Transcript Introduction to Economics Comparative advantage

What is Economics?
• Economics is the social science that studies how
societies (individuals, businesses, and
Government) allocate their scarce resources to
satisfy unlimited wants.
• Three IMPORTANT words
– Allocate – to assign, allot, distribute
– Scarce – insufficient to meet demand, not enough to
go around for all
– Resources – “things” available to a society that are
used to attempt to satisfy unlimited wants.
The principal problem of
Economics is…
Scarcity
“The first lesson of economics is
scarcity: There is never enough of
anything to satisfy all those who
want it. The first lesson of politics is
to disregard the first lesson of
economics”. --Thomas Sowell
SCARCITY
YOU CAN’T HAVE
EVERYTHING
YOU WANT!
The inability of
limited resources
to satisfy people’s wants
4/10/2016
Lesson 1: Scarcity
4
Scarcity
It’s about
RESOURCES and
WANTS.
You can’t eliminate
scarcity
But you can learn to deal
with it!
When faced with SCARCITY of
resources, decisions have to
be made about how to use
those resources
Trade-offs
Opportunity Costs
…are all the alternatives in making
a decision
…the cost of the next best use of
money, time, or resources (you’re 2nd
Choice)
… Are all of the alternatives that go
into making a decision….
In this case let’s say you have many
different choices of what you want
to do on Saturday night.
Here are all of your Choices on
Saturday night…which are…
•
•
•
•
•
•
Go on a Date
Hang out with friends
Watch TV
Read a good book
Hang out with parents
Go to bed early
These are
all of your
trade-offs
Opportunity Cost is different, though…
• Remember… Opportunity
Cost is the next highest
valued alternative. (The 2nd
Best Choice)
Great Forest!
1. Macro [national] economics – concerned
with the economy as a whole Macro
examines the “forest, not the trees,
leaves, or specific pieces of bark.”
2. Micro [details of the big picture] – concerned with specific
economic units or individual markets under a microscope.
Emphasis is on individual households, industries, or firms
[like the # of workers employed by Ford] [Concerns the
components of the economy]
Micro examines the “trees, leaves, & pieces of bark,
rather than the forest.”
.
Nice bark!
Macro[large](telescope) “whole economy” [economy-wide issues]
Micro[small](microscope] “segment of the economy” [issues in the economy]
“Check out those
pieces of bark!.
“Beautiful,
beautiful forest!”
Production
Microeconomics
Macroeconomics
How much steel
How much office space
.
Total industrial output
Gross Domestic Product
Prices
Price of individual goods
Price of medical care
Rate of inflation
Employment
Jobs in the steel industry
Total number of jobs
Economy’s unemployment
Introduction to Economics
What is Economics?
Two fields of Economic study: Micro and Macro
Economics is divided into two main fields of study
Microeconomics: Studies the behaviors of INDIVIDUALS within an economy:
Consumers and producers in particular markets.
Examples: The Automobile market in Switzerland, the market for movie tickets in
Zurich, the market for airline tickets between the US and Europe, the market for
vacations to Spain, the market for international school teachers.
Macroeconomics: Studies the total effect on a nation's people of all the
microeconomic activity within that nation. The four main concerns of
macroeconomics are:
1) total output of a nation,
2) the average price level of a nation,
3) the level of employment (or unemployment) in the nation and
4) distribution of income in the nation
Examples: Unemployment in Canada, inflation in Zimbabwe, economic growth in
China, the gap between the rich and the poor in America
Resources or “Factors of
Production”
Land – Natural Resources
•
Acreage, rivers, lakes, ports, natural resource (oil, precious metals,
minerals)
Labor – Human Resources
•
Physical and Mental talents that produce goods and services
Capital – “stuff you use to make other stuff”
All manufactured goods and services used in producing consumer goods.
Examples: Tools, machinery, equipment, trucks to carry goods, airplanes,
etc.
Entrepreneurship –
1.
2.
Someone who takes the initiative in using or combining the above
Resources to produce a good or service.
Someone who is innovative, a risk taker, and makes basic business
decisions.
