Why Don’t We Grow Bananas in Montana?

1. Why Don’t We Grow Bananas in Montana? Myles Watts Professor Department of Agricultural Economics and Economics February 2010

2. Situation • Robert J. Moneymaker travels to Costa Rica • Observes the nutritious and tasty banana growing in Costa Rica • Believes that Montanans would also enjoy eating bananas

3. Situation-Moneymaker’s Action • Builds a 20 acre greenhouse 5 stories tall to produce bananas • Sells 1 pound of bananas to each Montanan • Charges $10 per lb. and the profit is $2 per lb. or $2 million per year • Eventually Moneymaker lives in a million dollar house and drives a Mercedes

4. Situation-Middleman • Later, Betty K. Middleman travels to Costa Rica and sees the abundance of bananas • Middleman notices Moneymaker’s lifestyle and figures he is making a lot of money • Recently developed shipping methods make the transport of bananas feasible • She ships bananas to Montana • She charges $2 per lb., to cover cost of $1 per lb and to make a profit of $1 per lb.

5. Situation-Moneymaker • Moneymaker is livid • Contacts politicians to prohibit or make the importation of bananas more expensive • Moneymaker arguments are: • Investment risk in greenhouses • Costa Rica has unfair cost advantage particularly labor cost • Provides jobs in Montana • Extra cost to the Montana consumer is small. • Banana production in Montana results in consumer product and not just producing an input for out of state processors • Costa Rica bananas maybe a health risk

6. Middleman Responds • Only trying to serve the consumer with less expensive bananas • Has no customer complaints • Market should determine where bananas are produced

7. Consumer • Consumer gain from trade is $8 per lb and the gain maybe greater than $8 million dollars since consumers are likely to expand consumption at the lower price • Each consumer gains a small amount so there is little incentive for the individual consumer to enter the debate

8. Problem • Appears to be a political and intellectual swamp • Can economics help us better understand the problem and develop a rational solution?

9. Discussion Questions(Think like an economist) • What are the policy alternatives? • What should the policy makers do? • Who gains and looses under the recommended policy? • If your recommended policy adversely affects some parties, can that affect be ameliorated?

10. A Useful Tool: Production Possibilities Frontier • Resources are scarce • Resources or inputs could include land, labor, and/or capital • Inputs are used to produce outputs such as bananas and wheat • Since the inputs are scarce, the quantity of outputs are limited

11. B B PP PPF W W Production PossibilitiesFrontier (PPF) • The PPF for bananas and wheat is graphed below • PPF defines the combinations of outputs that can be produced if no inputs are wasted

12. PPF Assumptions • No waste • Technology level • Resource or input limit • Production time

13. Slope of PPF • PPF has a negative slope illustrating that one output can only increase if another output decreases. In the example, wheat can only increase if bananas decrease. • The slope of the PPF is the amount of bananas that must be given up to increase wheat one unit. • The slope is the opportunity cost of wheat in terms of bananas.

14. Linear PPF • Assume a straight line PPF • Algebraic B = 60 – 6W • Since the slope of the PPF is 6, the opportunity cost of wheat in terms of bananas is 6.

15. Concept: Comparative Advantage • PPFs vary by regions because of differences in resources and technology. • Differences in technologies lead to comparative advantage. • Exploited comparative advantage results in gains from trade.

16. B 70 60 50 P • 40 30 20 10 Q • 30 5 10 15 20 25 R N • • • C Costa Rica PPF Combined PPF Montana PPF M • W PPF for Montana andCosta Rica • Assume the two following simple linear PPFs for Montana and Costa Rica Bc = 60 – 6 Wc Bm = 6 - .5 Wm

17. Opportunity Cost • The slope of the PPF is the opportunity cost of producing wheat in terms of bananas. • Opportunity cost of wheat in Montana is .5. • Opportunity cost of wheat in Costa Rica is 6. • The opportunity cost of wheat in Montana is lower than in Costa Rica so Montana has a comparative advantage in wheat.

18. Before Trade Quantities • In the previous graph and in the table below, quantities without trade are designated as Points M, C, and N for Montana, Costa Rica, and combined, respectively.

19. After Trade Combined PPF • Begin with 0 wheat and 66 bananas • Increase wheat production (move to the right) by increasing Montana wheat and reducing Montana bananas • Increase Montana wheat production (rather than Costa Rica wheat) because Montana has comparative advantage in wheat

20. After Trade Combined PPF • Eventually cannot increase Montana wheat any more so then more wheat production must come from Costa Rica

21. After Trade Combined PPF • The segment PQR dominates the before trade combination, Point N

22. After Trade Combined PPF • Point P : Same wheat, more bananas • Point R: Same bananas, more wheat • Point Q: More bananas, more wheat • Superior combinations of bananas and wheat can be obtained from trade by exploiting comparative advantage • Recall Montana has a comparative advantage in wheat and Costa Rica has a comparative disadvantage in wheat • Comparative advantage was used to construct the after trade combined PPF since Montana wheat was chosen before Costa Rica wheat

23. Banana Comparative Advantage • Reverse the variables in both the graphical and algebraic PPFs Wc = 10 - .183 Bc Wm = 12 – 2 Bm • Costa Rica has a lower opportunity cost in bananas (.183 wheat) and therefore a comparative advantage in bananas. • Montana has a higher opportunity cost in bananas (2 wheat) and therefore a comparative disadvantage in bananas. • Therefore, Montana will avoid producing bananas and only produce bananas if a lot of bananas are wanted (more bananas than associated with Point Q). • Costa Rica will emphasize banana production and produce all of the bananas if the number of bananas produced is less the amount associated with point Q.

24. Summary • The amount of bananas and wheat chosen (point along the After Trade Combined PPF) will depend on: • Consumer preferences in Costa Rica and Montana. • International marketing conditions in the multi-country situation. • In most situations substantial gains from trade can be obtained by countries exploiting their comparative advantage

25. Discussion Questions • What are the policy alternatives? • What should the policy makers do? • Who gains and who looses under your recommended policy? • If your recommended policy adversely affects some parties, can that affect be ameliorated? • Should adversely affected parties be compensated? • Calculate the values associated with Points P, Q, and R in the previous table.

26. Discuss the Following Solution • Policy makers allow the importing of bananas to obtain the gains from trade. Moneymaker is compensated for his greenhouses and workers are retrained for other equal paying jobs. The cost is borne by the government (taxes paid by consumers.)