A BASIC QUESTION
How do you allocate scarce
resources among competing
needs and wants?
CHAPTER TWO DEFINITIONS
Land - All natural resources, such as minerals, forests, water
and unimproved land.
Labor - The physical and mental talents people contribute to
the production process.
Capital - Produced goods that can be used as inputs for
further production, such as factories, machinery, tools,
computers and buildings.
Entrepreneurship - The particular talent that some people
have for organizing the resources of land, labor and capital
to produce goods, seek new business opportunities, and
develop new ways of doing things.
MORE DEFINITIONS
Production - The conversion of labor, land, capital, and
entrepreneurial ability into goods and services.
Production Possibilities Curve - is a curve measuring the maximum
combinations of outputs that can be obtained from a given
number of inputs.
APPLICATION: A PRODUCTION POSSIBILITIES
CURVE
Econ Grade
100
A PPC demonstrates:
16 hrs for Econ
and 4 hrs for
History
88
•
10 hrs for each
History and
Econ
70
•
PP
C
40
58
66
78
10
0
History
grade
There is a limit to what you
can achieve, given existing
institutions, resources, and
technology
Every choice you make has
an opportunity cost
CHAPTER TWO DEFINITIONS,
CONT.
Production efficiency - achieving as much output as
possible from a given amount of inputs or resources.
Inefficiency - getting less output from inputs which, if
devoted to some other activity, would produce more
output.
Principle of increasing marginal opportunity cost - in
order to get more of something, one must give up everincreasing quantities of something else.
INCREASING OPPORTUNITY COSTS OF THE TRADEOFF (FROM CHAPTER TWO)
Butter
A
The principle of increasing marginal
opportunity cost tells us that opportunity
costs increase the more you concentrate on
the activity
• Slope is flat at A
• This means there is a low opportunity cost
to produce more guns
B
• Slope is steep at B
• This means there is a high opportunity cost
to produce more guns
Guns
EFFICIENCY (FROM CHAPTER TWO)
Butter
A
Productive efficiency is achieving
as much output as possible from a
given amount of inputs or resources
•
•D
•C
• Points of
efficiency
• Unattainable with given
amounts of inputs
•
•B
Guns
Point of inefficiency
Production Possibilities
Application:
Comparative Advantage and
International Trade
The Nature and Patterns of
Trade (from Chapter 19)
◦ Differences in the importance of trade
Total Output ($) Export Ratio (%)
Netherlands
Import Ratio (%)
844
78
71
Germany
3,695
47
41
Canada
1,706
29
31
Italy
2,180
27
29
France
2,825
26
28
United Kingdom
2,462
30
33
Japan
6,078
15
14
15,094
13
16
United States
U.S. Exports by Region,
2012 (from chapter 19)
Canada
19%
OPEC 4% Central and
South
America
11%
Other 10%
Mexico
13%
Pacific Rim
25%
European
Union
18%
U.S. Imports by Region,
2012 (from chapter 19)
Canada
15%
Mexico
11%
European
Union
17%
OPEC 9%
Central and
South
America
8%
Other 9%
Pacific Rim
31%
David Ricardo (1772-1823)
• David Ricardo (1772-1823) was one of the greatest
theoretical economists of all time. The third child (of
17) of Abigail and Abraham (a prosperous Jewish
stockbroker who had emigrated to London from
Holland), Ricardo attended school in London and
Amsterdam and at the age of fourteen entered his
father's business. In 1793 he married a Quaker, Priscilla
Wilkinson, with whom he was to have eight children.
The couple's different religious backgrounds meant that
the marriage created a rift with both their families, and
Ricardo was forced to set up independently as a broker
on the London Stock Exchange. Ricardo, though,
prospered in the financial business to a far greater
extent than his father, amassing a fortune of about
£700,000 (equivalent to approximately £40 million
today).
http://eh.net/encyclopedia/david-ricardo/
David Ricardo (1772-1823)
• Ricardo became interested in economics in 1799 after, apparently by chance, reading
the work of Adam Smith. He subsequently published pamphlets and articles analyzing
various economic problems of the day, including the stability of the currency and the
national debt. After some struggle (“I fear the undertaking exceeds my powers,” he
wrote), his classic work, The Principles of Political Economy, appeared in 1817.
• Two of Ricardo’s most important contributions were the theory of rent and the concept
of comparative advantage. The former, which drew on the writings of (among others)
his close friend and critic Robert Malthus, defined rent as “that portion of the produce
of the earth which is paid to the landlord [by the tenant farmer] for the use of the
original and indestructible powers of the soil.” Rent, Ricardo argued, is what remains
from gross farm revenue after all the farmer’s production costs have been paid,
including remuneration for the capital and labor he had expended on the land. It is an
unearned surplus (now referred to as an economic rent) in that its payment is not
necessary to ensure a supply of farmland. For Ricardo, rent arises from the advantages
that one site has over another due to differing degrees of soil fertility: rent per acre is
highest on the most fertile land, and declines to zero on the worst quality soil.
http://eh.net/encyclopedia/david-ricardo/
David Ricardo (1772-1823)
• Comparative advantage, Ricardo believed, ensured that international trade
would bring benefits for all countries; his theory remains the foundation of
the economic case for free trade today. He argued that each country should
specialize in making the products in which it possessed a comparative
advantage, that is could produce relatively efficiently. Portuguese sunshine,
for example, gave Portuguese entrepreneurs a comparative advantage in
producing wine, whereas England’s wet climate meant that her comparative
advantage was in making cloth. Ricardo showed that, by specializing in
production and then trading, Portugal and England would each achieve
greater consumption of both wine and cloth than in the absence of
international trade.
• Not surprisingly, then, Ricardo opposed the protectionist Corn Laws in place
during his lifetime, and upon retiring from the Stock Exchange in 1819,
made his case directly to the House of Commons as the member for
Portarlington, a pocket borough in Ireland. Ricardo’s Parliamentary career
was influential but brief: four years later he died suddenly after contracting
an ear infection.
http://eh.net/encyclopedia/david-ricardo/
Early Corn Laws History

