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Production, Economic Growth, and Trade

Understanding how economies grow based on the goods and services they choose to produce

Intst/Dreamstime.com; (inset) Cultura Creative (RF) / Alamy

Learning Objectives

2.1 Describe the three basic questions that must be answered by any economy.

2.2 Describe production and the factors that go into producing various goods and services.

2.3 Describe the opportunity cost an economy incurs to increase the production of one product.

2.4 Use a production possibilities frontier (PPF) to analyze the limits of production.

2.5 Describe economic growth and how it is stimulated by education and training, capital accumulation, and technological improvements.

2.6 Describe the concepts of absolute and comparative advantage.

2.7 Explain how specialization and trade can lead to gains for all countries involved.

Can a speck of sand be the most significant driver of economic growth of the last generation? Just about every piece of electronic and computing equipment contains a microchip, a tiny piece of circuitry that allows devices to function and to store immense amounts of data and multimedia. Most chips are made of silicon, which is nothing more than a basic element found in sand, and aside from oxygen is the most abundant element in the Earth’s crust.

Extracting silicon from sand, melting it, and creating silicon wafers on which transistors are produced to create a functioning microchip is a complex process. More impressive is how efficient the process has become. A single chip smaller than the size of a dime can hold billions of transistors, enough to store and display all of the music, videos, and photos you could ever want on a single device.

Arguably, no invention has transformed the economy more in the past 30 years than the development and advancement of the silicon chip. Technological change has made production methods more efficient, allowing countries to produce more goods and services using fewer physical and natural resources. And as we emphasized in the previous chapter on the importance of scarcity, determining how to achieve more using less—fewer resources—is one of the important goals of economics.

An industry that has experienced significant technological change is telecommunications. In 1950 long-distance phone calls were placed with the assistance of live operators, every minute on the line costing the average consumer the equivalent of several hours’ pay. Today, with Internet communications technology allowing one to call virtually anyone in the world for pennies or less, the globe is shrinking as communications brings us closer together and contributes to greater productivity.

Another driver of economic growth is trade. Several centuries ago, individuals produced most of what they consumed. Today, most of us produce little of what we consume. Instead, we work at specialized jobs, then use our wages to purchase the goods we need.

Nearly every country engages in commercial trade with other countries to expand the opportunities for consumption and production by its people. As products are consumed, new products must be produced, allowing increased consumption in one country to spur economic growth in another. Given the ability of global trade to open economic doors and raise incomes, trade is vital for economic growth in all nations.

This chapter gives you a framework for understanding economic growth. It provides a simple model for thinking about production, then applies this model to economies at large so you will know how to think about economic growth and its determinants. It then goes on to analyze international trade as a special case of economic growth. By the time you finish this chapter, you should understand the importance of economic growth and what drives it.