Where does your stuff come from?
Why have your clothes and personal
items traveled all around the world?
Why People Trade
1. Suppose you couldn’t trade with anyone.
What things would you have to give up?
Everything you don’t make yourself!
(Clothes, phones, bananas, heath care, etc)
2. Suppose you could only buy things that
were produced in Arizona.
Stopping trade would reduce people’s
choices and make them worse off.
Trade provides more choices =>
higher standard of living.
2
Absolute and
Comparative Advantage
3
Suppose that you have the skills to be both an excellent
fast food cook and an outstanding heart surgeon
Your neighbor, Ronald, is less talented: he could be a
mediocre fast food cook, but would make a terrible heart
surgeon
You have an absolute advantage over Ronald as a fast
food cook
You also have an absolute advantage over him as a
heart surgeon
Homework Review
1.A. What term is used to describe
the fundamental problem of
economics?
Scarcity!
1.B. Define scarcity
Humans have
unlimited wants but
limited resources with
which to satisfy them
2. What does it mean to “think at
the margin”? Give an example.
Comparing the costs and
benefits of one more unit
of something
Is one more slice of
pecan pie worth the cost?
3. What is the difference between a
positive and normative statement?
Give an example of each.
Positive – just facts
Normative – opinion/ value
judgment
Positive – Barack Obama is the
President
Normative – Barack Obama is the
best president ever!
4. What is the difference between
economic costs (costs according to
an economist) and accounting costs
(costs according to an accountant)?
Accounting costs – out-of-pocket
costs (explicit costs) only
Economic costs – out-of-pocket
costs AND opportunity costs
(implicit costs)
5. List the four factors of production.
Define each.
Land – any natural resources
Labor – human effort used to produce
goods and services
Capital
Physical – man-made resources (e.g.
machines, tools, equipment)
Human – education, knowledge, and
training
Entrepreneurship – the act of combining
land, labor and capital to make goods and
services people want
6. Give an example of a good.
Pecan Pie!
7. Give an example of a service.
A massage
8. What points on the graph are
productively efficient?
A through D
9. What is the opportunity cost of
moving from combination D to
combination B?
6 Twix Bars
10. What is the opportunity cost of
moving from combination C to
combination D?
6 Snickers Bars
11. What is the opportunity cost of
moving from combination A to
combination B?
2 Snickers Bars
12. What is true about point E?
It’s inefficient!
13. What is true about point G?
It’s impossible!
14. Assume that everyone in this
economy despises Snickers bars but
loves Twix bars. Which point(s)
is/are allocatively efficient?
D!
Experiment
1.Do NOT open your bag yet!
2.At the END of the class period,
whatever is in your bag will be yours
to keep.
3.Now, open your bag
4.Rate your satisfaction with the
contents of your bag on a scale
from 1 to 10 (1 being disgusted, 10
being elated)
5.Let’s add up our ratings
Round 1
1.Now, with ONLY YOUR
TABLEMATE, you may trade some
or all of the contents of your bag.
You are NOT required to trade if
you don’t want to.
2.Rate your satisfaction again.
3.Let’s add up our ratings.
Round 2
1.Now, with ONLY THE PEOPLE IN
YOUR ROW, you may trade some
or all of the contents of your bag.
You are NOT required to trade if
you don’t want to.
2.Rate your satisfaction again.
3.Let’s add up our ratings.
Round 3
1.Now, you may trade with anyone
else in the class!
2.Rate your satisfaction again.
3.Let’s add up our ratings.
Debrief
1.How many people made trades?
2.Did anyone not trade?
3.How many people traded more
than once?
4.We had exactly as much candy in
the classroom before and after the
experiment. Why did our average
satisfaction increase with each
new round?
Which career should you choose?
To become a cook, you must give up a far more lucrative
career as a heart surgeon – your opportunity cost is very
high
Ronald, however, has a lower opportunity cost – to
become a cook, he only has to give up a career as a
parking attendant
Therefore, Ronald has a comparative advantage in fast
food cooking... even though you would be a better cook
than him
26
Absolute advantage: the ability of an
individual or group to do something
better or more efficiently than another
individual or group.
