Good morningDay 5, to start…Let us say this is the table which represents the Production Possibility Curve for a person…

Graph the PPF first…

Then calculate the opportunity cost

Points Nike hightop shoes Hats with stickers on them still

A 10 0

B 5 10

C 0 20

Easier method (in notes you used what I called “the maximum production function”)…

Here, you will:

1) Find the difference

2) Write a sentence

3) Divide

The opportunity cost of ___ shoes is __ hats…

That is mostly it for exclusively PPF stuff… We will be using it in our next topic…

Interdependence and the Gains from Trade

Chapter 6

Interdependence and Trade Consider your typical day:You wake up to an alarm clock made in Korea.You pour yourself some orange juice made from oranges grown in Florida.

You put on some clothes made of cotton grown in Georgia and sewn in factories in Thailand.

You watch the morning news broadcast from New York on your TV made in China.

Your teacher is using a computer and projector made in the supply chain over twenty countries

You drive to class in a car made of parts manufactured in a half-dozen different countries.

…and you haven’t been up for more than two hours yet!

Two extremes

We can be economically self-sufficient (autarky)

We can specialize and trade with others, leading to economic

interdependence (this is globalization)

Individuals and nations rely on specialized production and

exchange as a way to address problems caused by scarcity.

A bonus of specialization:

When people specialize, allocative efficiency is realized, which entails that the most desired items are being produced and resources are efficiently divided

More to come on this… A LOT MORE

Why interdependence?

Interdependence occurs because people are better off when they specialize and

trade with others because of differences in opportunity costs.

Absolute Advantage

The producer (person, firm, or country) requires fewer resources per unit of output than an other country has AA… it can produce more of it GIVEN SAME NUMBER OF INPUTS

Comparative Advantage

Compares producers of a good according to their opportunity cost.

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Imagine . . .¼only two goods: potatoes and meat¼only two people: a potato farmer and a

cattle rancher What should each produce? Why should they trade?

A Parable for the Modern Economy

The Production Opportunities of the Farmer and the Rancher

Hours Needed to Make 1 lb. of: Amount Produced in 40 HoursMeat Potatoes Meat Potatoes

Farmer 20 hours/lb 10 hours/lb 2 lbs. 4 lbs.Rancher 1 hours/lb 8 hours/lb. 40 lbs. 5 lbs.

Self-Sufficiency

By ignoring each other: Each consumes what they each produce. The production possibilities frontier is also the

consumption possibilities frontier.

(write the ppfs on left and leave room on right for charts)

Production Possibilities Frontiers

Potatoes (pounds)

Meat (pounds)

4

2

1

2

(a) The Farmer’s Production Possibilities Frontier

0

A

Production Possibilities Frontiers

Potatoes (pounds)

Meat (pounds)

5

40

20

2.5

(b) The Rancher’s Production Possibilities Frontier

0

B

The Farmer and the Rancher Specialize and Trade

Each would be better off if they specialized in producing the product they are more suited to produce

The Gains from Trade: A Summary

The OutcomeWithout Trade:

Farmer1 lb meat (A)2 lbs potatoes

Rancher20 lbs meat (B)2.5 lbs potatoes

A and B are the midpoints

The Gains from Trade: A Summary

The OutcomeWith Trade:What TheyProduce

What TheyTrade

What TheyConsume

Farmer0 lbs meat 4 lbs potatoes

Gets 3 lbs meatfor 1 lb potatoes

3 lbs meat (A*)3 lbs potatoes

Rancher24 lbs meat 2 lbs potatoes

Gives 3 lbs meatfor 1 lb potatoes

21 lbs meat (B*)3 lbs potatoes

Trade Expands the Set of Consumption Possibilities

Potatoes (pounds)

Meat (pounds)

42

2

1

(a) How Trade Increases the Farmer’s Consumption

0

A

3

3

A*

Farmer’s consumption without trade

Farmer’s consumption with trade

Trade Expands the Set of Consumption Possibilities

Potatoes (pounds)

Meat (pounds)

52.5

40

20

(b) How Trade Increases The Rancher’s Consumption

0

B

21

3

B*

Rancher’s consumption without trade

Rancher’s consumption with trade

Day 6-Vocab Relax:

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Define these following terms:

• Ceteris Paribus/Other things equal assumption• Normative Economics • Law of Increasing Opportunity Cost• Comparative Advantage • Export Subsidies

If you were wondering, this is beyond the PPF because there are more resources

involved now

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Gains from Trade: A Summary

The GainsFrom Trade:The Increase in Consumption

Farmer2 lbs meat (A*- A)1 lb potatoes

Rancher1 lb meat (B*- B)1/2 lb potatoes

Specialization and Trade

Who has the absolute advantage?The farmer or the rancher?

