Transcript O`Sullivan Sheffrin Peres 6e

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Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.
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Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
6/e.
O’Sullivan, Sheffrin, Perez
Macroeconomics: Principles, Applications, and Tools
Exchange and
Markets
Mattel’s Barbie, the
most profitable doll in
history, is sold in 140
countries around the
world at a rate of two
dolls per second.
PREPARED BY
FERNANDO QUIJANO, YVONN QUIJANO,
AND XIAO XUAN XU
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3.1
COMPARATIVE ADVANTAGE
AND EXCHANGE
Specialization and the Gains from Trade
P R I N C I P L E O F O P P O RT U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
CHAPTER 3
Exchange and
Markets
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O’Sullivan, Sheffrin, Perez
Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.1
COMPARATIVE ADVANTAGE
AND EXCHANGE
 FIGURE 3.1
Specialization and the Gains
from Trade
● comparative advantage
The ability of one person
or nation to produce a
good at a lower
opportunity cost than
another person or nation.
• Fred has a comparative
advantage in producing fish
because his opportunity cost
of fish is one-third coconut per
fish, compared to 1 coconut
per fish for Kate.
• Kate has a comparative
advantage in harvesting
coconuts because her
opportunity cost of coconuts is
1 fish per coconut, compared
to 3 fish per coconut for Fred.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.1
COMPARATIVE ADVANTAGE
AND EXCHANGE
PRINCIPLE OF VOLUNTARY EXCHANGE
A voluntary exchange between two people makes both people better off.
Comparative Advantage versus Absolute Advantage
● absolute advantage
The ability of one person or
nation to produce a product at
a lower resource cost than
another person or nation.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.1
COMPARATIVE ADVANTAGE
AND EXCHANGE
The Division of Labor and Exchange
In his 1776 book An Inquiry into the Nature and Causes of the Wealth of
Nations, Adam Smith noted that specialization actually increased productivity
through the division of labor.
Smith listed three reasons for productivity to increase with specialization, with
each worker performing a single production task:
1 Repetition. The more times a worker performs a particular task, the more
proficient the worker becomes at that task.
2 Continuity. A specialized worker doesn’t spend time switching from one
task to another. This is especially important if switching tasks requires a
change in tools or location.
3 Innovation. A specialized worker gains insights into a particular task that
lead to better production methods.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
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3.2
COMPARATIVE ADVANTAGE AND
INTERNATIONAL TRADE
● import
A product produced in a foreign country and
purchased by residents of the home country.
● export
A product produced in the home country and
sold in another country.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.2
COMPARATIVE ADVANTAGE AND
INTERNATIONAL TRADE
Outsourcing
When a domestic firm shifts part of its production to a different
country, we say the firm is outsourcing or offshoring.
Some recent studies of outsourcing have reached a number of
conclusions:
1 The loss of domestic jobs resulting from outsourcing is a normal
part of a healthy economy, because technology and consumer
preferences change over time.
2 The jobs lost to outsourcing are at least partly offset by jobs
gained through insourcing, jobs that are shifted from overseas to
the United States.
3 The cost savings from outsourcing are substantial, leading to
lower prices for consumers and more output for firms. The jobs
gained from increased output at least partly offset the jobs lost
to outsourcing.
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3.2
COMPARATIVE ADVANTAGE AND
INTERNATIONAL TRADE
Movie Exports
 FIGURE 3.2
International Box Office
Revenue for U.S. Films, 2004
Macroeconomics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
CHAPTER 3
Exchange and
Markets
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
APPLICATION
1
CANDY CANE MAKERS MOVE TO MEXICO FOR CHEAP SUGAR
APPLYING THE CONCEPTS #1: Does the protection of one domestic
industry harm another?
About 90 percent of the world’s candy canes are consumed
in the United States, and until recently most were produced
domestically. Domestic firms used their superior access to
consumers to dominate the market.
In recent years, the domestic production of candy canes has decreased.
In 2003, Spangler Candy Company of Bryan, Ohio, shifted half its
production to Mexico because the cost of sugar, the key ingredient in
candy, is only $0.06 per pound in Mexico, compared to $0.21 in the United
States.
Since 1998, the Chicago area, the center of the U.S. confection industry,
has lost about 3,000 candy-production jobs.
Why is the price of sugar in the United States so high? The government
protects the domestic sugar industry from foreign competition by
restricting sugar imports. As a result, the supply of sugar in the United
States is artificially low and the price is artificially high. In this case, the
protection of jobs in one domestic industry reduces jobs in another
domestic industry.
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3.3
MARKETS
● market economy
An economy in which people
specialize and exchange goods and
services in markets.
Although it appears that markets arose naturally, a number of social and
government inventions have made them work better:
• Contracts specify the terms of exchange, facilitating exchange between
strangers.
• Insurance reduces the risk entrepreneurs face.
• Patents increase the profitability of inventions, encouraging firms to develop
new products and production processes.