Comparative advantage: the ability of
an individual or group to do
something at a lower opportunity cost
than another individual or group
The law of comparative advantage
says that if people specialize in the
activities in which they have the
lowest opportunity cost – then
everyone will be better off
27
• Comparative and absolute advantage
apply to countries!
• Climate, geography, the skills and size of
its labor force, etc. – make a country
good at producing some things and bad
at others
• Countries have to make choices about
what to produce
• To be efficient, they should produce those
goods and services
in which they have a
comparative
advantage
28
Benefits of
Specialization and
Trade
29
International Trade
1W = 1.5S
0
30
1.5
29
3
28
4.5
27
6
26
7.5
25
9
24
10.5
23
12
22
13.5
21
15
20
16.5
19
18
18
19.5
17
USA
45
Brazil
40
Brazil only
makes sugar
US only
makes wheat
35
30
30
Sugar (tons)
W
Sugar (tons)
S
25
20
15
25
20
15
10
10
5
5
0
0
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
S
W
20
0
18.5
1
17
2
15.5
3
14
4
12.5
5
11
6
9.5
7
8
8
6.5
9
5
10
3.5
11
30
International Trade
USA
45
Trade allows a
AFTER
TRADE
country
to
consume
outside of its AFTER TRADE
PPC!
40
35
30
30
Sugar (tons)
Sugar (tons)
Brazil
25
20
15
25
20
15
10
10
5
5
0
0
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
31
Wheat
USA
Sugar
30 (1W costs 1S) 30 (1S costs 1W)
Brazil 10 (1W costs 2S)
20 (1S costs 1/2W)
Which country has a comparative advantage in wheat?
45
Which country
has a comparative advantage in sugar?
40
Sugar (tons)
Sugar (tons)
1. Which country should EXPORT Sugar?
35
2. Which country should30 EXPORT Wheat?
30
25
20
25
20
15
15
10
5
10
15
20
Wheat (tons)
25
30
5
10
15
20
Wheat (tons)
32
Do Now
1. Pick up Economic Systems notes packet from cart
2. Answer the following in your notebook (use your Trade
and Comparative Advantage Notes if necessary:
Suppose there are two young men, Liam
and Harry, who enjoy knitting. The number
of headbands or scarves each man can knit
in one day is shown in the table below.
Who has a comparative advantage in
knitting headbands? Scarves? Who has
an absolute advantage in headbands?
Scarves?
Headbands Scarves
Liam 4
8
Harry 10
10
Headbands
Scarves
Liam
4 (1H costs 2S)
8 (1S costs 0.5H)
Harry
10 (1H costs 1S)
10(1S costs 1H)
Who has an absolute advantage in headbands?
Who has an absolute advantage in scarves?
Who has a comparative advantage in headbands?
Who has a comparative advantage in scarves?
34
Copper
Steel
Namibia 15 (1C costs 3S) 45(1S costs 1/3C)
Chile
40 (1C costs 2S)
80 (1S costs 1/2C)
Which country has a comparative advantage in copper?
Which country has a comparative advantage in steel?
1. Which country should IMPORT steel?
2. Which country should EXPORT copper?
35
Wine
Beef
Argentina 64(1W costs 0.25B) 16(1B costs 4W)
France
75 (1W costs 0.67B) 50(1B costs 1.5W)
Which country has a comparative advantage in wine?
Which country has a comparative advantage in beef?
1. Which country should produce beef?
2. Which country should produce wine?
36
Economic Systems
Every society must answer three
questions:
1. What should be produced?
2. How should it be produced?
3. Who gets to consume it?
The way these questions are answered
determines the economic system
An economic system is the method used by a
society to produce and distribute goods and
services.