Remember -- ALL THESE RESOURCES ARE IN
LIMITED SUPPLY
THEY ARE SCARCE!!!!
The Four Factors of Production
Resources beget production, which beget income, which beget wealth.
1. Land [natural resources] – Nature’s items [“gifts of nature”]
A. In the earth - coal, oil, water, fossil fuels, etc.
B. On the earth – vegetation and water
C. In the atmosphere – sun, wind, and rain
[Land is the starting point
of all production.
“Stuff” from which everything is made.
.
Water
Wind
Sun
Fossil fuels
“Gifts of Nature”
2.
Labor [human resources] {“effort”}
anyone who works [“paid work”]
[Labor is the “brain-power” and
“muscle-power” of human beings]
A. Physical – pro athletes & lumberjacks
B. Intellectual – ministers, doctors & lawyers
*Most important resource – 70% of input cost
.
“Hired Help”
Real Capital v. Financial Capital
REAL CAPITAL
[tools, machinery, & factories]
Can produce something
directly with these
.
FINANCIAL CAPITAL
[stocks, bonds, and money]
Can’t produce anything
directly with these
.
3. Capital Resources – all “man-made inputs” used in the
production process (tools, machinery, and physical plants).
A. Capital goods – goods [machinery, buildings, & tools] used to
produce other goods. [crane, Ford plant, hammer]
[products meant for “future consumption”]
B. Consumer goods – products meant for “immediate consumption”.
“Real Capital” [machinery, physical plants & tools] [capital is a
factor of production] v. “Financial Capital” [stocks, bonds, & $] [not factors of production]
A product can be both a consumer good & a capital good –depends on its use.
Ex: Jet aircraft used by a movie
star to visit friends (consumer good). The
same aircraft used by a business
manager to serve customers [capital good].
Ex: F150 pick-up to deliver produce [capital good] or take family to church [consumer good]
“man-made inputs”
Rent
Land
Wages
Labor
Interest
Capital
Profits
Entrepreneur
.
4. Entrepreneurship – starting a new business or introducing a new
product. “Sparkplugs” who introduce the product or start the new
business. He combines land, labor, & capital to produce products.
Resource payments. The resource owners receive rent [for
the use of their land; wages [for their labor]; interest [payment
for financial capital], and profits [for their entrepreneurial ability].
Introduction to Economics
The productive Resources
Payments for resources: Since resources are scarce, there is a cost associated with their use.
Firms (resource demanders) must provide households (resource suppliers) with a payment for
their resources.
For LAND: Firms pay households RENT. Landowners have the option to use
their land for their own use or to rent it to firms for their use. If the landowner
uses his land for his own use, the opportunity cost of doing so is the rent she
could have earned by providing it to a firm.
For LABOR: Firms pay households WAGES. To employ workers, firms must
pay workers money wages. If a worker is self employed, the opportunity cost of
self-employment is the wages he could have earned working for another firm.
For CAPITAL: Firms pay households INTEREST. Most firms will take out
loans to acquire capital equipment. The money they borrow comes mostly from
households' savings. Households put their money in banks because they earn
interest on it. Banks pay interest on loans, which becomes the payment to
households. If a household chooses to spend its extra income rather than save
it, the opportunity cost of doing so is the interest it could earn in a bank.
For ENTREPRENEURSHIP: Households earn PROFIT for their
entrepreneurial skills. An entrepreneur who takes a risk by putting his creative
skills to the test in the market expects to earn a normal profit for his efforts.
PRIVATE
PROPERTY
ROLE OF
SELF-INTEREST
FREEDOM OF
ENTERPRISE
& CHOICE
COMPETITION
PRIVATE
PROPERTY
ROLE OF
SELF-INTEREST
MARKETS
& PRICES
FREEDOM OF
ENTERPRISE
& CHOICE
COMPETITION
ACTIVE, BUT
LIMITED,
GOVERNMENT
1. Private Property – the right of individuals to
exercise control over things owned. Freedom to
negotiate binding legal contracts.
Contracts are legally binding in oral or written form.
[A verbal agreement is binding only if it involves a small sum of money
over a short period of time and does not involve real estate purchases.]
