MicroeconomicsLecture 2

Trade-offs, Comparative Advantage, and the Market System

Yabut

Intent

Result

FellPushedJumped

Result the same

Utopia vs. Reality

Reality always loses

Realistic Alternatives

Utility

a measure of happiness or satisfaction

SnickersTest of Utility

Change IncentivesChange Behavior

Speed Camera Lottery

PositiveWhat is

NormativeWhat ought to be

Fact

Values

FactsTrue or False

ValuesGood or Bad

MarketsWhere Buyers and

Sellers Trade

Households

Individuals in a home

Sell Factors of Production

Buy Goods & Services

Firms

Buy Factors of Production

Sell Goods & Services

Product Markets

Markets for finished goods and services

- Stores -

Factor Markets

Markets for goods and services used to make

products

LaborCapitalNatural

ResourcesEntrepreneurs

SpendingWages & Payments

for Factors

Goods & Services

Households

Firms

FactorMarkets

ProductMarkets

Absolute Advantage

Produce more with the same resources

Comparative Advantage

Produce at a lower opportunity cost

David Ricardo(1772 - 1823)

Principles of Political Economy

and Taxation

Comparative Advantage

The basis for trade is comparative advantage,

not absolute advantage.

Gale AliTotal

Hours

Make a Hook

Catch a Fish

TotalHours

3 2 5

4 1 5

7 3 10

No Trade2 Hooks and 2 Fish

10 Hours - 5 Hours per Fish

Gale AliTotal

Hours

Make a Hook

Catch a Fish

TotalHours

2 hooks6 hours

6

2 fish2 hours

2

6 2 8

With Trade2 Hooks and 2 Fish

8 Hours - 4 Hours Per Fish

Opportunity Cost

The highest valued alternative

Saudi Idaho

Dates Potatoes

24 0

20 1

16 2

12 3

8 4

4 5

0 6

Ratios24 to 6

4 Dates for 1 Potato6 to 24

1/4 Potato for 1 Date

Dates Potatoes

6 0

5 5

4 10

3 15

2 20

1 25

0 30

Ratios6 to 30

1/5 Dates for 1 Potato30 to 6

5 Potatoes for 1 Date

Saudi Arabia Idaho

24

30

6

6 Potatoes15

12

3

3

9

15

18

21

9 12 18 21 24 2700

27

Should Idaho and Saudi Trade?Dates

SaudiPPF

IdahoPPF

Dates Potatoes

6 0

5 5

4 10

3 15

2 20

1 25

0 30

Dates Potatoes

24 0

20 1

16 2

12 3

8 4

4 5

0 6

InternalPrice

Dates Potatoes

Idaho 5 Potatoes 1/5 Date

Saudi 1/4 Potato 4 Dates

No Trade Dates Potatoes

Idaho 3 15

Saudi 12 3

Total 15 18

Specialize Dates Potatoes

Idaho 0 30

Saudi 24 0

Total 24 30

Analysis Dates Potatoes

No TradeTotals 15 18

SpecializeTotals 24 30

Gain +9 +12

Trade Dates Potatoes

Idaho 3 to 12 = +9 15

California 12 3 to 15 = +12

Total 24 30

24

30

6

6 Potatoes15

12

3

3

9

15

18

21

9 12 18 21 24 2700

27

Should Idaho and Saudi Trade?Dates

SaudiPPF

IdahoPPF

TradePPF

Idaho gains

9 Dates

California gains 12

potatoes

Slope

Percentage Change

Relationships

Cause and Effect

Areas

Notation

% Percent

Change

% Percentage Change

% Percentage Change

New - Old

Old

= = .4 = 40%7 - 55

25

Last year the price was $6. This year the price is $9. What is the percentage change?

New - Old Old

= = .5 = 50%9 - 66

36

California Culture

or

Syria Culture