GAINS FROM TRADE ETP Economics 101 Lecturer: Jack Wu
RECALL <ul><li>The  production possibilities frontier  is a graph that shows the combinations of output that the economy c...
SHAPE OF PRODUCTION POSSIBILITIES FRONTIER <ul><li>Concave curve (bowed outward): </li></ul><ul><li>The opportunity cost o...
NOW <ul><li>Let’s use the “Production Possibilities Frontier” to analyze trade problems.  </li></ul>
AUTARKY OR TRADE? <ul><li>How do we satisfy our wants and needs in a global economy?  </li></ul><ul><ul><li>We can be econ...
CASE 1 <ul><li>only two goods: potatoes and meat </li></ul><ul><li>only two people: a potato farmer and a cattle rancher <...
CASE 1 (CONTINUED) <ul><li>Minutes needed to make 1 ounce of </li></ul><ul><li>___________________________________ </li></...
CASE 1 (CONTINUED) <ul><li>Amounts produced in 8 hours </li></ul><ul><li>___________________________________ </li></ul><ul...
THE FARMER ’ S PRODUCTION POSSIBILITIES FRONTIER Potatoes (ounces) 0 Meat (ounces) (a) The Farmer ’ s Production Possibili...
THE RANCHER ’ S PRODUCTION POSSIBILITIES FRONTIER Potatoes (ounces) 0 Meat (ounces) (b) The Rancher ’ s Production Possibi...
OPPORTUNITY COST <ul><li>Opportunity cost </li></ul><ul><ul><li>Whatever must be given up to obtain some item </li></ul></...
OPPORTUNITY COSTS 1oz of meat 1oz of potatoes Farmer 4 oz of potatoes ¼ oz of meat Rancher 2 oz of potatoes ½ oz of meat
ABSOLUTE ADVANTAGE <ul><li>The comparison among producers of a good according to their productivity — absolute advantage <...
COMPARATIVE ADVANTAGE <ul><li>Compares producers of a good according to their  opportunity cost . </li></ul><ul><ul><li>Wh...
APPLICATION <ul><li>Should Tiger Woods mow his own lawn? </li></ul><ul><ul><li>Woods </li></ul></ul><ul><ul><ul><li>Mow hi...
QUICK QUIZ 1 <ul><li>Who has the absolute advantage? </li></ul><ul><li>The farmer or the rancher? </li></ul><ul><li>Who ha...
SPECIALIZATION AND TRADE <ul><li>Comparative advantage and differences in opportunity costs are the basis for specialized ...
QUICK QUIZ 2 <ul><li>What should farmer produce (or specialize in)?  </li></ul><ul><li>What should rancher produce (or spe...
BENEFITS OF TRADE <ul><li>Whenever potential trading parties have differences in opportunity costs, they can each benefit ...
SELF-SUFFICIENCY (AUTARKY) <ul><li>By ignoring each other: </li></ul><ul><ul><li>Each consumes what they each produce. </l...
SELF-SUFFICIENCY (AUTARKY) <ul><li>Assume:  Farmer spends 4 hours on meat and 4 hours on potatoes.  Rancher spends 4 hours...
WITHOUT TRADE <ul><li>Production:  Farmer produces 4 oz of meat and 16 oz of potatoes.  Rancher produces 12 oz of meat and...
THE FARMER ’ S PRODUCTION AND CONSUMPTION WITHOUT TRADE Copyright©2003  Southwestern/Thomson Learning Potatoes (ounces) 0 ...
THE RANCHER ’ S PRODUCTION AND CONSUMPTION WITHOUT TRADE Copyright © 2004  South-Western Potatoes (ounces) 0 Meat (ounces)...
PROPOSALS FOR SPECIALIZATION <ul><li>Farmer devotes all his time to growing potatoes. </li></ul><ul><li>Rancher spends 6 h...
PRODUCTION WITH TRADE <ul><li>Farmer’s production with trade:  0 oz of meat and 32 oz of potatoes </li></ul><ul><li>Ranche...
PROPOSAL FOR TRADE <ul><li>The price of trade </li></ul><ul><ul><li>Must lie between the two opportunity costs </li></ul><...
CONSUMPTION WITH TRADE <ul><li>Farmer’s consumption with trade:  5 oz of meat and 17 oz of potatoes </li></ul><ul><li>Ranc...
HOW TRADE EXPANDS THE FARMER ’ S SET OF CONSUMPTION OPPORTUNITIES Potatoes (ounces) 0 Meat (ounces) (a) The Farmer ’ s Pro...
HOW TRADE EXPANDS THE RANCHER ’ S SET OF CONSUMPTION OPPORTUNITIES Potatoes (ounces) 0 Meat (ounces) (b) The Rancher ’ s P...
INTERNATIONAL TRADE <ul><li>Each country has many citizens with different interests. International trade can make some ind...
QUICK QUIZ 3  <ul><li>Martha and Stewart each spend 8 hours a day wallpapering and painting: </li></ul><ul><li>Hours neede...