2. Freedom of Enterprise (business) & Choice
Can move within the economy to any job, to
buy or sell property, or start a business.
The consumer is “sovereign” (king) in the economy. His
dollars vote as it is he who decides what gets produced.
The U.S. has over 100,000 business failures each year.
3. Role of Self-Interest–each producer or consumer
tries to do what is best for themselves. Self interest
is the main force driving the economy.
Producers aim for maximum profits.
Consumers seek the lowest prices & highest quality.
K-Mart?
5. Markets & prices. Markets bring the buyers and sellers into contact.
Prices send signals.
High prices send signals to increase
production and for other producers to enter the market.
Low prices send signals
to decrease production
and for producers to exit the market.
6. Limited Government Intervention in the economy.
The role of government was one of “laissez faire.” [“hands off”]
In the words of Adam Smith, the government should not interfere with
the operation of the economy except serve as an arbitrator in settling
disputes.
The government’s role:
(according to Smith)
a. provide defense,
b. administer justice, and
Arbitrator
c. maintain certain public institutions.
[settling disputes]
The Three Fundamental Questions...
1. What will be produced?
2. How will the goods be produced?
3. Who will get the goods and services?
The Case for the Market System
Efficiency, Incentives, and Freedom
Adam Smith said the “invisible hand” determines what
gets produced, how, & for whom. It is the invisible hand
that moves us along the PPC. The invisible hand is now
called the market mechanism. Its essential feature is
the price signal.
Scarcity
Choices
Unlimited
Wants
WHAT G/S
Limited
Resources
WHO will receive
HOW will the
to produce?
the G/S produced?
G/S be produced?
Businesses
Most needy or most money
BASIC
ECONOMIC
PROBLEMS
Answers to the above determine:
ECONOMIC SYSTEMS
TRADITIONAL
COMMAND
FREE MARKET
Economic Systems
– the way society produces products
1. Traditional
2. Pure Command
3. Pure Market
4. Mixed
a. Capitalism
b. Democratic Socialism
c. Authoritarian Socialism [Communism]
The way the 3 basic questions are answered
Determines an economic system.
1. Traditional-[where “CUSTOM RULES”]
I. Used to be
2. PURE COMMAND - where the
“GOVERNMENT RULES”. The government
controls all resources. What, How, and For
Whom answered by the government.
Karl Marx
3. PURE MARKET – where
“INDIVIDUALS RULE”. Individuals
and firms control all resources. The
government has no say. WHAT, HOW &
FOR WHOM are decided by individuals.
Adam Smith
MIXED – all countries have mixed economic systems
How are these words used in everyday life?
1. Traditional
2. Command
3. Market
• A mixed economy is one that uses
both market signals and
government directives to allocate
goods & resources.
• Most economies use a combination
of market signals and government
directives to select economic
outcomes.
ADAM SMITH
WEALTH OF NATIONS – 1776
[explained the free market concept]
The “INVISIBLE HAND” – when individual consumers/
producers compete to achieve their own private self-interest.
The “role of government” [“LAISSEZ-FAIRE” – “HANDS OFF”]
is limited to national defense, public education, maintaining the
infrastructure, and enforcing contracts. Smith said the market
system was best because it encouraged specialization, resulting in
increased output & more economic growth.
No “G”
Government was like an “INVISIBLE FOOT” – government action
to benefit particular groups. Keynes will say the G can act as a pressure In loving memory
gauge,
letting off excess steam or building it up as needed. [active-not all inclusive role]
My name is
mercantilism.
So mercantilism died
as economic theory.
of mercantilism
Smith’s book was an
attack on mercantilism.
Mercantilism
Wealth doesn’t come from an accumulation of gold and silver but
from more productive people. A nation is wealthier if its citizens
Are more productive. It is the ability of people to produce products
and trade in free markets that creates a nation’s wealth.
Smith’s
famous
Example
One manAdam
could do
maybe 1
pin perPin
dayFactory
[1 man =
1 pin]
Now if there is specialization
1 man draws the wire out
1 man straightens the wire
1 man cuts the wire
1 man sharpens the point
1 man flattens the head
There are 18 distinct operations
- some perform 2 or 3 operations
10 people do 48,000 pins per day
1 man = 4,800 pins per day
Three circumstances come from this specialization.
