The Congressional Budget Office estimates that as the U. Many policymakers are concerned that this rapid increase in Medicare spending will force a reduction in spending on other government programs. Daniel Callahan, a researcher at the Hastings Center for Bioethics, has argued that policymakers should consider taking some dramatic steps, such as having Medicare stop paying for open-heart surgery and other expensive treatments for people over 80 years of age.
Spending less on prolonging the lives of the very old in order to save resources that can be used for other purposes is a very painful trade-off to consider. But in a world of scarcity, trade-offs of some kind are inevitable. Suppose the U. He asks you, one of his economic advisors, to prepare a report discussing the relevant factors he should consider.
Use the concepts of opportunity cost and trade-offs to discuss some of the main issues you would deal with in your report. Solution: If the federal government has a fixed budget for medical research, then the opportunity cost of funding more research on heart disease is the reduction in funding for research on other diseases. The decision should be made at the margin: to maximize the benefits from government spending on medical research, the last dollar devoted to research on heart disease should result in the same marginal benefit—less disease and fewer deaths—as the last dollar spent on research for other diseases.
If the additional funding for research on heart disease comes at the expense of other non-medical research expenditures, then the opportunity cost will be different, but a similar analysis should be conducted. Uwe Reinhardt, an economist at Princeton University, wrote the following in a column in the New York Times: [Cost-effectiveness analysis] seeks to establish which of several alternative strategies capable of achieving a given therapeutic goal is the least-cost strategy.
It seems a sensible form of inquiry in a nation that is dismayed over the rising cost of health care. Are there any decisions you make during your everyday life that indicate whether you consider health and life to be priceless? Source: Uwe E.
Solution: Nothing is priceless. Every day we makes decisions, such as driving a car or flying in a plane, that increase by at least a small amount the chances that we will be hurt or killed. If health and life were literally priceless, every decision we make would have the sole objective of minimizing the chances of our being injured or killed.
In a broader sense, we do not devote all of our resources to improving health care because resources devoted to, say, saving lives through medical research are not available for other needs, such as improving education. We always have to consider the opportunity cost of using resources in one way rather than in another. Trade is the act of buying and selling. Trade makes it possible for people to become better off by increasing both their production and their consumption.
Specialization and Gains from Trade PPFs depict the combinations of two goods that can be produced if no trade occurs. We can use PPFs to show how someone can benefit from trade even if she is better than someone else at producing both goods. Absolute Advantage versus Comparative Advantage Absolute advantage is 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. If the two individuals have different opportunity costs for producing two goods, each individual will have a comparative advantage in the production of one of the goods.
Comparative advantage is the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Comparing the possible combinations of production and consumption before and after specialization and trade occur proves that trade is mutually beneficial.
Comparative Advantage and the Gains from Trade The basis for trade is comparative advantage, not absolute advantage. Individuals, firms, and countries are better off if they specialize in producing the goods and services for which they have a comparative advantage and obtain the other goods and services they need by trading. Teaching Tips Even good students have difficulty understanding comparative advantage. A good example of comparative advantage is the career of baseball legend Babe Ruth.
Before he achieved his greatest fame as a home run hitter and outfielder with the New York Yankees, Ruth was a star pitcher with the Boston Red Sox. Ruth may have been the best left-handed pitcher in the American League during his years with Boston — , but he was used more as an outfielder in his last two years with the team.
In fact, he established a record for home runs in a season 29 in The Yankees acquired Ruth in and made him a full-time outfielder. The opportunity cost of this decision for the Yankees was the wins he could have earned as a pitcher.
But because New York already had skilled pitchers, the opportunity cost of replacing him as a pitcher was lower than the cost of replacing Ruth as a hitter. It can be argued that Ruth had an absolute advantage as both a hitter and pitcher for the Yankees in , but a comparative advantage only as a hitter. In the United States and most other countries, trade is carried out in markets.
A market is a group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. A product market is a market for goods—such as computers—or services—such as medical treatment.
A factor market is a market for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability. Factors of production are the labor, capital, natural resources, and other inputs used to make goods and services. The Circular Flow of Income A circular-flow diagram is a model that illustrates how participants in markets are linked. The diagram demonstrates the interaction between firms and households in both product and factor markets.
The Gains from Free Markets A free market is 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. Adam Smith is considered the father of modern economics. His book, An Inquiry into the Nature and Causes of the Wealth of Nations, published in , was an influential argument for the free market system. This assumption underlies nearly all economic analysis.
