Good morning
Day 5, to start…
Let us say this is the table which
represents the Production Possibility
Curve for a person…
Points
Nike hightop shoes
Hats with stickers
on them still
A
10
0
B
5
10
C
0
20
Graph the PPF first…
Then calculate the opportunity cost
Easier method (in notes you used what I called “the
maximum production function”)…
Here, you will:
1) Find the difference
2) Write a sentence
3) Divide
The opportunity cost of ___ shoes is __ hats…
That is mostly it for exclusively PPF stuff… We will be
using it in our next topic…
Interdependence and
the Gains from Trade
Chapter 6
Interdependence and Trade
Consider your typical day:
You wake up to an alarm clock made in Korea.
You pour yourself some orange juice made from
oranges grown in Florida.
You put on some clothes made of cotton grown in
Georgia and sewn in factories in Thailand.
You watch the morning news broadcast from New
York on your TV made in China.
Your teacher is using a computer and projector made
in the supply chain over twenty countries
You drive to class in a car made of parts
manufactured in a half-dozen different countries.
…and you haven’t been up for more than two hours
yet!
Two extremes
We
can be economically selfsufficient (autarky)
We can specialize and
trade with others,
leading to economic
interdependence (this is
globalization)
Individuals and nations rely on
specialized production and
exchange as a way to address
problems caused by scarcity.
A bonus of specialization:
When people specialize, allocative
efficiency is realized, which entails that
the most desired items are being
produced and resources are efficiently
divided
 More to come on this… A LOT MORE

Why interdependence?
Interdependence occurs because people
are better off when they specialize and
trade with others because of differences in
opportunity costs.
Absolute Advantage
The
producer (person, firm, or country)
requires fewer resources per unit of
output than an other country has AA…
it can produce more of it GIVEN SAME
NUMBER OF INPUTS
Comparative Advantage
Compares
producers of a good
according to their opportunity cost.
The
producer who has the smaller
opportunity cost of producing a good
is said to have a comparative
advantage in producing that good.
A Parable for the Modern
Economy

Imagine . . .
only two goods: potatoes and meat
only two people: a potato farmer and a
cattle rancher


What should each produce?
Why should they trade?
The Production Opportunities of
the Farmer and the Rancher
Farmer
Rancher
Hours Needed to Make 1 lb. of:
Meat
Potatoes
20 hours/lb
10 hours/lb
1 hours/lb
8 hours/lb.
Amount Produced in 40 Hours
Meat
Potatoes
2 lbs.
4 lbs.
40 lbs.
5 lbs.
Self-Sufficiency
By ignoring each other:


Each consumes what they each produce.
The production possibilities frontier is also the
consumption possibilities frontier.
(write the ppfs on left and
leave room on right for
charts)
Production Possibilities
Frontiers
Meat
(pounds)
(a) The Farmer’s Production
Possibilities Frontier
2
1
0
A
2
4
Potatoes (pounds)
Meat 40
(pounds)
Production Possibilities
Frontiers
(b) The Rancher’s Production
Possibilities Frontier
B
20
0
2.5
5
Potatoes (pounds)
The Farmer and the Rancher
Specialize and Trade
Each would be better off if they specialized
in producing the product they are more
suited to produce
The Gains from Trade:
A Summary
Farmer
Rancher
The Outcome
Without Trade:
1 lb meat (A)
2 lbs potatoes
20 lbs meat (B)
2.5 lbs potatoes
A and B are the midpoints
The Gains from Trade:
A Summary
Farmer
Rancher
The Outcome
With Trade:
What They
Produce
0 lbs meat
4 lbs potatoes
24 lbs meat
2 lbs potatoes
What They
Trade
Gets 3 lbs meat
for 1 lb potatoes
Gives 3 lbs meat
for 1 lb potatoes
What They
Consume
3 lbs meat (A*)
3 lbs potatoes
21 lbs meat (B*)
3 lbs potatoes
Trade Expands the Set of
Consumption Possibilities
(a) How Trade Increases the
Farmer’s Consumption
Meat
(pounds)
Farmer’s
consumption
with trade
A*
3
Farmer’s
consumption
without trade
2
1
0
A
2
3
4
Potatoes (pounds)
Meat 40
(pounds)
Trade Expands the Set of
Consumption Possibilities
(b) How Trade Increases The
Rancher’s Consumption
21
20
B*
B
Rancher’s
consumption
with trade
Rancher’s
consumption
without trade
0
2.5 3
5
Potatoes (pounds)
Day 6Vocab Relax:
Define these following terms:
•
•
•
•
•
Ceteris Paribus/Other things equal assumption
Normative Economics
Law of Increasing Opportunity Cost
Comparative Advantage
Export Subsidies
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
If you were wondering, this
is beyond the PPF because
there are more resources
involved now
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Gains from Trade:
A Summary
Farmer
Rancher
The Gains
From Trade:
The Increase in
Consumption
2 lbs meat (A*- A)
1 lb potatoes
1 lb meat (B*- B)
1/2 lb potatoes
Specialization and Trade
Who
has the absolute advantage?
The farmer or the rancher?
Who
has the comparative advantage?
The farmer or the rancher?
Absolute Advantage
 The
Rancher needs only 8 hours to
produce a pound of potatoes, whereas the
Farmer needs 10 hours.
 The Rancher needs only 1 hour to
produce a pound of meat, whereas the
Farmer needs 20 hours.
The Rancher has an absolute
advantage in the production of both
meat and potatoes.
Think about the next chart…
take some time and wrap
your head around it
The Opportunity Cost
of Meat and Potatoes
Opportunity Cost of:
1 lb of Meat
1 lb of Potatoes
Farmer
2 lb potatoes
½ lb meat
Rancher
1/8 lb potatoes
8 lb meat
Comparative Advantage
…so, the Rancher has a
comparative advantage in the
production of meat but the
Farmer has a comparative
advantage in the production
of potatoes.
And AA and
CA can apply
to any entities
trading
Absolute Advantage
The
producer (person, firm, or country)
requires fewer resources per unit of
output than an other country has AA…
it can produce more of it GIVEN SAME
NUMBER OF INPUTS…. THAT
MEANS THE PERSON WITH AA is
more productive with the resources
Benefits of Trade
Trade can benefit everyone in
a society because it allows
people to specialize in activities
in which they have a
comparative advantage.
Terms of Trade
How do entities decide what to trade?
They agree to specialize where they have
comparative advantage in such a way
that both end up with more than could
have been possible without trade
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Adam Smith and Trade
In his 1776 book An Inquiry into the
Nature and Causes of the Wealth of
Nations, Adam Smith performed a
detailed analysis of trade and economic
interdependence, which economists still
adhere to today.
David Ricardo and Trade
In his 1816 book Principles of Political
Economy and Taxation, David Ricardo
developed the principle of comparative
advantage as we know it today.
“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 in her interest to import wine, and to
purchase it by the exportation of cloth. To produce the
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. This exchange might even take
place, notwithstanding that the commodity imported by
Portugal could be produced there with less labour than in
England.”
Ricardo’s law has been called the only proposition in the whole of the
social sciences that is both true and surprising. It is such an elegant idea
that it is hard to believe that Palaeolithic people took so long to stumble
upon it (or economists to define it); hard to understand why other species
do not make use of it, too. It is rather baffling that we appear to be the
only species that routinely exploits it. Of course, that is not quite right.
Evolution has discovered Ricardo’s law and applied it to symbioses, such
as the collaboration between alga and fungus that is a lichen plant or the
collaboration between a cow and a bacterium in a rumen. Within species,
too, there are clear gains from trade between cells of a body, polyps of a
coral colony, ants of an ant colony, or mole-rats of a mole-rat colony. The
great success of ants and termites – between them they may comprise onethird of all the animal biomass of land animals – is undoubtedly down to
their division of labour. Insect social life is built not on increases in the
complexity of individual behaviour, ‘but instead on specialization among
individuals’.
In the leafcutter ants of the Amazon rainforest, colonies may number millions, and workers
grow into one of four distinct castes: minors, medias, majors and supermajor. In one species
a supermajor (or soldier) may weigh the same as 500 minors.But the big difference is that in
every other species than human beings, the colonies consist of close relatives – even a city
of a million ants is really just a huge family. Yet reproduction is the one task that people
never delegate to a specialist, let alone a queen. What gave people the chance to exploit
gains from trade, without waiting for Mother Nature’s tedious evolutionary crawl, was
technology. Equipped with the right tool, a human being can become a soldier or a worker
(maybe not a queen), and he can switch between the roles. The more you do something, the
better you get at it. A band of hunter-gatherers in west Eurasia, 15,000 years ago, dividing
labour not just by gender but by individual as well, would have been formidably more
efficient than an undifferentiated band. Imagine, say, 100 people in the band. Some of them
make tools, others make clothes, others hunt, others gather. One tiresome bloke insists on
prancing around in a deer skull chanting spells and prayers, adding little to the general wellbeing, but then maybe he is in charge of the lunar calendar so he can tell people when the
tides will be lowest for limpet-picking expeditions.True, there is not much specialisation in
modern hunter-gatherers. In the Kalahari or the Australian desert, apart from the gathering
women, the hunting men and maybe the shaman, there are not too many distinct occupations
in each band. But these are the simple societies left in the harsh habitats. In the relatively
fertile lands of west Eurasia after 40,000 years ago, when bands of people were larger and
lines of work were diverse, specialisation had probably grown up within each band. The
Chauvet rhino painter was so good at his job (and yes, archaeologists think it was mainly
one artist) that he must surely have had plenty of time off hunting duties to practise. The
Sungir bead maker must have been working for a wage of some kind, because he cannot
surely have had time to hunt for himself. Even Charles Darwin reckoned that ‘primeval man
practised a division of labour; each man did not manufacture his own tools or rude pottery,
but certain individuals appear to have devoted themselves to such work, no doubt receiving
in exchange the produce of the chase.’
Should Bill Gates Mow His
Own Lawn?
?
?
?