1. Increased dexterity (learning by doing)
2. Saving time (lose time when you move
to different operations)
1. Invention of machines (fosters inventiveness)
Introduction to Economics
The Production Possibilities Curve
What basic economic concepts can it
be used to model?
·Scarcity, tradeoffs, opportunity cost,
economic growth, efficiency,
unemployment.
10
Italy's PPC
B
Robots
What is the PPC?
The PPC illustrates the possible
combinations of goods or services
that can be produced by a single
nation, firm, or individual using
resources efficiently
What does it show?
That nothing is free and that
everything has an opportunity cost. If
society wants more pizzas, it must
give up robots.
D
A
C
Pizzas
200
Understanding the PPC: The graph above shows that Italy can produce EITHER
10 robots OR 200 pizzas, or some combination of the two products, as long as it
remains on or within its PPC. A point inside the PPC is attainable but not desirable. A
point outside the PPC is desirable but unattainable.
Introduction to Economics
The Production Possibilities Curve
Italy's PPC
Assumptions about the PPC:
A
E
Robots
·The PPC is attainable only if a
nation achieves full-employment of
its productive resources
·The nation's resources are fixed in
quantity
·Assumes the nation must chose
between only two goods
·The economy is closed, i.e. does
not trade with other countries
·Represents only one country's
economy
Questions to consider about the PPC:
10
9
B
7
D
C
2
65
130
Pizzas
1) Which point(s) are attainable and desirable? WHY?
2) Which point(s) are attainable but not desirable? WHY?
3) Which point(s) are unattainable? Is this point desirable? Explain.
4) Which point will mean more consumption in the future? Explain.
5) Which point means more consumption now? Explain.
6) Why is the PPC bowed outwards?
7) How does the PPC illustrate opportunity cost? Tradeoff? Scarcity?
195
Introduction to Economics
The Production Possibilities Curve
1) Which point(s) are attainable and desirable?
·Points on the PPC (A, B and C) are attainable through full
employment, and thus desirable because they represent efficient
use of Italy's resources.
3) Which point(s) are unattainable? Is this point desirable?
·Point E is beyond Italy's production possibilities and is thus
unattainable. It is desirable because it represents greater
consumption of both pizzas and robots.
10
9
Robots
2) Which point(s) are attainable but not desirable?
·Point D is inside the PPC, thus represents inefficient use of
resources, and most likely high unemployment, and is thus
undesirable.
Italy's PPC
A
E
B
7
D
C
2
65
130
195
Pizzas
4) Which point will mean more consumption in the future?
·Point A represents more consumption in the future, because Robots are a capital good, used to make other
products for consumption. If Italy produces more robots now, it may mean more consumer goos in the
future.
5) Which point means more consumption now?
·Point C because pizza is a consumer good. Households don't buy and use robots, but they do like to eat
pizzas.
6) Why is the PPC bowed outwards?
·The Law of Increasing Opportunity Cost
Introduction to Economics
The Production Possibilities Curve
Pizzas and Robots:
Assume Italy was producing 200 pizzas and 0 robots. Surely,
many of the resources (land, labor and capital) being used to
make pizzas would be better suited to making robots. As Italy
starts making its first two robots it has to give up very few
pizzas, since only those resources that are suited for robot
production will be used. At first, 2 robots "cost" Italy only 5
pizzas. But as the country makes more and more robots, the
opportunity cost increases, because at some point pizza
makers will have to build robots. As Italy approaches 10
robots, the opportunity cost of the last two robots is 130
pizzas, as resources better suited for pizza production are
employed in robot factories.
Robots
Rationale: Economic resources are not completely
adaptable to alternative uses. Many resources are
better at producing one type of good than at producing
others.
10
9
8
7
6
5
4
3
2
1
0
Italy's PPC
constant opportunity cost
A
B
C
D
20 40 60 80 100 120 140 160 180 200
Pizzas
Italy's PPC
increasing opportunity cost
10
9
8
7
6
5
4
3
2
1
0
A
Robots
Law of increasing opportunity cost:
As the production of a particular good increases, the
opportunity cost of producing an additional unit rises.
