THE PROBLEM ALL SOCIETIES FACE IS UNLIMITED WANTS AND

LIMITED RESOURCES. WHICH WE WILL CALL SCARCITY

NO SOCIETY CAN AND WILL HAVE EVER ENOUGH TO SATISFY IT’S CITIZENS DESIRES OR WANTS

EVERYONE ALWAYS WANTS MORE AND THERE IS NOT ENOUGH TO GO AROUND FOR ALL

MY PICTURE OF SCARCITY

Unlimited Unlimited needs & wantsneeds & wants

Limited Limited ResourcesResources

ChoicesChoices

Dealing with “Scarcity”“Scarcity”

THE FOUNDATION OF ECONOMICSTHE FOUNDATION OF ECONOMICS

SOCIETY HAS VIRTUALLYSOCIETY HAS VIRTUALLY UNLIMITED WANTS... UNLIMITED WANTS...

1. Land Land [natural resourcesnatural resources] – Nature’s itemsNature’s items [“gifts of nature“gifts of nature”] A. In the earthIn the earth - coal, oil, water, fossil fuels, etc. B. On the earthOn the earth – vegetation and water C. In the atmosphereIn the atmosphere – sun, wind, and rain

[Land is the starting pointstarting point of all production.““Stuff”Stuff” from which everything is made.

.

The The Four Factors Four Factors ofof Production ProductionResources beget Resources beget productionproduction, which beget , which beget incomeincome, which beget , which beget wealthwealth..

““GiftsGifts of of NatureNature””

WaterWater WindWind

SunSun Fossil fuelsFossil fuels

.2. LaborLabor [human resourceshuman resources] {“effort”“effort”} anyone who works [“paid work”“paid work”] [Labor is the “brain-power”“brain-power” and ““muscle-power”muscle-power” of human beings] A. PhysicalPhysical – pro athletes & lumberjacks B. IntellectualIntellectual – ministers, doctors & lawyers

*Most important resource – 70% of input cost*Most important resource – 70% of input cost

““Hired HelpHired Help””

.Real Real CapitalCapital v.v. FinancialFinancial CapitalCapital

FINANCIAL FINANCIAL CAPITALCAPITAL[stocks, bonds, and money][stocks, bonds, and money]

REAL REAL CAPITALCAPITAL[tools, machinery, & factories]

CanCan produce something produce something

directly with thesedirectly with these

Can’tCan’t produce anything produce anythingdirectly with thesedirectly with these

.

A product can be both a consumer good and a capital goodcan be both a consumer good and a capital good –depends on its use.Ex: Jet aircraftJet aircraft used by a movie star [like Jim Carey]

to visit friends (consumer good). The same aircraft used by a business manager

to serve customers [capital good].Ex: F150 pick-upF150 pick-up to deliver produce [capital good]

or take family to church [consumer good]

3. Capital ResourcesCapital Resources – all “man-made inputs”“man-made inputs” used in the production process (tools, machinery, and physical plants)(tools, machinery, and physical plants). A. Capital goodsCapital goods – goods [machinery, buildings, & tools] used to produce other goodsproduce other goods. [crane, Ford plant, hammer] [products meant for “future consumption”“future consumption”] B. Consumer goodsConsumer goods – products meant for “immediate consumption”“immediate consumption”.

““man-made inputs”man-made inputs”

4. EntrepreneurshipEntrepreneurship – starting a new business starting a new business or introducing a newintroducing a new productproduct. “Sparkplugs”“Sparkplugs” who introduce the product or start the new business. He combines land, labor, & capital to produce productscombines land, labor, & capital to produce products.

Resource paymentsResource payments. The resource owners receive rentrent [for

the use of their land; wageswages [for their labor]; interestinterest [payment

for financial capital], and profitsprofits [for their entrepreneurial ability].

Rent Wages Interest ProfitsRent Wages Interest ProfitsLand Labor Capital EntrepreneurLand Labor Capital Entrepreneur

.