38
Economic Systems
1.Command Economy
2.Free Market Economy
3.Mixed Economy
39
Command Economies
40
In a command economy – also called a
centrally planned economy – the
government…
1. owns all the resources
2. answers all three economic questions
Examples:
Cuba, North Korea, former Soviet Union
Centrally planned economies often face
problems of poor quality goods,
shortages, and unhappy citizens. Why do
you think this is?
41
Incentives
Incentive: a thing that motivates or
encourages someone to do
something
Government policies can influence
the way people behave by changing
people’s incentives
These incentive changes may be
intended or unintended
Socialism and Communism
“From each according to his ability, to each
according to his needs”
Characteristics:
1. Abolition of private
property
2. State ownership of
all resources
3. Central planning
4. Elimination of
social classes
Karl Marx
Advantages and Disadvantages
of Socialism/Communism
Pros
Cons
1. Not much incentive
1. Equality!
to work too hard
2. Health care for all!
2. Little incentive to
3. Jobs for all!
innovate. No
4. No class warfare
competition keeps
because there are
quality of goods
no classes!
from improving.
3. Lots of opportunities
for corruption
44
Incentives
in
the
Soviet
Union
Soviet companies were not guided by prices or profit. Gov’t officials set
arbitrary output quotas based on quantitative measurements.
Businesses were paid based on meeting these quotas.
1.
Because of weight-based production quotas for certain products,
businesses would often fill products with lead to make them heavier that
were almost too heavy to carry
2.
Light bulb producers would only make tiny night light size bulbs because
of production quotas based on number of bulbs produced.
3.
Oil companies would intentionally drill many shallow holes when they knew
that oil deposits are usually found in deep holes that require slower
drilling, because companies were required to drill a certain number of feet
45
Incentives in the Soviet Union
4. Construction superintendents would order workers to remove
bathtubs from first floor and install them in the third floor while he
slowly lead inspectors through apartment building, because
businesses were paid based on number of apartments complete at
time of inspection.
5. State-owned businesses would receive resources – e.g.
functioning light bulbs – before the public did. Employees would
often steal bulbs from work and replace them with burnt out bulbs.
A black market for burnt out bulbs developed.
Do Now
1. Take out your Economic Systems notes
2. Answer the following in your notebook:
In the United States, the wealthiest
people must give 39.6% of their income
(above ~$400,000) to the federal
government as income tax. Meanwhile,
43% of low-income Americans pay no
federal income tax at all. In your
opinion, is this fair? Explain.
2015 Tax Brackets
Review
1. What are the three economic questions
that every society must answer?
2. Who decides how the three questions
are answered in a command economy?
3. What are the main characteristics of a
socialist/communist economic system?
4. What are some problems with
socialism/communism?
Free Market Capitalism
Characteristics of Free Markets
1. Little government involvement in the
economy. (Laissez Faire = Let it be)
2. Individuals own resources and answer the
three economic questions.
3. The opportunity to make PROFIT gives
people the INCENTIVE to produce quality
items efficiently.
4. Wide variety of goods available to
consumers.
5. Competition and self-interest work together
to keep prices down and quality up.
51
Adam Smith and the “Invisible
Hand” of the Free Market
How the free market regulates itself:
Suppose consumers want laptops and are
willing to pay for them…
•Businesses have an INCENTIVE to start
making laptops to earn PROFIT.
•This leads to more COMPETITION….
•Which means lower prices, better quality,
and more product variety.
•We produce the goods and services that
society wants because “resources follow
profits.”
End Result: Most efficient production of the
goods that consumers want, produced at
the lowest prices and the highest quality.
53
The Invisible Hand
The idea that society’s goals will be met as
individuals seek their own self-interest.
Example: Society wants fuel efficient cars…
•Profit-seeking producers will make more.
•Competition between firms results in low
prices, high quality, and greater efficiency.
•The government doesn’t need to get
involved since the needs of society are
automatically met.
Competition and self-interest act as an
invisible hand that regulates the free market.
