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Gains From Trade : Ch.3

Gains From Trade : Ch.3. PPF. Only 2 goods : Guns and Butter Production Possibility Frontier (PPF) shows graphically the trade-off between the two goods. The (negative) slope of the curve is the marginal opportunity cost of one good in terms of the other. guns. guns. A. B. butter.

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Gains From Trade : Ch.3

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  1. Gains From Trade : Ch.3

  2. PPF • Only 2 goods : Guns and Butter • Production Possibility Frontier (PPF) shows graphically the trade-off between the two goods. • The (negative) slope of the curve is the marginalopportunity cost of one good in terms of the other

  3. guns guns A B butter butter guns C Opportunity Cost: What you give up Constant Marginal Op. Cost Increasing Marginal Op. Cost Decreasing Marginal Op. Cost butter

  4. Opportunity Cost • Price of one thing in terms of what you give up • Example: dollars for bread • $/loaf • Now: guns for butter • #guns/#butter is “price of butter” • Opportunity cost

  5. Example : Constant Op. Cost Absolute Advantage : Lower cost of production (Sam has A.A. in both corn and soy) Comparative Advantage : Lower opportunity cost (cannot have C.A. in both)

  6. PPF John Sam corn corn 12 8 (6c,12s) (4c,6s) 12 soy 24 soy Now, what if they specialize and trade? Answer: they can both be better off.

  7. Say John specialize in corn and Sam in soy, then trade – why this way? • Trade 4 acres of corn for 7 acres of soy

  8. John Sam With Trade both consume beyond PPF Conclusion: Trade is good corn 12 8 (6c,13s) (4c,7s) 12 soy 24

  9. Where did price ratio of 4 corn for 7 soy come from? • Answer: between the two opportunity costs of John and Sam. • John Op. Cost of corn : 3/2 soy • Sam Op. Cost of corn : 2 soy • Between 6/4 and 8/4 is 7/4 • So 7 soy for 4 corn • Does it have to be middle? – No • Exactly where beyond this course, so anywhere

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