MY EXAMPLE

SCARCITY REQUIRES CHOICE ECONOMIST CALL THIS

OPPORTUNITY COST

• WHAT IS YOUR OPPORTUNITY FOR BEING IN THIS CLASS RIGHT NOW?

• OC- IS YOUR NEXT BEST ALTERNATIVE• THERE IS NO SUCH THING AS A FREE

LUNCH.• UNLESS IT IS A FREE GOOD—EXAMPLE

THE SUN-FREE DON’T HAVE TO GIVE UP ANYTHING TO GET IT.

SScarcitycarcity ChoicesChoices Opportunity CostsOpportunity Costs

OOpportunity pportunity BenefitBenefitOpportunity SetOpportunity Set[“what is possible for $10,000”][“what is possible for $10,000”]

OOpportunity Costpportunity Cost

Economic WayEconomic WayOf ThinkingOf ThinkingThere is one morehighway project &a lot less of manyother things.

High Five cost $261 millionHigh Five cost $261 millionA look at one of the tallest of the High 5 support structures

2 mil. Lbsof concrete,200,000 lbsof reinforcingsteel

Non-economic Non-economic Way Of ThinkingWay Of ThinkingThere is one more highway project and nothing less of anything else.

Cost twice as much as anyother state transport. project.500,000 cars dailyThey received $11 million$11 millionfor finishingfor finishing early early..

ACCOUNTANTS VS ECONOMIST

• ACCOUNTANTS=EXPLICIT COST ONLY

• EXPLICIT COST-THE SEEN COST

• ECONOMIST=EXPLICIT + IMPLICIT COST

• IMPLICIT COST =OPPORTUNITY COST

AN EXAMPLE OF ACCOUNTANT VERSUS ECONOMIST

• COST OF A LEMONADE STAND• SUGAR-$2 • WATER-$1• LEMONS-$5 • OTHER JOB YOU COULD HAVE WOULD PAY YOU $5• REVENUES=$10

• ACOUNTANT COST• =$8• ECONONOMIST COST• =$13

• ACCT WOULD SAY YOU MADE WHAT AMOUNT OF PROFIT?• $2 PROFIT• ECONOMIST WOULD SAY YOU LOST HOW MUCH?• $3

ANOTHER WAY OF SAYING IT

• ACOUNTANTS = ALL EXPLICIT COST

• (DON’T COUNT OPPORTUNITY COST)

• ECONOMIST=

• EXPLICIT +IMPLICIT

• OR EXPLICIT+ OPPORTUNITY COST

OC IS GRAPHED AS A PPC CURVE

• PPC CURVE- PRODUCTION POSSIBILITIES CURVE

• GUNS VERSUS BUTTER? WHATS THAT? YOU WILL SEE!

Production Possibilities Curve Production Possibilities Curve [PPC][PPC]

• Graphical representation of the opportunity costopportunity cost of using scarce resources to produce one good [or service] instead of another good [or service].

Consumer Good Consumer Good [iPods][iPods]

Cap

ital

Go

od

C

apit

al G

oo

d [R

ob

ots

][R

ob

ots

]

1010

44

77

55 66

33

..

1.1. SScarcitycarcity is represented by the frontier line.

2. ChoicesChoices - represented by pts A, B. or C.

3. Opportunity CostOpportunity Cost is illustrated in terms of moving from one point to another when resources are utilized to their full potential. [must make choices]

4. EfficiencyEfficiency - producing maximum output with available resources and technology. We can’t increase production of one good without decreasing that of another.

5. Economic growthEconomic growth occurs for one of two reasons. A. More resources [land, labor, or capital] become available.