Who has the comparative advantage?The farmer or the rancher?

Absolute Advantage

The Rancher needs only 8 hours to produce a pound of potatoes, whereas the Farmer needs 10 hours.

The Rancher needs only 1 hour to produce a pound of meat, whereas the Farmer needs 20 hours.

The Rancher has an absolute advantage in the production of both

meat and potatoes.

Think about the next chart…take some time and wrap your head around it

The Opportunity Cost of Meat and Potatoes

Opportunity Cost of:

1 lb of Meat 1 lb of Potatoes

Farmer 2 lb potatoes ½ lb meat

Rancher 1/8 lb potatoes 8 lb meat

Comparative Advantage

…so, the Rancher has a comparative advantage in the

production of meat but the Farmer has a comparative

advantage in the production of potatoes.

And AA and CA can apply to any entities

trading

Absolute Advantage

The producer (person, firm, or country) requires fewer resources per unit of output than an other country has AA… it can produce more of it GIVEN SAME NUMBER OF INPUTS…. THAT MEANS THE PERSON WITH AA is more productive with the resources

Benefits of Trade

Trade can benefit everyone in a society because it allows people

to specialize in activities in which they have a comparative

advantage.

Terms of Trade

How do entities decide what to trade?

They agree to specialize where they have comparative advantage in such a way that both end up with more than could have been possible without trade

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Adam Smith and Trade

In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith performed a detailed analysis of trade and economic interdependence, which economists still adhere to today.

David Ricardo and Trade

In his 1816 book Principles of Political Economy and Taxation, David Ricardo developed the principle of comparative advantage as we know it today.

“England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time. England would therefore find it in her interest to import wine, and to purchase it by the exportation of cloth. To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England.”

Ricardo’s law has been called the only proposition in the whole of the social sciences that is both true and surprising. It is such an elegant idea that it is hard to believe that Palaeolithic people took so long to stumble upon it (or economists to define it); hard to understand why other species do not make use of it, too. It is rather baffling that we appear to be the only species that routinely exploits it. Of course, that is not quite right. Evolution has discovered Ricardo’s law and applied it to symbioses, such as the collaboration between alga and fungus that is a lichen plant or the collaboration between a cow and a bacterium in a rumen. Within species, too, there are clear gains from trade between cells of a body, polyps of a coral colony, ants of an ant colony, or mole-rats of a mole-rat colony. The great success of ants and termites – between them they may comprise one-third of all the animal biomass of land animals – is undoubtedly down to their division of labour. Insect social life is built not on increases in the complexity of individual behaviour, ‘but instead on specialization among individuals’.

In the leafcutter ants of the Amazon rainforest, colonies may number millions, and workers grow into one of four distinct castes: minors, medias, majors and supermajor. In one species a supermajor (or soldier) may weigh the same as 500 minors.But the big difference is that in every other species than human beings, the colonies consist of close relatives – even a city of a million ants is really just a huge family. Yet reproduction is the one task that people never delegate to a specialist, let alone a queen. What gave people the chance to exploit gains from trade, without waiting for Mother Nature’s tedious evolutionary crawl, was technology. Equipped with the right tool, a human being can become a soldier or a worker (maybe not a queen), and he can switch between the roles. The more you do something, the better you get at it. A band of hunter-gatherers in west Eurasia, 15,000 years ago, dividing labour not just by gender but by individual as well, would have been formidably more efficient than an undifferentiated band. Imagine, say, 100 people in the band. Some of them make tools, others make clothes, others hunt, others gather. One tiresome bloke insists on prancing around in a deer skull chanting spells and prayers, adding little to the general well-being, but then maybe he is in charge of the lunar calendar so he can tell people when the tides will be lowest for limpet-picking expeditions.True, there is not much specialisation in modern hunter-gatherers. In the Kalahari or the Australian desert, apart from the gathering women, the hunting men and maybe the shaman, there are not too many distinct occupations in each band. But these are the simple societies left in the harsh habitats. In the relatively fertile lands of west Eurasia after 40,000 years ago, when bands of people were larger and lines of work were diverse, specialisation had probably grown up within each band. The Chauvet rhino painter was so good at his job (and yes, archaeologists think it was mainly one artist) that he must surely have had plenty of time off hunting duties to practise. The Sungir bead maker must have been working for a wage of some kind, because he cannot surely have had time to hunt for himself. Even Charles Darwin reckoned that ‘primeval man practised a division of labour; each man did not manufacture his own tools or rude pottery, but certain individuals appear to have devoted themselves to such work, no doubt receiving in exchange the produce of the chase.’

Should Bill Gates Mow His Own Lawn?

?? ?