http://www.math.grin.edu/~simpsone/Teaching/Romantics/ellen.html
 In 1436 and 1463, England issued the first Corn Laws granting grain growers a
monopolistic advantage of the market. The laws mandated high grain prices and
specified price levels necessary for exportation and importation. The Corn laws
were constantly adapted to changing foreign and domestic market conditions during
the 16th, 17th, and 18th centuries. Before 1660, consumer happiness was the chief
concern. However, afterwards, wheat producers became equally influential and
England grew to become a great consumer and producer of wheat.
 With the Corn Laws, England established a well-defined system for regulating corn
trade from 1660 through 1814. Importation and exportation duties or tariffs on a
sliding scale, meaning that they are adjusted to changing economic conditions,
enforced the laws' chief purpose to secure enough grain to supply domestic needs
and to sustain profitable and reasonable grain price levels. Until 1750, the laws
remained undisturbed.
End of War with France
 On June 8, 1815, Napoleon is finally defeated at the Battle of
Waterloo. This ends a war between England and France that
had essentially began in 1689.
 The end of the war means that France can now export “corn”
(this means grain) to England
 The importation of grain will lower food prices.
 But not everyone benefits from this trade.
Corn Law Economics
Three groups in society
Workers: Paid in Wages
Landowners (aristocracy): Paid in
Rents
Manufacturers (capitalists): Paid in
Profits
Iron Law of Wages

http://www.econlib.org/library/Ricardo/ricP2.html#Ch.5, Of Wages

http://www.fordham.edu/halsall/mod/ricardo-wages.asp

It is when the market price of labour exceeds its natural price, that the condition of the labourer is flourishing and happy, that he has it in his
power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family. When,
however, by the encouragement which high wages give to the increase of population, the number of labourers is increased, wages again fall to
their natural price, and indeed from a reaction sometimes fall below it.

Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period,
be constantly above it; for no sooner may the impulse, which an increased capital gives to a new demand for labour, be obeyed, than another
increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labour may give a
continued stimulus to an increase of people....

Thus, then, with every improvement of society, with every increase in its capital, the market wages of labour will rise; but the permanence of
their rise will depend on the question, whether the natural price of labour has also risen; and this again will depend on the rise in the natural
price of those necessaries on which the wages of labour are expended....