B. Technology improves. [more outputs from same inputs]

5 PPC Concepts5 PPC Concepts

Q

QQ

Ro

bo

tsR

ob

ots

(th

ou

san

ds)

PizzasPizzas (hundred thousands)

14141313121211111010 99 88 77 66 55 44 33 22 11

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

AABB

CC

DD

EE

WW

AttainableAttainablebutbut

InefficientInefficient

UnattainableUnattainable

AAttainablettainable& & EEfficientfficient

PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES

PizzasPizzas

Ind

ust

rial

Ro

bo

tsIn

du

stri

al R

ob

ots

Attainable

0 1 2 3 4 5 6 7 8 9

1414

1313

1212

1111

1010

99

88

77

66

55

44

33

22

11

UnattainableUnattainable

AB

C

D

E

Economic GrowthEconomic Growth1.1. More/better More/better

resourcesresources2.2. Better technologyBetter technology

Now Attainable

A’A’

B’B’

C’C’

D’D’

E’E’

Production Possibilities CurveProduction Possibilities Curve

Q

Q

Ro

bo

tsR

ob

ots

(th

ou

san

ds)

PizzasPizzas (hundred thousands)

1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

UU

UUnemploymentnemployment & &

UUnderemployment nderemployment Shown by Point Shown by Point UU

More of either orMore of either orboth is possibleboth is possible

PRODUCTION POSSIBILITIESPRODUCTION POSSIBILITIES

More or better resources or better technologyMore or better resources or better technologyGGCCAAPPIITTAALL

GGOOOODDSS

40. At what letter is there unemploymentunemployment [recessionrecession]?41. What letters represent resources being used in their most productive mannermost productive manner? [full employment, full production, and best available technology]42. What letter represents an improvement in technologyimprovement in technology, therefore a new PPCnew PPC frontier line?43. The (straight line/curve) illustrates the “law of increasing“law of increasing cost”cost”??44. The (straight line/curve) illustrates the “law of constant cost.”“law of constant cost.”45. At what letter would there be the most economic growth inmost economic growth in thethe futurefuture if a country were producing there now?46. What is the opportunity costopportunity cost when moving from “C” to “D”;“C” to “D”; when moving fromwhen moving from EE to to B B; & do we have to give anything updo we have to give anything up when moving from F to DF to D?

FF

A,B,C,D,EA,B,C,D,E

GG

AACapitalCapital

ConsumerConsumernono

AABB

CC

DD

EE

FF

PPCPPCConsumer GoodsConsumer Goods

PPCPPC Practice Questions Practice Questions1. An economy that is fully employingfully employing all its productive resources but allocating less to investmentless to investment than than toto consumptionconsumption will be at which of the following positions on the PPC to the right? a. A b. B c. C d. D e. E

2. Which of the following best explains the shape of the PPC for the two-commoditytwo-commodity economy shown above? a. Opportunity cost of producing another unit of each stays the same. b. Opportunity cost of producing another unit of each decreasesdecreases. c. Opportunity cost of producing another unit of each increasesincreases.

3. Which of the following is true of the PPCtrue of the PPC on the right? a. Point Q is attainable but undesirable. b. Point R is unattainable but undesirable. c. A technological improvement of watches would move the economy from T to P. d. There is unemployment at point T because workers e. The opportunity cost of moving from S to T is the # of watches given up.

4. If we move from B to CB to C on the graph (right), the opportunity costopportunity cost is? a. AH units of good Y b. OG units of good Y c. EF units of good X d. HG units of good Y

BB

CC

AA

HH

GG

OO

PPCPPC PPracticeractice QQuestionsuestions [continued][continued]

5. Which of the following would cause the PPC shown (right) to shift outward? a. Reopening steel plants that had been closed b. Rehiring laid-off workers c. Using machinery for missile production instead of steel production d. Using machinery for steel production instead of missile production e. Developing a more efficient steelmaking process

6. Base on the graph (right), which statements are true? I. The opportunity cost of moving from P to R is 10 units of Y. II. The opportunity cost of moving from R to P is 8 units of X. III. The opportunity cost of moving from Q to R is 0 units. a. I only b. III only c. I & II only d. I, II, & III