B
C
D
20 40 60 80 100 120 140 160 180 200
Pizzas
Introduction to Economics
The Production Possibilities Curve
Italy's PPC
9
How does the PPC illustrate:
A
·Scarcity?
·Tradeoffs?
·Decisions?
·Resources?
·Opportunity costs?
·Actual output?
·Potential output?
E
Robots
B
7
D
C
2
65
130
Pizzas
195
And some more challenging ones:
·Unemployment?
·Economic growth?
·Economic development?
Introduction to Economics
The Production Possibilities Curve
Italy's PPC
9
How does the PPC illustrate:
A
·Scarcity?
·Tradeoffs?
·Decisions?
·Resources?
·Opportunity costs?
·Actual output?
·Potential output?
E
Robots
B
7
D
C
2
65
130
Pizzas
195
And some more challenging ones:
·Unemployment?
·Economic growth?
·Economic development?
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
Unemployment &
Underemployment
Shown by Point U
13
12
11
10
9
8
7
6
5
4
3
2
1
More of either or
both is possible
U
1
2
3
4
5
6
7
8
Pizzas (hundred thousands)
Q
PRODUCTION POSSIBILITIES
Notes...
Economic Growth
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
The ability to produce
a larger total output - a
rightward shift of the
production possibilities
curve caused by...
1
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Notes...
Robots (thousands)
Q 14
Economic Growth
13
12
11
10
9
8
7
6
5
4
3
2
1
1. Increase in resources -
2. Better resource quality -
More of either or
both is possible
3. Technological advances -
1
2
3
4
5
6
7
8
Pizzas (hundred thousands)
Q
C
A
P
I
T
A
L
G
O
O
D
S
AB
PPC
C
G
D
F
E
Consumer Goods
40. At what letter is there unemployment [recession]? F
41. What letters represent resources being used in their
most productive manner? [full employment, full
production, and best available technology] A,B,C,D,E
42. What letter represents an improvement in technology,
therefore a new PPC frontier line?
G
43. The (straight line/curve) illustrates the “line of increasing cost”?
44. The (straight line/curve) illustrates the “law of constant cost.”
45. At what letter would there be the most economic growth in
the future if a country were producing there now? A
46. What is the opportunity cost when moving from “C” to “D”; Capital
Consumer E to B; & do we have to give anything up when moving from F to D?no
PPC Practice Questions
1. An economy that is fully employing all its productive
resources but allocating less to investment than
to consumption will be at which of the following
positions on the PPC to the right?
a. A
b. B
c. C
d. D
e. E
2. Which of the following best explains the shape of the
PPC for the two-commodity economy shown above?
a. Opportunity cost of producing another unit of each stays the same.
b. Opportunity cost of producing another unit of each decreases.
c. Opportunity cost of producing another unit of each increases.
3. Which of the following is true of the PPC on the right?
a. Point Q is attainable but undesirable.
b. Point R is unattainable but undesirable.
c. A technological improvement of watches would move
the economy from T to P.
d The opportunity cost of moving from S to T is the # of
watches given up.
4. If we move from B to C on the graph (right),
the opportunity cost is?
a. AH units of good Y
b. OG units of good Y
c. EF units of good X
d. HG units of good Y
A
H
G
O
B
C
PPC Practice Questions
[continued]
5. Which of the following would cause the
PPC shown (right) to shift outward?
a. Reopening steel plants that had been closed
b. Rehiring laid-off workers
Missiles
c. Using machinery for missile production
instead of steel production
d. Using machinery for steel production
instead of missile production
e. Developing a more efficient steelmaking process
6. Base on the graph (right), which statements
are true?
I. The opportunity cost of moving from P to R
is 10 units of Y.
II. The opportunity cost of moving from R to P
is 8 units of X.
III. The opportunity cost of moving from Q to R
is 0 units.
a. I only b. III only c. I & II only d. I, II, & III
Steel
X
Introduction to Economics
Product and Resource Markets
What is a Market?