The Role of the Entrepreneur in the Market System Entrepreneurs are an essential part of a market economy. An entrepreneur is someone who operates a business, bringing together the factors of production—labor, capital, and natural resources—to produce goods and services. Entrepreneurs often risk their own funds to start businesses and organize factors of production to produce those goods and services that consumers want.
The Legal Basis of a Successful Market System The absence of government intervention is not enough for a market economy to work well. Government has to provide a legal environment that allows markets to operate efficiently. Property rights are the rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. To protect intellectual property rights, the federal government grants a patent that gives an inventor — often a firm—the exclusive right to produce and sell a new product for 20 years from the date the patent was filed.
Books, films, and software receive copyright protection. Under U. Business activity often involves someone agreeing to carry out some action in the future. These agreements often take the form of legal contracts. For the market system to work, businesses and individuals have to rely on these contracts being carried out. Enforcing contracts or property rights requires an independent court system and judges who are able to make impartial decisions on the basis of the law.
If property rights are not well enforced fewer goods and services will be produced, leaving the economy inside its production possibilities frontier.
Teaching Tips To initiate class discussion regarding intellectual property rights, ask students these questions: 1. How many of you have downloaded music via the Internet? Should the government have the right to grant exclusive rights to musicians and other artists to produce and sell their creative works?
Should the government fine or prosecute individuals who illegally obtain music, books, movies, and other creative works in violation of property rights laws? What types of regulation and privilege might merchants and manufacturers seek from the government? How might these regulations and privileges keep the invisible hand from working? Solving the Problem Step 1: Review the chapter material. This problem is about how goods and services are produced and sold and how factors of production are employed in a free market economic system as described by Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations.
Step 2: Answer part a. At the time, governments gave guilds—associations of producers—the authority to control production. The production controls limited the output of goods such as shoes and clothing, as well as the number of producers of these items. Limiting production and competition led to higher prices and fewer choices for consumers. Instead of catering to the wants of consumers, producers sought favors from government officials. Step 3: Answer part b. Under a market system, producers who sell poor quality goods at high prices suffer economic losses; producers who provide better quality goods at low prices are rewarded with profits.
Therefore, it is in the self-interest of producers to address consumer wants. This is how the invisible hand works in a free market economy, but not in most of Europe in the eighteenth century. But most economists believe that free trade policies, including allowing goods and services to be produced in other countries, benefit domestic economies.
In a letter dated March 5th , 14 economists including R. Questions: a Should the United States accept the advice of economists and support free trade policies even if this increases the risk of some workers losing their jobs to outsourcing?
Answers: a Given the opposition from firms and workers in industries that would be harmed by free trade, it is unlikely that the United States would eliminate all trade barriers. But studies such as the one cited by Ben Bernanke show that increased trade can significantly boost the incomes of U.
In , maximum production is , two-door convertibles or , four-door sedans, so to gain one four-door sedan, Apple must give up producing one two-door convertible. Connect with us to learn more. We're sorry! We don't recognize your username or password.
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With an ever-changing US and world economy, the 6th Edition has been updated with the latest developments using new real-world business and policy examples. Regardless of their future career path -- opening an art studio, trading on Wall Street, or bartending at the local pub, students will benefit from understanding the economic forces behind their work. Download Preface. This material is protected under all copyright laws, as they currently exist. No portion of this material may be reproduced, in any form or by any means, without permission in writing from the publisher.
A flexible chapter organization satisfies a variety of approaches to teaching the principles of macroeconomics. Foster thorough understanding via a flexible, student-focused approach.
Check out the preface for a complete list of features and what's new in this edition. Consumer Choice and Elasticity. Firms in Perfectly Competitive Markets. Unemployment and Inflation. Money, Banks, and the Federal Reserve System. Important: To use the test banks below, you must download the TestGen software from the TestGen website.
If you need help getting started, read the tutorials on the TestGen site. Access Code Card. Glenn Hubbard, policymaker, professor, and researcher. Hubbard is the dean and Russell L. He received his PhD in economics from Harvard University in He currently serves as co-chair of the nonpartisan Committee on Capital Markets Regulation. His research has been supported by grants from the National Science Foundation, the National Bureau of Economic Research, and numerous private foundations.
He has taught principles of economics for more than 20 years, in both large sections and small honors classes. His research has been supported by grants from government agencies and private foundations. Paper Bound with Access Card. We're sorry! We don't recognize your username or password. Is it possible for a country to have a comparative advantage in producing a good without also having an absolute advantage? Briefly explain. Absolute advantage is the ability to produce more of a good or service than competitors using the same amount of resources.