As population increases, these necessaries will be constantly rising in price, because more labour will be necessary to produce them. If, then, the
money wages of labour should fall, whilst every commodity on which the wages of labour were expended rose, the labourer would be doubly
affected, and would be soon totally deprived of subsistence. Instead, therefore, of the money wages of labour falling, they would rise; but they
would not rise sufficiently to enable the labourer to purchase as many comforts and necessaries as he did before the rise in the price of those
commodities....

These, then, are the laws by which wages are regulated, and by which the happiness of far the greatest part of every community is governed.
Like all other contracts, wages should be left to the fair and free competition of the market, and should never be controlled by the interference
of the legislature.
LANDOWNERS AND RENT
• Given the Iron Law of Wages, changing the price of
corn will not alter the “natural price” of labor. So this
does not directly impact workers in the long-run.
• The higher price does benefit landowners.
• The key is the concept of “rent”
• The following slides are taken from:
people.westminstercollege.edu/faculty/jwatkins/105
/.../ricardo2.PPT
RENT
• Return to an factor of
production for which there are
no substitutes or no “good”
substitutes
• Examples: land, a particular
location, a living legend, etc.
RICARDIAN RENT
• Ricardo defined rent as follows:
• different between output on
the most and least fertile land in
cultivation
• difference between costs of
production on the most and
least fertile lands in cultivation
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Summarizing the impact of the
Corn Laws
 Workers are not impacted in the long-run
(although food riots did happen in the short-run)
 Landowners see their “rents” increase as more and
more marginal land is put into production
 Manufacturers see their “profits” decline as higher
Corn Laws increase wages.
Why 1815 to 1846?
 In 1815, the House of Commons is dominated by Landowners

http://www.parliament.uk/about/livingheritage/evolutionofparliament/houseofcommons/reformacts/overview/reformact1832/
 The Reform Act of 1832

The Representation of the People Act 1832, known as the first Reform Act or Great Reform Act:

disenfranchised 56 boroughs in England and Wales and reduced another 31 to only one MP

created 67 new constituencies

broadened the franchise's property qualification in the counties, to include small landowners, tenant farmers, and shopkeepers

created a uniform franchise in the boroughs, giving the vote to all householders who paid a yearly rental of £10 or more and
some lodgers