A place where buyers and sellers come together
In economics, we will study two types of market
Product Markets
Households buy goods and services
produced by firms
Resource Markets
Firms buy productive resources from
households
Introduction to Economics
Product and Resource Markets
Product Markets
Who are the buyers?
Households
Who are the sellers?
firms
What is bought and sold?
goods and services
Resource Markets
Who are the buyers?
firms
Who are the sellers?
households
What is bought and sold?
Capital, land, labor
Which way does money flow?
from households to firms
Which way does money flow?
What are the goals of firms and
households?
What are the goals of firms and
households?
Maximize profit (firms) and utility (households)
Maximize income (households), minimize costs (firms)
Why does everyone benefit?
Why does everyone benefit?
Because exchanges are mutual and voluntary
From firms to households
Because exchanges are mutual and voluntary
Introduction to Economics
Product and Resource Markets
Resource Market:
·Households supply productive resources (land, labor, capital)
·Firms buy productive resources from households. In exchange for their productive resource,
firms pay households:
-Wages: payment for labor
-Rent: payment for land
-Interest: payment for capital
-Profit: payment for entrepreneurship
·Firms seek to minimize their costs in the resource market
·Firms employ productive resources to make products, which they sell back to households in the
product market
Product Market:
·Consumers buy goods and services from firms
·Households use their money incomes earned in the resource market to buy goods and services
·Expenditures by households become revenues for firms
·Firms seek to maximize their profits
·Households seek to maximize their utility (happiness)
Notice the CIRCULAR FLOW of resources and money
between these two markets!
Introduction to Economics
The Circular Flow of Resources
Expenditures / revenue
Product market
Goods/Services
Firms
Households
Factors of
production
Resource market
Income: W I R P
Questions:
·Give three examples of resource owners.
·Give three examples of transactions you made this week in the product market.
·Give an example of a transaction you or your family made this month in a factor market.
·What resources or "input factors" do households provide in the resource market?
·What determines the prices of land, labor, capital and entrepreneurship in a factor market?
·Where do households get the money to buy goods and services in the product market?
·Where do business firms get the money to pay households for their resources?
·How does the circular flow diagram illustrate interdependence in a market economy?
Introduction to Economics
The Circular Flow of Resources
Resource Market
Product Market
Firms employ productive resources to
Productive resources: Households provide
make finished goods and services. They
firms with the productive resources they
sell their products to households in
need to produce goods and services
exchange for money.
-Land
-Labor
Mutual benefits and
Households spend
-Capital
voluntary
exchange
-Entrepreneurship
their
income from the sale
of
Resource payments: Firms pay
households for their resources, using
revenue from the sale of their goods and
services, which creates income for
households
-Rent
-Wages
-Interest
-Profit
their resources.
·Households make expenditures on goods
and services
·Firms earn revenue, which is needed to
cover their costs. Any revenue earned
beyond all costs is considered economic
profit.
·The goal of households is to maximize
happiness (utility)
·The goal of firms is to maximize profits
NCEE Workbook Activity (TR-TC)
5: The Circular Flow
Introduction to Economics
Introduction to Trade
What is trade?
Trade is one of the concepts fundamental to the field of economics. Voluntary
exchanges between individuals and firms in resource and product markets
involving the exchange of goods, services, land, labor and capital is a type of trade.
International trade involves the exchange of resources, goods, services, assets
(both real and financial) across national boundaries.
Trade
makes everyone better off, and leads to a more efficient
allocation of society's scarce resources.
"It is not from the benevolence of the butcher, the brewer, or the
baker, that we expect our dinner, but from their regard to their own
interest. We address ourselves, not to their humanity but to their selflove, and never talk to them of our necessities but of their
advantages" - Adam Smith "The Wealth of Nations"
Discuss...
Introduction to Economics
Introduction to Trade
Adam Smith, the father of modern Economics.
·Lived 1723-1790
·Leading thinker of the Scottish Enlightenment
·Two great works: The Theory of Moral Sentiments (1759) and The Wealth of
Nations (1776)
·Believed that humans acting in their own self-interest would lead to benefits
for society as a whole, since the pursuit of self-interest naturally leads
individuals to meet the wants and needs of those around them.
