Economic Principles 1

Tutorial 2

Ben Gussen

Question 1

• Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self-sufficient?

Question 1

• Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self-sufficient?

• Examples of regularly purchased items or services could include food for meals or a contracted lawn-mowing service

• Examples of goods or services could include home-gown vegetables or washing dishes

Question 1

• Give an example of a good or service that you regularly buy. Then give an example of a good or service you provide in your own household. Why don’t you become more self-sufficient?

• Self-sufficiency would mean producing goods

and services you don’t have a comparative advantage in. This would tend to make you worse off

Question 2

• George and Martha face the production possibilities frontiers shown for brownies and cupcakes.

Question 2

a. If George and Martha choose not to trade and divide their time equally between the production of brownies and cupcakes, how many of each would they be able to consume? (Show this point on your graphs.)

b. Now assume that George and Martha each decide to specialize in the good in which they have a comparative advantage and then trade. Who would trade brownies and who would trade cupcakes?

c. c. If George and Martha decided to trade 60 brownies for 60 cupcakes, how many cupcakes and brownies would each have to consume?

d. d. How do we know each is better off with trade than acting alone?

Question 2 (a)

• If George and Martha choose not to trade and divide their time equally between the production of brownies and cupcakes, how many of each would they be able to consume? (Show this point on your graphs.)

• If George and Martha divide their time equally, George would be able to produce 50 brownies and 100 cupcakes (point A on his PPF) and Martha would be able to produce 80 brownies and 40 cupcakes (point A on her PPF)

Question 2 (b)

• Now assume that George and Martha each decide to specialise in the good in which they have a comparative advantage and then trade. Who would trade brownies and who would trade cupcakes?

Question 2 (b)

• George’s opportunity cost:

• If George uses all his time to produce Brownies he makes 100 Brownies

• If George uses all his time to produce Cupcakes he makes 200 Cupcakes

Question 2 (b)

• George’s opportunity cost:

• Hence, for George 100 Brownies are equivalent to 200 Cupcakes

• For George: – 1 Brownie = 2 Cupcakes , or – 1Cupcake = ½ Brownie

Question 2 (b)

• Martha’s opportunity cost:

• If Martha uses all her time to produce Brownies she makes 160 Brownies

• If Martha uses all her time to produce Cupcakes she makes 80 Cupcakes

Question 2 (b)

• Martha’s opportunity cost:

• Hence, for Martha 160 Brownies are equivalent to 80 Cupcakes

• For Martha: – 1 Brownie = ½ Cupcakes– 1 Cupcake = 2 Brownie

Question 2 (b)

• George has a comparative advantage in and would trade, cupcakes;

• For him the opportunity cost of 1 cupcake is ½ Brownie

• For Martha the opportunity cost of 1 cupcake is 2 Brownies

Question 2 (b)

• Martha has a comparative advantage in and would trade, Brownies;

• For Martha the opportunity cost of 1 Brownie is ½ Cupcake

• For George the opportunity cost of 1 Brownie is 2 Cupcakes

Question 2 (c)• We assume total

specialization:

• George has comparative advantage in Cupcakes and hence would specialize in Cupcakes

• Martha has comparative advantage in Brownies and hence would specialize in Brownies

Question 2 (c)

• Since George is producing 200 cupcakes and no brownies, if he traded 60 cupcakes, he would be left with 140 cupcakes and would expect to receive 60 brownies from Martha in return.

Question 2 (c)

• Since Martha is producing 160 brownies and no cupcakes, if she traded 60 brownies, she would be left with 100 brownies and would expect to receive 60 cupcakes from George in return.

Question 2 (d)

• We know that both George and Martha are better off with trade because both are able to consume outside their own production possibilities frontiers

Question 3

• The table below describes the production possibilities for Lee and Amy in a four-hour shift.

Coffee Croissants

Lee 20 15

Amy 8 16

Question 3

• a. What is the opportunity cost of one coffee for each person? What is the opportunity cost of one croissant?

