The saga of North Potato
Residents of the isolated country of
North Potato subsist entirely on
potatoes and fish.
• There are 1000 farmers in North Potato.
• 900 of these farmers have land that is dry and
not very fertile.
• 100 of them have more fertile soil.
The 900 farmers with poor soil work 60 hours a week,
either growing yams or catching fish. It takes a worker
3 hours to produce a unit of yams and 1 hour to
produce a unit of fish. The production possibility set
for one of these farmers consists of combinations of
yams Y and fish F that lie on or below the line with
equation
A)
B)
C)
D)
3Y+F= 60
Y/3+F=60
Y+3F=60
Y+F/3=60
If it takes him three times as long to produce a
unit of yams as a unit of fish if a farmer does
not trade with others, what is his tradeoff
between yams and fish.
A) A unit of yams costs three times as much as
a unit of fish
B) A unit of fish costs three times as much as a
unit of yams.
The fertile farms
• The island has 100 more fertile farms.
Farmers on these farms can produce one unit
of yams per hour spent farming or they can
catch one fish for every hour they spend
fishing. They spend 60 hours per week either
fishing or farming.
What equation describes combinations
of fish F and yams Y that a fertile farm
can produce in a week?
A) C+F=60
B) C+F/3=60
C) F+C/2=60
Comparative advantage in N.P.
• Farmers with poor land can produce 1/3 of a
unit of yams per hour and 1 unit of fish per
hour.
• Farmers with rich land can produce 1 unit of
yams and 1 unit of fish per hour.
• Who has comparative advantage in yams?
• Who has comparative advantage in fish?
What if everybody specialized
according to comparative advantage?
• Farmers with poor land would produce fish only.
• Farmers with rich land would produce yams only.
• What would output be? 900 poor land farmers
would each produce 60 fish.
– Total fish =60x900=54,000
• 100 rich land farmers would each produce 60
units of yams.
– Total yams =60x100=6,000
Consumption in North Potato
• Residents of North Potato find it essential to
their diets that they each consume equal
quantities of fish and yams
• So if both types of farmers specialized
according to comparative advantage, there
would be too many fish (54,000) and not
enough yams (6,000)
• What has to happen?
Efficiency demands that poor land
farmers produce some yams and some
fish while rich land farms specialize in
yams. To induce poor land farmers to
do this, we need unit price of yams to
be 3 times the price of fish.
National Production Possibility Set
Farmers with good land can produce
one unit of yams or one unit of fish
per hour. If the price of yams is 3
times the price of fish, what will they
do?
A) Produce only yams,
B) Produce only fish,
C) Produce some of each
Rich farmers’ possibilities
Rich land farmers specialize in yams,
produce 60 yams and no fish. They
trade yams for fish at price of 3 fish per
yam. If they sell 15 yams, they will have
45 yams and 60-15=45 fish.
Poor land farmer’s possibilities
What do poor land farmers do
• When yams cost 3 times as much as fish, poor
land farmers are just indifferent between
specializing in fish and trading in the market or
producing some fish and some yams.
Unlike the rich land farmers, they don’t gain (or
lose) by specializing.
But they do need to either trade or diversify to
equalize yams and fish. Best they can do is spend
15 hours fishing and 45 hours growing yams.
Then they get 15 units of each good.
Suppose that in the rest of the world,
outside of North Potato, yams trade
for slightly more than one yam per
fish. What would happen if North
Potato opened up to trade?
Price of yams would fall to about one
fish per yam.
• Who would benefit?
– Poor land farmers, Why?
– Now they can specialize in fish, and buy their
yams for one fish per yam rather than 3 fish per
yam
• Who would lose?
– Rich land farmers, Why?
– They can no longer get 3 fish per yam, since poor
land farmers can buy them abroad at 1 fish per
yam.
Possibilities for Poor land farmers with
world trade
With world trade, and prices of one
fish per yam, poor land farmers can
specialize in fish, buy yams for one fish
and consume 30 fish and 30 yams.
Without free trade, prices of yams
were 3 fish and they could only
consume 15 fish and 15 yams.
Poor land famers gain.
What about rich land farmers?
• Before international trade, they specialized in
yams and sold yams at a price of 3 fish per yam.
• They were able to consume 45 units of fish and
45 units of yams.
• Now price of yams falls to 1 fish.
• They are now indifferent between specializing in
yams or spending some time in each activity.
• Either way they can only get 30 fish and 30 yams.
• They are worse off.
Free trade doesn’t always benefit
everybody
• Typical argument: Rich land farmers would
complain that “Unfair competition is ruining
our way of life”. Taking the profit out of
agriculture.
• They do not experience the benefits of trade.
Comparing gains and losses
• Without world trade, 100 rich land farmers were
able to consume 45 yams and 45 fish, while 900
poor land farmers could consume only 15 yams
and 15 fish.
• With world trade, all 1000 residents consume 30
yams and 30 fish.
• Total gains of winners exceed total losses of
losers.
• Could winners “buy off” losers to get free world
trade adopted?
Converting fish to yams
By means of trade