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Recall

Recall. Economies are defined by scarcity. Scarcity forces people to make choices. Choices involve costs. Since we all face different costs, by specializing and trading we can create wealth. Markets form to facilitate trade (formal/informal). Comparative Advantage &

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Recall

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Presentation Transcript

  1. Recall • Economies are defined by scarcity. • Scarcity forces people to make choices. • Choices involve costs. • Since we all face different costs, by specializing and trading we can create wealth. • Markets form to facilitate trade (formal/informal).

  2. Comparative Advantage & the Tale of Robinson Crusoe • Consider the simplest possible economy. • One actor, Robinson Crusoe (R.C.). • One resource, time. • Since R.C. can only work eight hours in a day, he is faced with scarcity. • Scarcity forces R.C. to make choices.

  3. R.C.’s Choices(The number of hours to get 1 unit)

  4. R.C.’s Opportunity Costs • It takes R.C. 1/2 hour (30m) to catch 1 fish and it takes him 1/4 hour (15m) to cut 1 palm. • So, each fish he catches requires giving up 2 palms (1/2 hour (30m) not spent palming). • It takes R.C. 1/4 hour (15m) to cut 1 palm and it takes him 1/2 hour (30m) to catch 1 fish. • So, each palm he cuts requires giving up 1/2 fish (1/4 hour (15m) not spent fishing).

  5. R.C.’s Opportunity Costs • 1 fish costs 2 palms. • The opportunity cost of 1 fish is 2 palms. • 1 palm costs 1/2 fish. • The opportunity cost of 1 palm is 1/2 fish. • Let’s put it in a table.

  6. R.C.’s Choices/Opportunity Costs The number of hours to get 1 unit • What is possible in eight hours? What he gives up for 1 unit

  7. R.C.’s Possibilities • R.C. likes an even mix in his consumption so he spends half his time fishing and half palming. Slope = 1/2 = Opp. Cost of 1P R.C.’s PPF F 16 A ■ 8 16 32 P

  8. Meanwhile on the other side of the island Friday plans his workday…(The number of hours to get 1 unit)

  9. Friday’s Opportunity Costs • It takes Friday 1/2 hour (30m) to catch 1 fish and it takes him 1/8 hour (7.5m) to cut 1 palm. • So, each fish he catches requires giving up 4 palms (1/2 hour (30m) not spent palming). • It takes Friday 1/8 hour (7.5m) to cut 1 palm and it takes him 1/2 hour (30m) to catch 1 fish. • So, each palm he cuts requires giving up 1/4 fish (1/8 hour (7.5m) not spent fishing).

  10. Friday’s Opportunity Costs • 1 fish costs 4 palms. • The opportunity cost of 1 fish is 4 palms. • 1 palm costs 1/4 fish. • The opportunity cost of 1 palm is 1/4 fish. • Let’s put it in a table.

  11. Friday’s Choices/Opportunity Costs The number of hours to get 1 unit • What is possible in eight hours? What he gives up for 1 unit

  12. Friday’s Possibilities Slope = 1/4 = Opp. Cost of 1P • Like R.C., Friday likes an even mix of consumption so he spend half his time fishing and half palming. Friday’s PPF F 16 A ■ 8 32 64 P

  13. Opportunity Costs: Summing Up • Although R.C. and Friday have similar resources, they face different costs. • R.C. is the low cost producer of Fish. • Friday is the low cost producer of Palms. • Remember, cost is always measured in terms of Opp. Costs. • Friday is a better palmer because of a superior tree climbing ability. Opportunity Costs

  14. Comparative Advantage • We say someone has a “Comparative Advantage” if they can produce a good at a lower relative cost compared to someone else.

  15. Can life improve for both R.C. & Friday? R.C’s PPF Friday’s PPF F F 16 16 A A ■ 8 ■ 8 16 32 P 32 64 P

  16. Taking the (comparative) Advantage • Exchange rate (fish for palms): 1F for 3P • Will R.C. trade? • Will Friday trade? • And if so…how will they do it?

  17. The Deal Goes Down • What effect does this trade have on R.C.’s and Friday’s level of consumption?

  18. Gains From Trade • BOTH R.C. and Friday are OUTSIDE their PPF. Robinson’s PPF Friday’s PPF F F A 16 16 ■ 8 B B ■ ■ 8 A ■ 24 32 P 40 64 P

  19. Gains From Trade • When people specialize in their comparative advantage, and trade in markets for other goods, wealth increases. • Notice that no extra resources are used. • Using the Low-Cost Producer conserves scarce resources. • Specialization and trade REDUCES scarcity!

  20. The Big Picture • Specialization and trade creates wealth. • With trade we get more goods from fewer resources. • Trade (in aggregate) makes societies better off. • Trade improves welfare even if one party is bigger, smarter, or more productive than another.

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