SteelSteel

Mis

sile

sM

iss

iles

XX

(89%)(89%) 3. If two coats are currently being produced, the opportunity opportunity cost of producing the third coatcost of producing the third coat is a. 85 belts b. 75 belts c. 40 belts d. 15 belts e. 10 belts

(50%)(50%) 4. The best combination of belts and coatsbest combination of belts and coats for this for this economyeconomy to produce is a. 95 belts & 1 coat b. 85 belts & 2 coats c. 70 belts & 3 coats d. 40 belts & 4 coats e. indeterminate with the available information

0 1 2 3 4

1009585

40B

elts

Bel

ts

CoatsCoats

70PPCPPC

From the 2005 Macro MC Exam

BECAUSE OF SCARCITY SOCIETIES MUST CHOOSE A

SYSTEM TO ANSWER 3 QUESTIONS

• WHAT TO PRODUCE?

• HOW TO PRODUCE IT?

• FOR WHOM TO PRODUCE IT?

3 TYPES OF ECONOMIES

• TRADITIONAL ECONOMY- Traditions dictate what gets produced, who gets it and who will produce it.

• COMMAND ECONOMY-government dictate what gets produced, who gets it and who will produce it.

• MARKET ECONOMY- Supply and Demand. The market dictate what gets produced, who gets it and who will produce it.

The Circular Flow

The The Circular FlowCircular Flow is an abstract, is an abstract, oversimplified model, showing how oversimplified model, showing how economic transactions economic transactions [ [resourcesresources, , productsproducts (g/s), (g/s), and and moneymoney] take place.] take place.

Hog CIRCULAR FLOW MODELHog CIRCULAR FLOW MODEL

BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS

PRODUCT MARKETPRODUCT MARKET

Mechanic

RESOURCE MARKETRESOURCE MARKET11

22

33

44

Flow 4. Products Flow 4. Products [Goods/services][Goods/services]

Flow 3: CFlow 3: Consumer expendituresonsumer expenditures

Hog CIRCULAR FLOW Hog CIRCULAR FLOW MODELMODEL

BUSINESSESBUSINESSES HOUSEHOLDSHOUSEHOLDS

PRODUCT MARKETPRODUCT MARKET

Mechanic

RESOURCE MARKETRESOURCE MARKET11

22

33

44

Flow 4. Products Flow 4. Products [Goods/services][Goods/services]

Flow 3: CFlow 3: Consumer expendituresonsumer expenditures

Flow 1: Flow 1: LLand,and, L Labor, abor, CCapital, apital, EEntrepreneurntrepreneur

Flow 2: Flow 2: RRent, Wages, Interest, Profitsent, Wages, Interest, Profits

11

Product MarketProduct Market

BusinessesBusinessesBusinesses

The Circular-Flow The Circular-Flow DiagramDiagram

BusinessesBusinesses

Resource MarketResource Market

HouseholdsHouseholds

22

33LaborLabor

What flow are the following?What flow are the following?A. Consumer expenditures?A. Consumer expenditures?B. Goods and services?B. Goods and services?C. Land, labor, capital, C. Land, labor, capital, and entrepreneurs?and entrepreneurs?D. Rent, wages, interest, D. Rent, wages, interest, and profits?and profits?

221144

33

44

BusinessesBusinessesBusinesses

1

The Circular-Flow DiagramThe Circular-Flow Diagram

HouseholdsHouseholds

Product MarketProduct Market

Resource MarketResource Market

2

3

4

What flow are the following?What flow are the following?A. Goods/services?A. Goods/services?B. Consumer expenditures?B. Consumer expenditures?C. Land, labor, capital andC. Land, labor, capital and entrepreneurial ability?entrepreneurial ability?D.D. Rent, wages, interest, Rent, wages, interest, and profits?and profits? BusinessesBusinesses

443311

22

LaborLabor

NS 56-59NS 56-59

56. In the product marketproduct market (householders/businesses) are the demandersdemanders and (householders/businesses) are the supplierssuppliers.57. In the resource marketresource market (householders/businesses) are the demandersdemanders and (householders/businesses) are the supplierssuppliers.58. In the resource marketresource market, (householders/businesses) sell resourcessell resources to (householders/businesses).59. In the product marketproduct market, (householders/businesses) sellsell productsproducts [goods/services] to (householders/businesses).