QUICK QUIZ 4 <ul><li>Suppose that a worker in Cornland can grow either 40 bushels of corn or 10 bushels of oats per year, ...
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Etp econ lecture note 3

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Etp econ lecture note 3

  1. 1. GAINS FROM TRADE ETP Economics 101 Lecturer: Jack Wu
  2. 2. RECALL <ul><li>The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. </li></ul>
  3. 3. SHAPE OF PRODUCTION POSSIBILITIES FRONTIER <ul><li>Concave curve (bowed outward): </li></ul><ul><li>The opportunity cost of producing one good increases as the production of this good rises. </li></ul><ul><li>REASON: </li></ul><ul><li>Some resources are better suited to the production of this good than another good (and vice versa). </li></ul><ul><li>Straight line: </li></ul><ul><li>The opportunity cost of producing one good is constant as the production of this good rises. </li></ul>
  4. 4. NOW <ul><li>Let’s use the “Production Possibilities Frontier” to analyze trade problems. </li></ul>
  5. 5. AUTARKY OR TRADE? <ul><li>How do we satisfy our wants and needs in a global economy? </li></ul><ul><ul><li>We can be economically self-sufficient (Autarky). </li></ul></ul><ul><ul><li>We can specialize and trade with others, leading to economic interdependence. </li></ul></ul>
  6. 6. CASE 1 <ul><li>only two goods: potatoes and meat </li></ul><ul><li>only two people: a potato farmer and a cattle rancher </li></ul><ul><li>Each only works 8 hours/day </li></ul><ul><li>What should each produce? </li></ul><ul><li>Why should they trade? </li></ul>
  7. 7. CASE 1 (CONTINUED) <ul><li>Minutes needed to make 1 ounce of </li></ul><ul><li>___________________________________ </li></ul><ul><li>Meat Potatoes </li></ul><ul><li>___________________________________ </li></ul><ul><li>Farmer 60min/oz 15min/oz </li></ul><ul><li>Rancher 20min/oz 10min/oz </li></ul>
  8. 8. CASE 1 (CONTINUED) <ul><li>Amounts produced in 8 hours </li></ul><ul><li>___________________________________ </li></ul><ul><li>Meat Potatoes </li></ul><ul><li>___________________________________ </li></ul><ul><li>Farmer 8 oz 32 oz </li></ul><ul><li>Rancher 24 oz 48 oz </li></ul>
  9. 9. THE FARMER ’ S PRODUCTION POSSIBILITIES FRONTIER Potatoes (ounces) 0 Meat (ounces) (a) The Farmer ’ s Production Possibilities Frontier 8 32
  10. 10. THE RANCHER ’ S PRODUCTION POSSIBILITIES FRONTIER Potatoes (ounces) 0 Meat (ounces) (b) The Rancher ’ s Production Possibilities Frontier 48 24
  11. 11. OPPORTUNITY COST <ul><li>Opportunity cost </li></ul><ul><ul><li>Whatever must be given up to obtain some item </li></ul></ul><ul><ul><li>Measures the trade-off between the two goods that each producer faces </li></ul></ul>
  12. 12. OPPORTUNITY COSTS 1oz of meat 1oz of potatoes Farmer 4 oz of potatoes ¼ oz of meat Rancher 2 oz of potatoes ½ oz of meat
  13. 13. ABSOLUTE ADVANTAGE <ul><li>The comparison among producers of a good according to their productivity — absolute advantage </li></ul><ul><ul><li>Describes the productivity of one person, firm, or nation compared to that of another. </li></ul></ul><ul><ul><li>The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. </li></ul></ul>
  14. 14. COMPARATIVE ADVANTAGE <ul><li>Compares producers of a good according to their opportunity cost . </li></ul><ul><ul><li>Whatever must be given up to obtain some item </li></ul></ul><ul><li>The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. </li></ul>
  15. 15. APPLICATION <ul><li>Should Tiger Woods mow his own lawn? </li></ul><ul><ul><li>Woods </li></ul></ul><ul><ul><ul><li>Mow his lawn in 2 hours </li></ul></ul></ul><ul><ul><ul><li>Film a TV commercial and earn $10,000 (2 hours) </li></ul></ul></ul>
  16. 16. QUICK QUIZ 1 <ul><li>Who has the absolute advantage? </li></ul><ul><li>The farmer or the rancher? </li></ul><ul><li>Who has the comparative advantage? </li></ul><ul><li>The farmer or the rancher? </li></ul>
  17. 17. SPECIALIZATION AND TRADE <ul><li>Comparative advantage and differences in opportunity costs are the basis for specialized production and trade. </li></ul>
  18. 18. QUICK QUIZ 2 <ul><li>What should farmer produce (or specialize in)? </li></ul><ul><li>What should rancher produce (or specialize in)? </li></ul>
  19. 19. BENEFITS OF TRADE <ul><li>Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. </li></ul><ul><li>Benefits of Trade </li></ul><ul><ul><li>Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage. </li></ul></ul>