Limited change had been achieved but for many it did not go far enough. The property qualifications meant that the majority of
working men still could not vote. But it had been proved that change was possible and over the next decades the call for further
parliamentary reform continued
 Why 1846? The Irish Potato Famine appears to be the key event that leads to the
triumph of the Anti-Corn League
Triumph of Free Trade?
 The movement to repeal the Corn Laws has been commonly treated in the literature as
an example of the power of non-self-interested ideology to influence economic policy.
Without denying that ideology played a role, there is ample evidence to question the
dominance of ideology in motivating the repeal campaign. Specifically, we have
presented considerable evidence to support two propositions: 1) the Anti-Corn Law
League, despite its name, devoted substantial efforts towards preventing and impeding
the passage of further Factory Acts in the cotton textile industry and towards the repeal
of the raw cotton duty; and 2) the principal financial support for the League came from
the cotton textile industry, which had a strong economic interest in these activities (if
not repeal of the Corn Laws per se). A concentrated and localized industry group,
sharing very specific common interests, invested heavily in promoting the League and its
activities.
 Gary M. Anderson and Robert D. Tollison (1985)
Interdependence and the Gains
from Trade
Absolute advantage - the comparison among
producers of a good according to their
productivity.
Comparative advantage - the comparison among
producers of a good according to their
opportunity cost.
“England may be so circumstanced, that to produce
the cloth may require the labour of 100 men for
one year; and if she attempted to make the wine, it
might require the labour of 120 men for the same
time. England would therefore find it her interest to
import wine, and to purchase it by the exportation
of cloth. To produce wine in Portugal, might require
only the labour of 80 men for one year, and to
produce the cloth in the same country, might
require the labour of 90 men for the same time. It
would therefore be advantageous for her to export
wine in exchange for cloth.” [Ricardo (1817) as
reprinted in McCulloch (1888, p. 76-77)]
“This exchange might even take place,
notwithstanding that the commodity imported by
Portugal could be produced with less labour than in
England. Though she could make the cloth with the
labour of 90 men, she would import it from a country
where it required the labour of 100 men to produce it,
because it would be advantageous to her rather to
employ her capital in the production of wine, for which
she would obtain more cloth from England, than she
could produce by diverting a portion of her capital
from the cultivation of vines to the manufacture of
cloth.”(Ricardo (1817) as reprinted in McCulloch
(1888, p. 76-77).
Ricardo, the numbers
Nation
Wine
Cloth
England
120
100
Portugal
80
90
In Ricardo’s example, Portugal has an
absolute advantage with respect to both
goods. However, Portugal’s comparative
advantage only lies in the production of wine.
Another Example
• Venezuela can produce a unit of cloth with 15 units of
labor while a unit of grain requires 30 units of labor.
Spain can produce a unit of cloth with 6 units of labor
while a unit of grain requires 3 units of labor. Let’s
assume each nation has 3,000 units of labor.
• Prior to trade:
• For Venezuela one unit of cloth costs ½ a unit of grain.
• one unit of grain costs 2 units of cloth
• For Spain one unit of cloth costs 2 units of grain
• one unit of grain costs ½ a unit of cloth
More on “another example”
• With free trade Venezuela can specialize in cloth, Spain can
specialize in grain. Without trade, a unit of cloth costs Spain
two units of grain. What if the terms of exchange allowed
Spain to acquire a unit of cloth for only one unit of grain?
Spain would be better off.
• Would Venezuela benefit from this trade? Grain costs
Venezuela two units of cloth before trade. After trade, one unit
of grain only costs one unit of cloth. Venezuela is also better
off.
• Trade allows a nation to expand its consumption possibilities
beyond its production possibilities. And everyone ends up
with more.
Ricardo’s conclusions
1. Comparative advantage, not absolute
advantage, determines the pattern of
trade.
2. Free trade benefits every nation by
expanding each nation’s consumption
possibilities beyond its production
possibilities.
3. NOTE: Free trade benefits every nation
but not everybody in every nation.
Additional Benefits from Trade
1. Increased Variety of Goods
2. Increase Competition
3. Enhanced flow of technology
WHY PROTECTIONISM?
• If free trade is so wonderful, why isn’t it universal?
• Free Trade Benefits Every Nation, but Not Everyone in Every
Nation
• Back to the Corn Laws...
• Free trade in corn benefits industry and hurts landowners
• Free trade in textiles might harm industry (and help
landowners)
• Even Great Britain was not practicing completely free trade
in the latter 19th century. And neither was the U.S.
THE INFANT INDUSTRY
ARGUMENT
• Imagine a nation attempting to develop a manufacturing
industry where economies of scale (what is this?) are
important.
• If the nation practices free trade, its domestic
manufacturers will have higher cost than existing firms in
more established nations.
• So allowing free trade means the nation will never
develop its manufacturing industry.
• Has this argument ever persuaded people in the U.S.?
HENRY CLAY AND ABRAHAM
LINCOLN
•
from, Land of Promise: An Economic History of the United States (Michael Lind)
• The centerpiece of Henry Clay’s plan for the industrialization of the United States
had been a high protective tariff (Hamilton had preferred government subsidies to
infant industries). Lincoln told a correspondent in 1859, “I was an old Henry-ClayTariff Whig. In old times I made more speeches on that subject than any other. I have
not since changed my views.”
• In arguing for a protective tariff, Lincoln followed Clay in identifying industrial
