product, the market systern responds without a guild or the government aiving orders about how much to produce or what price to charge. Economists have ‘used Adam Smith metaphor ofthe sale hand to describe how the market leads firme to provide consumers with the goode they want Firme respond inal to ‘changes in prices by making decisions that alte end up eatiiying the preferences ‘of consumers yLab Eeonemiet ose sk @ SPbIY the Concept lab Economie ie A Story of the Market System in Action: How Do You Make ‘an iPad? Apple produces the iad, Because Apple's headquarters i in Cupertino, Cabifornis, i sem fearonable to aznme that iads ae also manvactare in that state. poll by the New York Times showed that. in fact, 2 majority of people interviewed believed that ‘ads are manuetured inthe United States, snot specifically in California. Although ‘engineers at Apple designed the iPad, the company produces none ofthe components The Maxtor System 758 CHAPTER 2 Tade.0%, Comparetve Advantage, end he Mario: Systom ofthe ed, and it doesn't assemble the components int finished products Far rom being produced entirely by one company in one county, he iPad requires the coordinated activities of thousands of workers and dozens of firme spread around the word Foxconn, which s based in Taiwan assembles mos Pas in factories fn Chins and Brazil and ships them to Apple forsale in the United State. Pogatron, another Taivancse firm wath factories in China, alzo assembles some iads. Although Foxconn and Pegatton do final assembly, they don't make any ofthe components and, in fact, charge Apple only about $6 for seeembling each Pad ‘Mulple firme can supply a particular component for sn iad model ‘The fllowing table lit just some ofthe fies tat have supplied Apple with Pad componente ‘Qhsshe Banh mg ‘Themurket ordinates the sctites of arypepespeaamndthewrl c om whoconbatto malig an Pal pan jensen AL Opti ivan Desby ‘ago Tehrloper | Unies Sates Pennayhans) | Wreler weno Boseh Serre Gormary Reeser Breseorn ‘Unsea Stites Catvonio) | Touehsereen eonaier na Grn lore Unie Se on) Auto eh Coming Unie Sates New Yorg | ss sere cover Dig Serizenaucier | Germany over manage Sib Es Une states 59) Sten menery (Queer Une Knesom Wire ecion semaine South ores ‘py, theh memory sna opesban proceso EI pan Disaliy Sieyne Seu rea as nemo | ‘Shywors Setters | Unied Stats (assechasets) | ress eee STMereehetonics | Freca/tay eter sesers Tens isturents | untea Stats (eas) Touetseeen eonaier Tiguan Seicenductor | Uned Sates (Oregon) Wicks techraey Each ofthese suppliers in tuen relies on it own suppliers For example, Broadcom design the touchscreen controller forthe Pad and supplies ito Appl, butt does not ‘manufacture the components of the controler or asemble them, To manufacture the ‘components, Broadcom eles on Sierra, based in Malaysia; SMIC, based in mainland China; and Taiwan Semiconductor Manufacturing Corporation (TSMC) and UMC, based in Taiwan. TSMC factories ate forthe most part not in Taswan but in miaine land China and Eastern Europe. To assemble the components, Broadcom utes several companies, including Amkor Technology, based in Chandler, Arizons, and STATS CChipPAC aed in Singapore "All old an iPad contains hundreds of parte that ae designed, manufactured, and assembled by firms around the world Many ofthese firms area even aware of which other firms ate aio producing components fr the iPad. Few of the managers ofthese firms have met managers of the other firms or shared knowiedge of how their pate Ueular components ate produced. Infact, no one person-—from Tim Caok, the chief‘executive officer of Apple, on down—possesses the knowledge of how to produce all the components that ae assembled ino an Pad, Instead, he invisible hand ofthe mar- [ket has led these firma to contribute their knowledge and secoutces to the process that ‘ultimately results in an iPad avaible forsale ina etore in the United States. Apple as to elliciently organized the procees of prodcing the iPad tht you can order a custom isd wath a personal engraving and have it delivered from an azzemly plain China or Brazil to your doorstep inthe United States in ae lea three days Senter Ds se, al A 2 Mae Ct Ae 275 1 5, Tamms ee” em, aber? 204 sitjnc coal Recomm en Wer pee een a saat ‘Anew Ruma eae ape tr Lng ee o ec as Fare {eden Ose 2 4 nd Den pba Aol ec as Epa ‘tied Deer? ate ‘Your Tur: fs yeutunestrang oy dong bles pools an 3.9on age Dae oe ‘The Role of the Entrepreneur in the Market System [Burepreees are ceneal toa market system. An entrepreneur is someone who operates a bosiness. Entrepreneurs fst determine what goods and services they believe consum- ‘esovant and then decide how to produce those goods and services most profitably wing the avaiable factors of production—labor, capita and natural resources. Succesfal “entrepreneurs are able to search out opportomtce ta provide new goods and services Frequent these opportunities are created by new technology. Consumers and existing Jpusneste often do not ist realize thatthe new technology makes new product fas ble, For example even afer the development ofthe internal combustion engine had made sawiomabales practicable, Henry Ford remarked: had asked my cistomers what they ‘wanted they would have said a faster horse” Because consumers often cannot evaluate 2 ‘new product before i exits, ome ofthe most acess entrepreneurs uch a the late ‘Stee Jobe of Apple, ras se fpr or meetings wth consumers in which the con- sumere ae asked what ner prot they would like to see Instead, enteeprencrs hile ‘of products that consumers may not even realize they need, uch asin Job's case, an MP3 player—the ior a tablet computer—the #8, Enteprencure af important to the “scanomiy because they are often response for making new produce wide avalible to “consumers, a Hency Ford did wit the automobile and Steve abe di with the Pod “The firms tht entrepreneurs found sre typically smalls fits, ae Apple and Ford ‘were Table 23 on the nex page lst some ofthe important products entepeeneue3¢ small irs introduced during the twentieth century Entrepreneurs put thei own funde at cs when they start busineses. If they are ‘wrong about what consumets want or about the best way to produce goods and ser vices, they can lose those Fund. fact, ie not unusual for entepreneute who even- ally achieve geeat sucess to fll at frst. For instance, ealy in thet careers, bath Hensy Ford and Sakichi Toyoda, who evenualy founded the Toya Motor Corporation, started companies that quickly fled. Research by ichaed Freman of Harvard Universty ha shown that atypical entrepreneur cars lese chan an employee ata lage frm who hae the same educstion and othe chaactrutis. Few eneeprencurs make the fortunes earned by Make Zuckerberg Facebook), Steve Jobs (Apple), or Bill Gates (Microsoft) Entrepreneurs make vital contributions to economic growth through their rales in responding to consumer waite and inteoducing new produce. Government policies that encourage entepreneurship are alto likely fo increase economic growth and raise the standard of living Inthe next section, we consider the legal framework required fora ‘successful matketin which entrepreneurs can succeed. Mylab Economies cnr cht The Legal Basis of a Successful Market System Ina fee market, government does not restrict how fim produce and sell goods nd services 07 how they employ factors of production. But the absence of such gover ment restrictions isnot enough for the market system to succeed in providing people The Mater sytem 89 MyLab Economie a Pr Entrepreneur Sonicone ho pers aban riging together ‘Be actor of productontidor, ‘Spal and natunl exert produce goods and erie.