Lecture Notes Week 2 - Principles of Microeconomics
Lecture Notes Week 2 - Principles of Microeconomics EC 110
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This 6 page Class Notes was uploaded by Matt Owens on Saturday January 24, 2015. The Class Notes belongs to EC 110 at University of Alabama - Tuscaloosa taught by Kent O. Zirlott in Spring2015. Since its upload, it has received 179 views.
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Date Created: 01/24/15
Matt Owens Principles of Microeconomics January 20th 2015 Chapter 3 Notes Interdependence and the Gains from Trade A Parable For the Modern Economy Two goods 0 Meat 0 Potatoes Two people 0 Rancher 0 Farmer If the rancher produces only meat 0 And the farmer only produces potatoes 0 Both gain from trade If both the rancher and farmer produce both meat and potatoes 0 They are selfsufficient I Robinson Crusoe model Somebody is both the producer and the consumer 0 However they still gain from specialization and trade The Production Possibilities Frontier a 0 Minutes needed to make 1 ounce of I Meat Farmer 60 minutesounce Rancher 20 minutes ounce I Potatoes Farmer 15 minutesounce Rancher 10 minutes ounce 0 Amount produced in 8 hours I Meat Farmer 8 ounces Rancher 24 ounces I Potatoes Farmer 32 ounces Rancher 48 ounces 0 Panel a shows the production opportunities available to the farmer and the rancher I Rancher is better at producing meat AND potatoes absolute advantage The Production Possibilities Frontier bc o b The Farmer s production possibilities frontier I If there is no trade the farmer chooses this production and consumption 0 ounces of potatoes 8 ounces of meat 16 ounces of potatoes 4 ounces of meat 32 ounces of potatoes 0 ounces of meat 0 c The Rancher s production possibilities frontier I If there is no trade the rancher chooses this production and consumption 0 ounces of potatoes 24 ounces of meat 24 ounces of potatoes 12 ounces of meat 48 ounces of potatoes 0 ounces of meat 0 Panel b shows the combinations of meat and potatoes that the farmer can produce Panel c shows the combinations of meat and potatoes that the rancher can produce Both production possibilities frontiers are derived assuming that the farmer and rancher each work 8 hours per day If there is no trade each person s production possibilities frontier is also his or her consumption possibilities frontier Specialization and Trade 0 Farmer specialize in growing potatoes I More time growing potatoes I Less time raising cattle o Rancher Specialize in raising cattle I More time raising cattle I Less time growing potatoes 0 Trade I 5 ounces of meat for 15 ounces of potatoes 0 Both gain from specialization and trade How trade expands the set of consumption opportunities ab 0 a The Farmer s production and consumption I 0 ounces of potatoes 8 ounces of meat I 16 ounces of potatoes 4 ounces of meat Farmer s production and consumption without trade Point A I 17 ounces of potatoes 5 ounces of meat Farmer s consumption with trade Point A I 32 ounces of potatoes 0 ounces of meat Farmer s production with trade 0 b The Rancher s production and consumption I 0 ounces of potatoes 24 ounces of meat I 12 ounces of potatoes 18 ounces of meat Rancher s production with trade I 24 ounces of potatoes 12 ounces of meat Rancher s production and consumption without trade Point B I 27 ounces of potatoes 13 ounces of meat Rancher s consumption with trade Point B I 48 ounces of potatoes 0 ounces of meat 0 The proposed trade between the farmer and the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade In panel a the farmer gets to consume at point A rather than point A In panel b the rancher gets to consume at point 3 rather than point B Trade allows each to consume more meat and more potatoes How Trade Expands the Set of Consumption Opportunities c o c The gains from trade A summary Without trade 0 Production and consumption I Farmer 4 ounces of meat 16 ounces of potatoes I Rancher 12 ounces of meat 24 ounces of potatoes With trade 0 Production I Farmer 0 ounces of meat 32 ounces of potatoes I Rancher 18 ounces of meat 12 ounces of potatoes 0 Trade I Farmer Gets 5 ounces of meat Gives 15 ounces of potatoes I Rancher Gives 5 ounces of meat Gets 15 ounces of potatoes 0 Consumption I Farmer 5 ounces of meat 17 ounces of potatoes I Rancher 13 ounces of meat 27 ounces of potatoes Gains from trade 0 Increase in consumption I Farmer 0 1 ounce in meat 0 1 ounce in potatoes I Rancher 0 1 ounce in meat 0 3 ounces in potatoes Comparative Advantage Absolute Advantage Produce a good using fewer inputs than another producer 0 If you re given a certain amount of inputs and you can produce more with it you also have absolute advantage Opportunity Cost 0 Whatever must be given up to obtain some item 0 Measures the trade off between the two goods that each producer faces 0 The opportunity cost of meat and potatoes I Opportunity cost of 1 ounce of meat 0 Farmer 4 ounces of potatoes I If a farmer wants to produce an additional ounce of meat he has to give up 4 ounces of potatoes 0 Rancher 2 ounces of potatoes I If a rancher wants to produce and additional ounce of meat he has to give up 2 ounces ofpotatoes 1 ounce of potatoes 0 Farmer 1 ounce of meat I If a farmer wants to produce an additional ounce of potatoes he has to give up 11 an ounce of meat 0 Rancher 12 ounce of meat I If a rancher wants to produce an additional ounce of potatoes he has to give up 12 an ounce of meat Comparative Advantage Produce a good lower opportunity cost than another producer 0 Re ects relative opportunity cost 0 America s Got Talent is a show that is all about comparative advantages I Different talents are comparative advantages David Ricardo Father of comparative advantage Principle of comparative advantage 0 Each good produced by the individual that has the smaller opportunity cost of producing that good One person 0 Can have absolute advantage in both goods 0 Cannot have comparative advantage in both goods For different opportunity costs 0 One person comparative advantage in one good 0 The other person comparative advantage in the other good Opportunity cost of one good 0 Inverse of the opportunity cost of the other Gains from specialization and trade 0 Based on comparative advantage 0 Total production in economy rises I Increase in the size of the economic pie I Everyone better off Trade benefit everyone in society 0 Allows people to specialize in activities I Have a comparative advantage 0 The price of trade I Principle of rationality we assume people and countries are rational You would not agree to terms of trade that would leave you worse off 0 Principle of comparative advantage explains o Interdependence o Gains from trade Applications of Comparative Advantage Should the US trade with other countries 0 Imports Goods produced abroad and sold domestically 0 Exports Goods produced domestically and sold abroad Principle of comparative advantage 0 Foundation of international trade 0 Each good produced by the country I Smaller opportunity cost 0 f producing that good 0 Specialization and trade I All countries greater prosperity Example Output of labor per hour 0 Food I US 4O I Mexico 10 0 Clothing I US 40 I Mexico 20 US 0 Opportunity cost of 1 unit of food is 4040 1 unit of clothing 0 Opportunity cost of 1 unit of clothing is 4040 1 unit of food Mexico 0 Opportunity cost of 1 unit of food is 2010 2 units of Whatever clothing you re taking 0 Opportunity cost of 1 unit of clothing is 1020 12 units the Opportunity of food cost of goes in US has complete advantage in food because 1 is less than 2 the Mexico has complete advantage in clothing because 12 is less denominator than 1
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