On mutual benefits of trade: "Whoever offers to another a bargain of any kind, proposes
to do this. Give me that which I want, and you shall have this which you want, is the
meaning of every such offer; and it is in this manner that we obtain from one another the far
greater part of those good offices which we stand in need of."
On self-interest: "Every man…is first and principally recommended to his own
care; and every man is certainly, in every respect, fitter and abler to take care of
himself than of any other person."
Discussion Question: What IS the "invisible hand" that makes all this work?
Introduction to Economics
Introduction to Trade
Abraham Lincoln was once advised to buy cheap iron rails from Britain to finish
the transcontinental railroad. He replied, "It seems to me that if we buy the rails
from England, then we've got the rails and they've got the money. But if we build
the rails here, we've got our rails and we've got our money."
To paraphrase: "If I buy meat from the butcher, then I get the meat and he
gets my money. But if I raise a cow in my backyard for three years and
slaughter it myself, then I've got the meat and I've got my money."
Why don't we keep cows in our backyard?
Source: "Naked Economics" by Charles Wheelan
Discussion Questions:
1. Why do nations trade?
2. What is specialization?
3. How does a nation determine what it should specialize in?
4. How do nations benefit from trade?
Introduction to Economics
Introduction to Trade
Three facts help answer this question:
·Uneven distribution of land, labor and capital resources
·Efficient production requires different combinations of resources
·People may simply prefer products made in other countries due to non-price attributes
Labor-intensive goods
-Examples:
-Where?
Land-intensive goods
-Examples:
-Where?
Capital-intensive goods
-Examples
-Where?
What does Switzerland specialize in? Why? China? US? India? UK?
Introduction to Economics
Comparative advantage and the PPC
Comparative Advantage: A country has a comparative advantage in production of a certain product
when it can produce that product at a lower relative opportunity cost than another country.
Production Possibilities Analysis: Specialization is economically desirable because it results in
more efficient production.
How much do apples "cost"?
39
PPC - Korea
PPC - USA
apples
apples
·in the US? -> 1a = 1/3c
24
·in Korea? -> 1a = 1/2c
How much do cell phones "cost"
·in the US? -> 1c = 3a
13
cell phones
12
cell phones
·in Korea? -> 1c = 2a
Should the countries trade? Why or why not?
Introduction to Economics
Comparative advantage and the PPC
United States: Specialize in apples -> trade apples for cell phones with Korea. Korea should be willing to trade 1
apple for anything up to, but not beyond, 1/2 cell phone. Before trade, 1 apple could only be get America 1/3 cell
phone. The US has gained from trade.
Korea: Specialize in cell phones -> trade cell phones for apples with the US. The US should be willing to
exchange up to three apples for one cell phone. Before trade, Korea could only get two apples for each cell
phone it gave up. Korea has gained from trade.
Trading possibilities line
USA
36
apples
apples
Terms of trade:
39
The "real exchange rate"
between apples and cell
phones will depend on the
relative success of the US
and Korea at the negotiating
table. The red dashed lines
represent the best possible
outcome for both countries.
13
cell phones
Trading possibilities line
Korea
24
19.5
12
cell phones
Introduction to Economics
Comparative advantage and the PPC
Specialization: "The use of the resources of an individual, a firm, a region, or a nation to concentrate
production on one or a small number of goods and services."
·What a person, company or country should specialize in depends on the
task for which it has the lowest opportunity costs.
·Countries should specialize based on the products for which they
have a comparative advantage
·Terms of trade: terms that are mutually beneficial to the two countries in trade. Where the trade
leaves both countries better off than they were originally
·Gains from Specialization and Trade: Specialization based on comparative advantage improves
global resource allocation. Each country would result in a larger global output with the same total
inputs or world resources and technology.
Conclusion: "Specialization and trade based on comparative advantage increases the
productivity of a nation's resources and allows for greater total output than would
otherwise be possible."
Introduction to Economics
Comparative advantage and the PPC
Production possibilities tables: Countries' production possibilities can be displayed using tables.