Britain as America’s economic rival, and claimed that those who purchased
imported British goods were unpatriotic snobs: “Those whose pride, whose
abundance of means, prompt them to spurn the manufactures of their own country,
and to strut in British cloaks, and coats, and pantaloons, may have to pay a few cents
more on the yard for the cloth that makes them. A terrible evil, surely, to the Illinois
farmer, who never wore, nor never [sic] expects to wear, a single yard of British
goods in his whole life.”
THE TARIFF AND THE 1860
ELECTION
• from, Land of Promise: An Economic History of the United States (Michael Lind)
• The tariff was part of the Republican Party platform of 1860, whose wording, the product of
the efforts of Henry Carey among others, sought to please every constituency: “While
providing revenue for the support of the general government by duties upon imports,
sound policy requires such an adjustment of these imports as to encourage the
development of the industrial interests of the country; and we recommend that policy of
national exchanges, which secures to the working man liberal wages, to agriculture
remunerative prices, to mechanics and manufacturers an adequate reward for their skill,
labor, and enterprise, and to the nation commercial prosperity and independence.”
• One observer reported: “The Pennsylvania and New Jersey delegations were terrific in
their applause over the tariff resolution, and their hilarity was contagious, finally
pervading the whole vast auditorium.”
• The electoral votes of protectionist Pennsylvania and New Jersey were crucial in helping
Lincoln and the Republicans win the White House in 1860. “Protection made Mr. Lincoln
president,” Carey said.
REPUBLICANS AND
PROTECTIONISM
•
from, Land of Promise: An Economic History of the United States (Michael Lind)
• In May 1860, before the election, the House had passed the Morrill Tariff, which was
passed by the Senate between Lincoln’s election and his inauguration.
• Tariffs were raised again during the Civil War in 1862 and 1864.
• The administration of Abraham Lincoln inaugurated an era that lasted until World
War II, in which the United States had the most protected home market in the world.
Between 1867 and 1914, while many goods were admitted free from duties, the US
tariff on dutiable imports, chiefly manufactured goods, hovered between 40 and 50
percent.
• From Ulysses S. Grant to Herbert Hoover, Lincoln’s Republican successors shared his
view that the government should protect and promote American manufacturing.
President Grant pointed out that Britain had industrialized behind a wall of
protective tariffs, turning to free trade only when its manufactured exports were
superior to those of other countries: “After two centuries, England found it
convenient to adopt free trade because it thinks that protection can no longer offer it
anything. Very well, Gentlemen, my knowledge of our country leads me to believe
that within 200 years, when America has gotten out of protection all that it can offer,
it too will adopt free trade.”
PROTECTION IN THE 20TH
CENTURY
• from, Land of Promise: An Economic History of the United States (Michael Lind)
• William McKinley, who published a book on the tariff, succeeded Justin Morrill as the
leading spokesman for protectionism in the Republican Party and gave his name to the
1890 McKinley Tariff. McKinley and his vice president and successor, Theodore Roosevelt,
recognized the need for reciprocal trade liberalization in sectors where infant industry
protection had successfully created mature American industries.
• But like other Republicans of their time, they remained committed economic nationalists.
Roosevelt wrote in 1895: “Thank God I am not a free-trader. In this country pernicious
indulgence in the doctrine of free trade seems inevitably to produce fatty degeneration of
the moral fibre.”
• The US model of import substitution became a model for other industrializing countries
like Germany, Japan, Russia, and the British Dominions of Canada, Australia, and New
Zealand.
• In the early twentieth century, the economist Frank W. Taussig, despite his commitment to
free trade, conceded that without protectionism the development of American
manufacturing might not have taken place as rapidly as it did
LABOR UNIONS AND TRADE
LIBERALIZATION
• From the Council of Industrial Organization in 1943,
specifically the director of research J. Raymond Walsh....
• " '...almost unanimous consensus of informed opinion for
over a century... had held that obstacles to trade were
invariable costly to a nation. Unfettered trade enabled
every nation to realize the highest standard of living;
specialization in producing things with the greatest
efficiency induced maximum productiveness. Nothing
less than national defense considerations could justify, in
the CIO view, 'artificial obstacles' in the way of free
international trade." (from the U.S. Congress (1943) as
reprinted (Donahue 1992, p. 9)
MORE FROM THE CIO
 "Without 'free trade'... at least half of the American
people would be doomed to a life of poverty. The nation
would be consumed by crime, civil disorders, race riots,
violence, forcing an end to all civil and individual
liberties. America's roads would be clogged with masses
of wandering, homeless people, threatening the existence
of the family as an institution and giving rise to a
generation of juvenile delinquents. Sickness and disease
would plague the population. Demagogues would
harangue the people and mislead and confuse them. The
crisis would convulse the nation, threatening private
property and democratic political institutions alike"
(Donahue 1992, p. 23).
DEATH OF PROTECTIONISM
WHY DID PROTECTIONISM END?
 During the Cold War, the United States became committed to
spreading capitalism throughout the world.
 Access to the U.S. market was considered essential to
promoting capitalism (i.e. anti-communism).
 Hence, the U.S. became a nation of “free trade” (although
today, labor unions are opposed to free trade and prefer a
policy of “fair” trade)