54
Why socialism/communism fails:
If consumers want laptops and only one
state-owned company is making them…
•Other businesses CANNOT start making
laptops.
•There is NO COMPETITION…
•Which means higher prices, lower quality,
and less product variety.
•More laptops will not be made until the
government decides to expand production
The End Result: There is a shortage of
goods that consumers want, produced at
higher prices and lower quality.
55
Criticisms of Capitalism
1. Companies are greedy and will do anything to screw
over consumers!
• Companies have an incentive to satisfy the needs of
consumers. If they don’t they will go out of business.
2. Capitalism causes companies to outsource US jobs
overseas. America suffers because companies want
more profit!
• The number of people who benefit from lower prices far
exceed the number of people who lose jobs
3. Capitalism only helps the rich. US companies enslave
and exploit third-world workers in sweatshops!
• Sweatshop workers are not forced labor. They make the
decision to work there voluntarily. Why?
• Although the working conditions are far below US
standards, working in a sweatshop is usually better
than the alternative
• Sweatshop wages in Vietnam, Honduras, and
Nicaragua are often dramatically higher than the
average wages in those countries
56
GDP Per Capita Heat Map
Economic Freedom Heat Map
The degree of economic freedom in a
country correlates strongly with per capita
wealth
North Korea's GDP is $40 Billion
South Korea's GDP is $1.45 Trillion (36 times greater).
Mixed Economies
Countries in blue have mixed economies
Mixed economies feature some
characteristics of both command and
market economies
The Socialist Temptation
Even the freest countries have some socialist
characteristics
The biggest knock on capitalism is that it leads
to wealth inequality
Many countries attempt to mitigate this with
redistributive policies like progressive income
taxes and generous social welfare programs
Heritage Foundation Index of
Economic Freedom Rankings
Homework Review
1. What is the difference between
absolute and comparative advantage?
Absolute advantage – doing
something better and/or more
efficiently
Comparative advantage – doing
something at a lower opportunity cost
2. What does the law of comparative
advantage say?
If everyone specializes in the activity
in which they have the lowest
opportunity cost, everyone will be
better off
Berets
Lederhosen
Germany 50
25
France
5
40
The table above shows the production
alternatives of two countries, France and
Germany, which produce berets (a type of hat)
and lederhosen (a type of pants) using equal
amounts of resources.
Berets
Lederhosen
Germany 50
25
France
5
40
Which country has an absolute
advantage in beret production?
Germany
Berets
Lederhosen
Germany 50
25
France
5
40
Which country has an absolute
advantage in lederhosen production?
Germany
Berets
Lederhosen
Germany 50
25
France
5
40
What is the opportunity cost to
France of producing 1 pair of
lederhosen?
8 berets
Berets
Lederhosen
Germany 50
25
France
5
40
What is the opportunity cost to
Germany of producing 1 beret?
½ lederhosen
Berets
Lederhosen
Germany 50
25
France
5
40
Which country has a comparative
advantage in lederhosen production?
Germany
Berets
Lederhosen
Germany 50
25
France
5
40
Which country has a comparative
advantage in beret production?
France
Berets
Lederhosen
Germany 50
25
France
5
40
According to the law of comparative
advantage, which country should specialize
in berets?
France
Berets
Lederhosen
Germany 50
25
France
5
40
According to the law of comparative
advantage, which country should specialize
in lederhosen?
Germany
1.List three advantages of
socialism/communism.
1.List three disadvantages of
socialism/communism.
Advantages and Disadvantages
of Socialism/Communism
Pros
Cons
1. Not much incentive
1. Equality!
to work too hard
2. Health care for all!
2. Little incentive to
3. Jobs for all!
innovate. No
4. No class warfare
competition keeps
because there are
quality of goods
no classes!
from improving.
3. Lots of opportunities
for corruption
82
6. Explain how the “invisible hand” of
the free market regulates the
production of a good or service that
you enjoy. How is it possible that it
can be provided without the
government forcing someone to
produce it?