Comparative advantage is the ability to produce a good or service at a lower opportunity cost than competitors. It is possible to have a comparative advantage in producing a good even if someone else has an absolute advantage in producing that good and every other good. Unless the two producers have exactly the same opportunity costs of producing two goods—the same trade-off between the two goods—one producer will have a comparative advantage in making one of the goods and the other producer will have a comparative advantage in making the other good.
The basis for trade is comparative advantage. If each party specialises in making the product for which it has the comparative advantage, they can arrange a trade that makes both of them better off. Each party will be able to obtain the product made by its trading partner at a lower opportunity cost than without trade. Who has a comparative advantage in producing apples? Who has a comparative advantage in producing oranges?
Explain your reasoning. Suppose that both countries are currently producing tonnes of apples and tonnes of oranges. Show that both can be better off if they specialise in producing one good and then engage in trade. New Zealand has the comparative advantage in producing oranges.
Whereas for Australia, the opportunity cost of producing tonnes of oranges is giving up tonnes of apples. Australia has the comparative advantage in producing apples. Neither country has an absolute advantage in making both goods.
Australia has the absolute advantage in producing apples, but New Zealand has the absolute advantage in producing oranges. If both countries specialise in the good in which they have a comparative advantage and then trade with the other, they can both be better off.
Australia will specialise by producing 12 tonnes of apples and New Zealand will specialise by producing tonnes of oranges. This means they are better off than before trading, since they end up with the same amount of oranges, but twice as many apples. Others trades will make them better off as well. The table shows combinations of both goods that each country can produce in a day, measured in thousands of barrels.
When Iraq produces one more barrel of olive oil, it produces one barrel less of crude oil. When Iran produces one more barrel of olive oil, it produces one less barrel of crude oil.
Therefore, neither country has a comparative advantage in either good. In both countries, the opportunity cost of one barrel of crude oil is one barrel of olive oil. Comparative advantage arises only if someone has a lower opportunity cost, but these two countries have the same opportunity cost.
Trading across the border would result in the same trade-offs that can be made within each country. The following table shows combinations of the goods that each country can produce in a day. Who has a comparative advantage in producing wine? Who has a comparative advantage in producing schnitzel? Suppose that France is currently producing one bottle of wine and 6 kg of schnitzel and Germany is currently producing three bottles of wine and 6 kg of schnitzel.
Demonstrate that France and Germany can both be better off if they specialise in producing only one good and then engage in trade. France has the comparative advantage in making wine.
When France produces one more bottle of wine, it produces two fewer kilograms of schnitzel. When Germany produces one more bottle of wine, it produces three fewer kilograms of schnitzel.
When Germany produces one more kilogram of schnitzel, it produces 0. When France produces one more kilogram of schnitzel, it produces 0. We can conclude that France has the comparative advantage in making wine and that Germany has the comparative advantage in making schnitzel. We know that France should specialise where it has a comparative advantage and Germany should specialise where it has a comparative advantage.
If both countries specialise, France will make 4 bottles of wine and 0 kg of schnitzel, and Germany will make 0 bottles of wine and 15 kg of schnitzel. After both countries specialise, France could then trade 3 bottles of wine to Germany in exchange for 7 kg of schnitzel. France will have the same amount of wine as they initially had, but one more kilogram of schnitzel.
Germany will have 3 bottles of wine and 8 kg of schnitzel—that is, the same amount of wine, but two more kilograms of schnitzel. Other mutually beneficial trades are possible as well.
Can an individual or a country produce beyond its production possibility frontier? Can an individual or a country consume beyond its production possibility frontier? An individual or a country cannot produce beyond its production possibility frontier.
The production possibility frontier shows the most that an individual or country can produce for a given amount of resources and technology. Without trade, an individual or country cannot consume beyond its production possibility frontier, but with specialisation and trade an individual or country can consume. In Table 2. If country A can produce twice as much coffee as country B, using the same amount of resources, explain how country B could have the comparative advantage in producing coffee.
Country B could have the comparative advantage in producing coffee if country A has an even larger absolute advantage relative to country B at producing another product. For example, if country A can produce four times more cashews than country B can using the same resources, then country B will have a comparative advantage in producing coffee. Is specialisation and trade between individuals and countries more about having a job or about obtaining a higher standard of living?
Individually, if you go from a situation of not trading with others you produce everything yourself to a situation of trading with others, do you still have a job? Does your standard of living increase?
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