• Accounting rules provide potential investors with reliable information about the
financial performance of a firm.
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3.3
MARKETS
Virtues of Markets
● centrally planned economy
An economy in which a government
bureaucracy decides how much of
each good to produce, how to
produce the good, and who gets
the good.
Under a market system, decisions are made by the millions of people who
already have information about consumers’ desires, production
technology, and resources. These decisions are guided by prices of
inputs and outputs.
Prices provide signals about the relative scarcity of a product and help an
economy respond to scarcity.
The market system works by getting each person, motivated by selfinterest, to produce products for other people.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
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3.3
MARKETS
The Role of Entrepreneurs
Entrepreneurs play a key role in a market economy.
Prices and profits provide signals to entrepreneurs about what to
produce. If a product suddenly becomes popular, competition
among consumers to obtain it will increase its price and increase the
profits earned by firms producing it.
Entrepreneurs will enter the market and increase production to meet
the higher demand, switching resources from the production of other
products.
As entrepreneurs enter the market, they compete for customers,
driving the price back down to the level that generates just enough
profit for them to remain in business.
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Exchange and
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APPLICATION
2
GOLD FARMING FOR WORLD OF WARCRAFT
APPLYING THE CONCEPTS #2: What is the role of opportunity
cost in the development of markets?
As an example of a market that results from comparative advantage, consider the
market for virtual currency. Firms in China pay workers (called gold farmers) to
play the online game World of Warcraft (WoW). In the game, workers earn virtual
currency in the form of gold coins by killing monsters. In the real world, firms pay
the workers a piece rate of about $0.0125 per coin, which translates into a wage of
about $0.30 per hour. The firm sells the coins to an online retailer for about $0.03
per coin, and the retailer then sells the coins to consumers for about $0.20 per
coin. The consumers in this market are WoW gamers in the United States, who
are willing to pay cash for game shortcuts—they use the purchased coins to buy
the equipment and magic spells required to battle virtual monsters and move to the
next level of the game.
Let’s look at this exchange in terms of opportunity cost. Suppose a gamer in the
United States is roughly half as productive as a gold farmer in earning gold in the
game, getting 12 coins per hour. The gamer can either spend an hour to earn 12
coins or take a shortcut by paying $0.20 per coin, or $2.40. If the gamer’s
opportunity cost is greater than $2.40 per hour, buying the coins is sensible.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
APPLICATION
3
MARKETS IN A PRISONER OF WAR CAMP
APPLYING THE CONCEPTS #3: Why do markets develop wherever
people go?
To illustrate the pervasiveness of exchange, consider the
emergence of markets in prisoner of war (POW) camps
during World War II, as documented by economist
R. A. Radner.
During World War II, the International Red Cross gave each Allied
prisoner a weekly parcel with the same mix of products—tinned milk, jam,
butter, biscuits, corned beef, chocolate, sugar, and cigarettes. In addition,
many prisoners received private parcels from family and friends. The
prisoners used barter to exchange one good for another, and cigarettes
emerged as the medium of exchange. Prisoners wandered through the
camp calling out their offers of goods. For example, “cheese for seven”
meant that the prisoner was willing to sell a cheese ration for seven
cigarettes. In addition to food, the prisoners bought and sold clothing (80
cigarettes per shirt), laundry services (2 cigarettes per garment), and hot
cups of coffee (2 cigarettes per cup).
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.4
MARKET FAILURE AND
THE ROLE OF GOVERNMENT
Although markets often operate efficiently on their
own, sometimes they do not.
Market failure happens when a market doesn’t
generate the most efficient outcome.
Later in the book, we’ll explore several sources of
market failure and discuss possible responses by
government. Here is a preview of the topics:
•
•
•
•
Pollution.
Public goods.
Imperfect information.
Imperfect competition.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.4
MARKET FAILURE AND
THE ROLE OF GOVERNMENT
Government Enforces the Rules of Exchange
To facilitate exchange, the government helps to enforce contracts by
maintaining a legal system that punishes people who violate them.
This system allows people to trade with the confidence that the terms
of the contracts they enter will be met.
In the case of consumer goods, the implicit contract is that the
product is safe to use. The government enforces this implicit contract
through product liability or tort law.
The government disseminates information about consumer products.
The government uses antitrust policy to foster competition.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
3.4
MARKET FAILURE AND
THE ROLE OF GOVERNMENT
Government Can Reduce Economic Uncertainty
Given the uncertainty of market economies, most governments fund
a “social safety net” that provides for citizens who fare poorly in
markets.
Of course, there are private responses to economic uncertainty. For
example, we can buy our own insurance to cover losses.
Some types of insurance, however, are unavailable in the private
insurance market. As a result, the government steps in to fill the
void.
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Macroeconomics: Principles, Applications, and Tools
CHAPTER 3
Exchange and
Markets
KEY TERMS
absolute advantage
export
centrally planned economy
import
comparative advantage
market economy
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