Circular-Flow Diagram: a visual model of the economy that shows how dollars flow through markets among households and firms
Production Possibilities Frontier: a graph that shows the combiantions of output that the economy can possibly produce given the available factors of production and the available production technology
Microeconomics: the study of how households and firms make decisions and how they interact in markets
Macroeconomics: the study of economywide phenomena, including inflation, unemployment, and economic growth
Absolute Advantage: the ability to produce a good using fewer inputs than another producer
Comparative Advantage: the ability of produce a good at a lower opportunity cost than another producer
Economic Models
The Circular-Flow Diagram
A more complex and realistic circular-flow model would include, for instance, the roles of government and international trade.
The Production Possibilities Frontier
Microeconomics and Macroeconomics
- Microeconomics is the study of how households and firms make decisions and how they interact in specific markets.
- Macroeconomics is the study of economywide phenomena.
Comparative Advantage: The Driving Force of Specialization
Economists use the term absolute advantage when comparing the productivity of one person, firm, or nation to that of another.
The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.
Economists use the term comparative advantage when describing the opportunity costs faced by two producers.
The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing.
The gains from specialization and trade are based not on absolute advantage but on comparative advantage.
Trade can benefit everyone in society because it allows people to specialize in the activities in which they have a comparative advantage.
For both parties to gain from trade, the price at which they trade must lie between their opportunity costs.