These tables come in two types, Output and Input tables.
Input Problem
Output Problem
Reading the table: Given a fixed amount of
resources, Mexico and the USA can choose
between the following alternatives.
Soybeans
Reading the table: In order to produce one
ton of output, Mexico and the USA must use
the following amount of resources. (in acres
of land)
Avocados
Soybeans
Avocados
Mexico
15
60
Mexico
16
8
USA
30
90
USA
8
6
How to decide who should specialize in what:
·Identify the opportunity costs of soybeans and avocados in Mexico and the USA
·The countries should specialize in the one for which they have the lower opportunity cost.
·Cross multiplication trick. (maximize output and minimize inputs)
Introduction to Economics
Comparative advantage and the PPC
Another way to determine who should specialize in what using production
possibilities tables: CROSS MULTIPLY!
Input Problem
Output Problem
Avocados
Soybeans
Mexico
15
60
= 1800
Mexico
16
X
USA
30
Avocados
Soybeans
8
= 64
6
= 96
X
90
= 1350
For an output problem, simply cross multiply and
then choose the highest level of output. Output is
maximized when the US specializes in soybeans and
Mexico in avocados.
USA
8
For an input problem, cross-multiply and then
choose the combination that uses the least
amount of inputs. Inputs are minimized when
the US specializes in soybeans and Mexico in
avocados.
Introduction to Economics
Comparative advantage and the PPC
Soybeans
Avocados
Soybeans
30
USA
Mexico
Mexico
15
60
USA
30
90
15
PPC shows the the two countries
potential output.
60
Avocados
90
·Who should specialize in what?
·Illustrate the possible gains from
trade on the two PPCs
Introduction to Economics
Unit 1 Definitions
Economic growth: An increase in total output (and income) or per capita output (and
income) of a nation over a period of time. Can be illustrated by an outward shift of the
PPC
Economic development: a sustained increase in the standard of living of the
people of a nation. Characterized by improvements in health, education, life
expectancy, and per capita income.
Positive and normative concepts:
·Positive concepts are those rooted in fact. They are observable and definitive.
Example: The average income of Americans HAS increased by 2.5% per year
since 1970.
·Normative concepts are those rooted in opinion. They are statements of what
should be rather than what is. Example: American incomes should be higher
given the increases in productivity since the 1970s.
Introduction to Economics
Unit 1 Definitions
Ceteris Paribus: Translates to "all else equal". Economists assume "ceteris
paribus" in all of their models. The purpose is to simplify an economic event
down to one or two observable variables, understanding that other factors could
change that affect the model.
Example: "ceteris paribus", an increase in price of a good will lead to a
decrease in the quantity demanded by consumers. The ceteris paribus means
that other factors besides price are NOT changing, (i.e. the price of other goods
or the incomes of consumers).
Utility: The economists word for happiness. Economists assume that rational
consumers always behave in a way that maximizes their utility.
Free vs. Economic goods:
·Free goods are those that are desired but not limited. A free good is available in
as great a quantity as desired with zero opportunity cost to society. Air is a free
good. Sunlight is a free good
·Economic goods are those that are desired and limited. This is most resources
and goods in society. They are economic because the supply is limited, therefore
there is a price attached to them, or an opportunity cost associated with their use.
Models in Economics
A model is a simplified representation of a real
situation that is used to better understand reallife situations.
Ceteris Paribus
The “other things equal” assumption means
that all other relevant factors remain
unchanged.
65
Scientific Thinking
• The AssociationCausation Issue
• The Fallacy of
Composition
• The Ceteris
Paribus Assumption
“How much?” is a decision at the
margin.
•You make a trade-off when you compare the
costs with the benefits of doing something.
•Decisions about whether to do a bit more or a
bit less of an activity are marginal decisions.
67
Marginal Analysis
•Making trade-offs at the margin: comparing
the costs and benefits of doing a little bit
more of an activity versus doing a little bit
less.
•The study of such decisions is known as
marginal analysis.
•
Ex.: Hiring one more worker, studying
one more hour, eating one more cookie,
buying one more CD
68