EP1 Tutorial 2 FC 2013

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Tutorial 2 for Economic Principles 1

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EP1 Tutorial 2 FC 2013

  1. 1. Economic Principles 1 Tutorial 2 Ben Gussen
  2. 2. Question 1 • Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self- sufficient?
  3. 3. Question 1 • Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self-sufficient? • Examples of regularly purchased items or services could include food for meals or a contracted lawn- mowing service • Examples of goods or services could include home- gown vegetables or washing dishes
  4. 4. Question 1 • Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self-sufficient? • Self-sufficiency would mean producing goods and services you don’t have a comparative advantage in. This would tend to make you worse off
  5. 5. Question 2 • George and Martha face the production possibilities frontiers shown for brownies and cupcakes.
  6. 6. Question 2 a. If George and Martha choose not to trade and divide their time equally between the production of brownies and cupcakes, how many of each would they be able to consume? (Show this point on your graphs.) b. Now assume that George and Martha each decide to specialize in the good in which they have a comparative advantage and then trade. Who would trade brownies and who would trade cupcakes? c. c. If George and Martha decided to trade 60 brownies for 60 cupcakes, how many cupcakes and brownies would each have to consume? d. d. How do we know each is better off with trade than acting alone?
  7. 7. Question 2 (a) • If George and Martha choose not to trade and divide their time equally between the production of brownies and cupcakes, how many of each would they be able to consume? (Show this point on your graphs.) • If George and Martha divide their time equally, George would be able to produce 50 brownies and 100 cupcakes (point A on his PPF) and Martha would be able to produce 80 brownies and 40 cupcakes (point A on her PPF)
  8. 8. Question 2 (b) • Now assume that George and Martha each decide to specialise in the good in which they have a comparative advantage and then trade. Who would trade brownies and who would trade cupcakes?
  9. 9. Question 2 (b) • George’s opportunity cost: • If George uses all his time to produce Brownies he makes 100 Brownies • If George uses all his time to produce Cupcakes he makes 200 Cupcakes
  10. 10. Question 2 (b) • George’s opportunity cost: • Hence, for George 100 Brownies are equivalent to 200 Cupcakes • For George: – 1 Brownie = 2 Cupcakes , or – 1Cupcake = ½ Brownie
  11. 11. Question 2 (b) • Martha’s opportunity cost: • If Martha uses all her time to produce Brownies she makes 160 Brownies • If Martha uses all her time to produce Cupcakes she makes 80 Cupcakes
  12. 12. Question 2 (b) • Martha’s opportunity cost: • Hence, for Martha 160 Brownies are equivalent to 80 Cupcakes • For Martha: – 1 Brownie = ½ Cupcakes – 1 Cupcake = 2 Brownie
  13. 13. Question 2 (b) • George has a comparative advantage in and would trade, cupcakes; • For him the opportunity cost of 1 cupcake is ½ Brownie • For Martha the opportunity cost of 1 cupcake is 2 Brownies
  14. 14. Question 2 (b) • Martha has a comparative advantage in and would trade, Brownies; • For Martha the opportunity cost of 1 Brownie is ½ Cupcake • For George the opportunity cost of 1 Brownie is 2 Cupcakes
  15. 15. Question 2 (c) • We assume total specialization: • George has comparative advantage in Cupcakes and hence would specialize in Cupcakes • Martha has comparative advantage in Brownies and hence would specialize in Brownies
  16. 16. Question 2 (c) • Since George is producing 200 cupcakes and no brownies, if he traded 60 cupcakes, he would be left with 140 cupcakes and would expect to receive 60 brownies from Martha in return.
  17. 17. Question 2 (c) • Since Martha is producing 160 brownies and no cupcakes, if she traded 60 brownies, she would be left with 100 brownies and would expect to receive 60 cupcakes from George in return.
  18. 18. Question 2 (d) • We know that both George and Martha are better off with trade because both are able to consume outside their own production possibilities frontiers
  19. 19. Question 3 • The table below describes the production possibilities for Lee and Amy in a four-hour shift. Coffee Croissants Lee 20 15 Amy 8 16
  20. 20. Question 3 • a. What is the opportunity cost of one coffee for each person? What is the opportunity cost of one croissant? • b. Who has a comparative advantage in coffees? Who has a comparative advantage in croissants? • c. Who has an absolute advantage in coffees? Who has an absolute advantage in croissants? • d. Who should produce coffees? Who should produce croissants?
  21. 21. Question 3 (a) • If Lee uses all his time to produce Coffee he can make 20 • If Lee uses all his time to produce Croissants he can make 15 • Hence for Lee 20 Coffee = 15 Croissants • Or 1 Coffee = ¾ Croissants
  22. 22. Question 3 (a) • If Amy uses all his time to produce Coffee she can make 8 • If she uses all his time to produce Croissants she can make 16 • Hence for Amy 8 Coffee = 16 Croissants • Or 1 Coffee = 2 Croissant
  23. 23. Question 3 (a) • The opportunity cost of one coffee for Lee is 3/4 croissants and the opportunity cost of one coffee for Amy is 2 croissants. • The opportunity cost of one croissant for Lee is 1 1/3 (=4/3) coffee. The opportunity cost of one croissant for Amy is 1/2 coffee.
  24. 24. Question 3 (b) • Lee has a comparative advantage in coffees • Amy has a comparative advantage in croissants.
  25. 25. Question 3 (c) • Lee has an absolute advantage in coffees • Amy has an absolute advantage in croissants.
  26. 26. Question 3 (c) • For absolute advantage we look at the operating cost rather than the opportunity cost
  27. 27. Question 3 (c) • If Lee uses all his time (which is his operating cost) to produce Coffee he gets 20 • If Amy uses all her time to produce Coffee she gets 8 • Hence, Lee has an absolute advantage in producing Coffee
  28. 28. Question 3 (c) • If Lee uses all his time (which is his operating cost) to produce Croissants he gets 15 • If Amy uses all her time to produce Croissants she gets 16 • Hence, Amy has an absolute advantage in producing Croissants
  29. 29. Question 3 (d) • Based on their COMPARATIVE ADVANTAGES: • Lee should produce coffees • Amy should produce croissants
  30. 30. THE END
  31. 31. Objectives (Week 2) Students should be able to: 1. understand the concept of opportunity cost 2. define, explain ,analyse and apply the theories of trade such as absolute advantage and comparative advantage to current economic issues and examine their implications for business in a national and international context 3. examine the international trade environment, policies and institutions
  32. 32. Big Picture COMPARATIVE and ABSOLUTE ADVANTAGE
  33. 33. Comparative and absolute advantage Differences in costs determine pattern of trade Production Costs Absolute Advantage Opportunity Costs Comparative Advantage
  34. 34. Econ Rap: Keynes vs Hayek • http://www.youtube.com/watch?v=d0nERTFo-Sk • http://www.youtube.com/watch?v=GTQnarzmTOc
  35. 35. See Japan / Australia example from the lecture slides
  36. 36. Another Example: • Absolute advantage does not mean comparative advantage: • Country B has absolute advantage in Notebooks and Pens, but does it have a comparative advantage in both? • Also see Textbook at 56, paragraph 4 100 300 Notebooks Pens Country A 200 1000 Notebooks Pens Country B
  37. 37. Before Trade George Martha 50 Brownies 100 Cupcakes 80 Brownies 40 Cupcakes
  38. 38. After Trade George Martha 60 Brownies 200 Cupcakes 160 Brownies 60 Cupcakes 140 Cupcakes 10 more than before 40 more than before 100 Brownies 20 more than before 20 more than before

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