• b. Who has a comparative advantage in coffees? Who has a comparative advantage in croissants?

• c. Who has an absolute advantage in coffees? Who has an absolute advantage in croissants?

• d. Who should produce coffees? Who should produce croissants?

Question 3 (a)

• If Lee uses all his time to produce Coffee he can make 20

• If Lee uses all his time to produce Croissants he can make 15

• Hence for Lee 20 Coffee = 15 Croissants

• Or 1 Coffee = ¾ Croissants

Question 3 (a)

• If Amy uses all his time to produce Coffee she can make 8

• If she uses all his time to produce Croissants she can make 16

• Hence for Amy 8 Coffee = 16 Croissants

• Or 1 Coffee = 2 Croissant

Question 3 (a)

• The opportunity cost of one coffee for Lee is 3/4 croissants and the opportunity cost of one coffee for Amy is 2 croissants.

• The opportunity cost of one croissant for Lee is 1 1/3 (=4/3) coffee. The opportunity cost of one croissant for Amy is 1/2 coffee.

Question 3 (b)

• Lee has a comparative advantage in coffees

• Amy has a comparative advantage in croissants.

Question 3 (c)

• Lee has an absolute advantage in coffees

• Amy has an absolute advantage in croissants.

Question 3 (c)

• For absolute advantage we look at the operating cost rather than the opportunity cost

Question 3 (c)

• If Lee uses all his time (which is his operating cost) to produce Coffee he gets 20

• If Amy uses all her time to produce Coffee she gets 8

• Hence, Lee has an absolute advantage in producing Coffee

Question 3 (c)

• If Lee uses all his time (which is his operating cost) to produce Croissants he gets 15

• If Amy uses all her time to produce Croissants she gets 16

• Hence, Amy has an absolute advantage in producing Croissants

Question 3 (d)

• Based on their COMPARATIVE ADVANTAGES:

• Lee should produce coffees

• Amy should produce croissants

THE END

Objectives (Week 2)

Students should be able to:

1. understand the concept of opportunity cost

2. define, explain ,analyse and apply the theories of trade such as absolute advantage and comparative advantage to current economic issues and examine their implications for business in a national and international context

3. examine the international trade environment, policies and institutions

Big Picture

COMPARATIVE and ABSOLUTE ADVANTAGE

Comparative and absolute advantage

Differences in costs determine pattern of trade

Production Costs

Absolute Advantage

Opportunity Costs

Comparative Advantage

Econ Rap: Keynes vs Hayek

• http://www.youtube.com/watch?v=d0nERTFo-Sk

• http://www.youtube.com/watch?v=GTQnarzmTOc

http://images.google.com/url?sa=i&rct=j&q=comparative+advantage&source=images&cd=&cad=rja&docid=HmFHKoV4y0AWcM&tbnid=6zCdKZSQCo3pBM:&ved=0CAUQjRw&url=http://www.docstoc.com/docs/46695697/Absolute-vs-Comparative-Advantage&ei=giMvUfv7Le-MmQXYzIAQ&bvm=bv.43148975,d.aGc&psig=AFQjCNFartUj1fK2qp2Ea8dnkupxLQ-zsg&ust=1362130110250317

See Japan / Australia

example from the lecture slides

Another Example:• Absolute advantage does not mean comparative advantage:

• Country B has absolute advantage in Notebooks and Pens, but does it have a comparative advantage in both?

• Also see Textbook at 56, paragraph 4

100

300

Notebooks

Pens

Country A

200

1000

Notebooks

Pens

Country B

Before Trade

George Martha

50 Brownies

100 Cupcakes

80 Brownies

40 Cupcakes

After Trade

George Martha

60 Brownies

200 Cupcakes

160 Brownies

60 Cupcakes140 Cupcakes

10 more than before

40 more than before

100 Brownies

20 more than before

20 more than before