  20. 20. SELF-SUFFICIENCY (AUTARKY) <ul><li>By ignoring each other: </li></ul><ul><ul><li>Each consumes what they each produce. </li></ul></ul><ul><ul><li>The production possibilities frontier is also the consumption possibilities frontier. </li></ul></ul><ul><ul><li>Without trade, economic gains are diminished. </li></ul></ul>
  21. 21. SELF-SUFFICIENCY (AUTARKY) <ul><li>Assume: Farmer spends 4 hours on meat and 4 hours on potatoes. Rancher spends 4 hours on meat and 4 hours on potatoes. </li></ul>
  22. 22. WITHOUT TRADE <ul><li>Production: Farmer produces 4 oz of meat and 16 oz of potatoes. Rancher produces 12 oz of meat and 24 oz of potatoes. </li></ul><ul><li>Consumption: Farmer consumes 4 oz of meat and 16 oz of potatoes. Rancher consumes 12 oz of meat and 24 oz of potatoes. </li></ul>
  23. 23. THE FARMER ’ S PRODUCTION AND CONSUMPTION WITHOUT TRADE Copyright©2003 Southwestern/Thomson Learning Potatoes (ounces) 0 Meat (ounces) (a) The Farmer ’ s Production and Consumption 4 16 8 32 A Farmer's production and consumption without trade
  24. 24. THE RANCHER ’ S PRODUCTION AND CONSUMPTION WITHOUT TRADE Copyright © 2004 South-Western Potatoes (ounces) 0 Meat (ounces) (b) The Rancher ’ s Production and Consumption 12 24 B 48 24 Rancher's production and consumption without trade
  25. 25. PROPOSALS FOR SPECIALIZATION <ul><li>Farmer devotes all his time to growing potatoes. </li></ul><ul><li>Rancher spends 6 hours a day raising cattle and 2 hours growing potatoes. </li></ul>
  26. 26. PRODUCTION WITH TRADE <ul><li>Farmer’s production with trade: 0 oz of meat and 32 oz of potatoes </li></ul><ul><li>Rancher’s production with trade: 18 oz of meat and 12 oz of potatoes. </li></ul>
  27. 27. PROPOSAL FOR TRADE <ul><li>The price of trade </li></ul><ul><ul><li>Must lie between the two opportunity costs </li></ul></ul><ul><li>Trade deal: Farmer gives rancher 15 oz of potatoes, and rancher gives farmer 5 oz of meat in return. </li></ul><ul><li>Note: Price of Meat: 2~4 oz of potatoes </li></ul><ul><li>Note: Price of Potatoes: 1/4 oz ~1/2 oz of meat </li></ul>
  28. 28. CONSUMPTION WITH TRADE <ul><li>Farmer’s consumption with trade: 5 oz of meat and 17 oz of potatoes </li></ul><ul><li>Rancher’s consumption with trade: 13 oz of meat and 27 oz of potatoes. </li></ul>
  29. 29. HOW TRADE EXPANDS THE FARMER ’ S SET OF CONSUMPTION OPPORTUNITIES Potatoes (ounces) 0 Meat (ounces) (a) The Farmer ’ s Production and Consumption 4 16 5 17 8 32 A A* Farmer's production and consumption without trade Farmer's consumption with trade Farmer's production with trade
  30. 30. HOW TRADE EXPANDS THE RANCHER ’ S SET OF CONSUMPTION OPPORTUNITIES Potatoes (ounces) 0 Meat (ounces) (b) The Rancher ’ s Production and Consumption 12 24 13 27 B 48 24 12 18 B* Rancher's consumption with trade Rancher's production with trade Rancher's production and consumption without trade
  31. 31. INTERNATIONAL TRADE <ul><li>Each country has many citizens with different interests. International trade can make some individuals worse off, even as it makes the country as a whole better off. </li></ul><ul><ul><li>Imports — goods produced abroad and sold domestically </li></ul></ul><ul><ul><li>Exports — goods produced domestically and sold abroad </li></ul></ul>
  32. 32. QUICK QUIZ 3 <ul><li>Martha and Stewart each spend 8 hours a day wallpapering and painting: </li></ul><ul><li>Hours needed to Do 1 Room </li></ul><ul><li>Paint Wallpaper </li></ul><ul><li>Martha 2 hours/room 8 hours/room </li></ul><ul><li>Stewart 4 hours/room 10 hours/room </li></ul>
  33. 33. QUICK QUIZ 4 <ul><li>Suppose that a worker in Cornland can grow either 40 bushels of corn or 10 bushels of oats per year, and a worker in Oatland can grow either 20 bushels of corn or 5 bushels of oats per year. There are 20 workers in Cornland and 20 workers in Oatland. Which of the following statements is true? </li></ul><ul><li>a. Both countries could gain from trade with each other. </li></ul><ul><li>b. Neither country would gain from trade because Cornland has an absolute advantage in both goods. </li></ul><ul><li>c. Neither country would gain from trade because neither one has a comparative advantage. </li></ul><ul><li>d. Only Oatland could possibly gain from trade. </li></ul>

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