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Recall

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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.