2. Managers Making Choices at BMW Learning Objectives To compete in the automobile market, the managers of BMW must make many strategic decisions, such as whether to introduce a new car model. Explain the basic idea of how a market system works. 2.3 Understand comparative advantage and explain how it is the basis for trade . 2.2 Use a production possibilities frontier to analyze opportunity costs and trade-offs. 2.1

3. Trade-offs, Comparative Advantage, and the Market System Scarcity The situation in which unlimited wants exceed the limited resources available to fulfill those wants.

4. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production possibilities frontier ( PPF ) A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology.

5. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Graphing the Production Possibilities Frontier FIGURE 2-1 BMW’s Production Possibilities Frontier

6. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Graphing the Production Possibilities Frontier Opportunity cost The highest-valued alternative that must be given up to engage in an activity.

7. Drawing a Production Possibilities Frontier for Rosie’s Boston Bakery Learning Objective 2.1 Solved Problem 2-1 6 2 3 2 D 8 1 4 1 E 0 5 0 5 A 2 4 1 4 B 10 0 5 0 F 4 3 2 3 C PIES CAKES PIES CAKES CHOICE QUANTITY MADE HOURS SPENT MAKING

9. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Increasing Marginal Opportunity Costs FIGURE 2-2 Increasing Marginal Opportunity Cost

10. Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Economic Growth FIGURE 2-3 Economic Growth Economic growth The ability of the economy to produce increasing quantities of goods and services.

11. Comparative Advantage and Trade Learning Objective 2.2 Trade The act of buying or selling. Specialization and Gains from Trade FIGURE 2-4 Production Possibilities for You and Your Neighbor, without Trade

12. Learning Objective 2.2 Specialization and Gains from Trade FIGURE 2-5 Gains from Trade Comparative Advantage and Trade

13. Learning Objective 2.2 Specialization and Gains from Trade TABLE 2-1 A Summary of the Gains from Trade Comparative Advantage and Trade 42 9 12 8 Production and consumption without trade 60 0 0 20 Production with trade 3 1 3 2 Gains from trade (increased consumption) 45 10 15 10 Consumption with trade CHERRIES (IN POUNDS) APPLES (IN POUNDS) CHERRIES (IN POUNDS) APPLES (IN POUNDS) YOUR NEIGHBOR YOU

14. Learning Objective 2.2 Absolute advantage The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources Absolute Advantage versus Comparative Advantage Table 2-2 Opportunity Costs of Picking Apples and Cherries Comparative Advantage and Trade 1 pound of apples 1 pound of cherries YOU 0.5 pounds of apples 2 pounds of cherries YOUR NEIGHBOR OPPORTUNITY COST OF PICKING 1 POUND OF CHERRIES OPPORTUNITY COST OF PICKING 1 POUND OF APPLES

15. Learning Objective 2.2 Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Absolute Advantage versus Comparative Advantage Comparative Advantage and Trade

16. Learning Objective 2.2 The basis for trade is comparative advantage, not absolute advantage. Individuals, firms, and countries are better off if they specialize in producing goods and services for which they have a comparative advantage and obtain the other goods and services they need by trading. Comparative Advantage and the Gains from Trade Don’t Let This Happen to YOU! Don’t Confuse Absolute Advantage and Comparative Advantage Comparative Advantage and Trade

17. Learning Objective 2.2 Comparative Advantage and the Gains from Trade Solved Problem 2-2 20 30 15 30 CANADA 40 20 40 10 UNITED STATES MAPLE SYRUP (IN TONS) HONEY (IN TONS) MAPLE SYRUP (IN TONS) HONEY (IN TONS) AFTER TRADE BEFORE TRADE 0 50 10 40 0 40 50 0 60 0 40 10 45 10 20 30 15 30 30 20 30 20 MAPLE SYRUP (IN TONS) HONEY (IN TONS) MAPLE SYRUP (IN TONS) HONEY (IN TONS) UNITED STATES CANADA

18. Learning Objective 2.2 Comparative Advantage and the Gains from Trade Solved Problem 2-2

19. The Market System Learning Objective 2.3 Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. Product markets Markets for goods—such as computers—and services—such as medical treatment. Factor markets Markets for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability. Factors of production The inputs used to make goods and services.

22. The Market System Learning Objective 2.3 FIGURE 2-6 The Circular-Flow Diagram The Circular Flow of Income

23. The Market System Learning Objective 2.3 Free market A market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed. The Gains from Free Markets

24. The Market System Learning Objective 2.3 The Market Mechanism Individuals usually act in a rational, self-interested way. Adam Smith understood that people’s motives can be complex. In a famous phrase, Smith said that firms would be led by the “invisible hand” of the market to provide consumers with what they wanted.

25. Learning Objective 2.3 A Story of the Market System in Action: How Do You Make an iPod? The market coordinates the activities of the many people spread around the world who contribute to the making of an iPod. Making the Connection

26. The Market System Learning Objective 2.3 Entrepreneur Someone who operates a business, bringing together the factors of production—labor, capital, and natural resources—to produce goods and services. The Role of the Entrepreneur

27. The Market System Learning Objective 2.3 Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. The Legal Basis of a Successful Market System Protection of Private Property Enforcement of Contracts and Property Rights If property rights are not well enforced, fewer goods and services will be produced. This reduces economic efficiency, leaving the economy inside its production possibilities frontier.

28. Learning Objective 2.3 Property Rights in Cyberspace: YouTube and MySpace Controlling unauthorized copying is more difficult today than it was when “copying” meant making a physical copy of a book, CD, or DVD. The popularity of YouTube and MySpace highlights the problem of unauthorized copying of videos and music. Some recording artists worry that the copyrights for their songs are not being protected on the Internet. Making the Connection

29. An Inside LOOK BMW Managers Change Production Strategy Redesigned X5 to lead increase; new coupe to debut in 2008

30. Absolute advantage Circular-flow diagram Comparative advantage Economic growth Entrepreneur Factor markets Factors of production Free market Market Opportunity cost Product markets Production possibilities frontier ( PPF ) Property rights Scarcity Trade K e y T e r m s