Fuzzy WuzzyFuzzy Wuzzy

43

12

OuthouseOuthouse

NS 60-63NS 60-63

[ScarcityScarcity, choiceschoices, and opportunity costsopportunity costs are building blocks].33. The economizing problemeconomizing problem is deciding how to make the best use of (limited/unlimited) resources to satisfy (limited/unlimited) wants.34. Money is not considered an economic resourceMoney is not considered an economic resource because money (is/is not) productive. The process of accumulating accumulating capital goodscapital goods [toolstools, , machinerymachinery, , and factoriesfactories) is (depreciation/investment).35. Give examples of real capitalexamples of real capital. ________________________36. The payments for the 4 factors of production are:

37. The PPC illustrates the principle that if all resources of an economy are in use, more of one good can be producedmore of one good can be produced only if (more/less) of another good is produced.38. Give two reasons that could shift the PPC outward. __________________________________________________39. The opportunityopportunity (cost/benefit) is the 2nd best choice.

NS 33-39

Land Labor Capital EntrepreneurLand Labor Capital EntrepreneurRentRent WagesWages InterestInterest ProfitsProfits

Any tool, machine, or factoryAny tool, machine, or factory

More or better resources; better technologyMore or better resources; better technology

An example of Absolute and Comparative Advantage

Absolute and Comparative Advantage

• Hat 8 = 1 corn• 10 hrs for 1 cloth• 18hours to make both

• Mc• 15 hrs 1 corn• 12 hrs to make 1cloth• 27 hour

• Hat grow two corns16 hour for hat• MCcoys grow two cloths- 24 hours

COMPARATIVE AND ABSOLUTE ADVANTAGE DEFINITIONS

• Absolute advantage- you can just plain out produce some one else

• Hatfields had an AA in both corn and cloth.

• Comparative advantage- the one with the lowest opportunity cost decides what to produce-

I Can do 8 push-ups.

I Can do 42 push-ups, but I Can do 42 push-ups, but 102 if you play the Aggie 102 if you play the Aggie

Fight Song.Fight Song.

I have an I have an absolute advantageabsolute advantage in the production of push-ups.in the production of push-ups.

I can clean that I can clean that house in 4 hours.house in 4 hours.

I’m more efficient. I can do the I’m more efficient. I can do the same work in 3 hours so I have same work in 3 hours so I have an an absolute advantageabsolute advantage..

TTexas exas LLonghornonghorn TTexas exas Aggie Aggie

AN EXAMPLE OF COMPARATIVE AND ABSOLUTE ADVANTAGE

• ---------------Cars Tacos

• Usa 100 50

• Mexico 30 90

• Absolute advantage in cars-• usa• Absolute advantage in tacos-• mexico• Comparative advantage in cars-• USA• Comparatve tacos• MEXICO

PRACTIVE COMPARATIVE AND ABSOLUTE ADVANTAGE

• cars tacos

• Usa 2 4

• Mexico 4 12

• AA Cars• Mexico• AA Tacos• Mexico• CA Cars• USA• CA Tacos• Mexico• What does It cost USA to make 1 car?• 2 tacos• ‘ Mexico• 3 tacos• What does it cost USA to make 1 taco• ½ car• Mexico• 1/3 of a car

MORE PRACTICE• cars tacos

• Usa 4 20

• Mexico 10 40

• AA C• MEX• AAT• MEX• CAC• MEX• CAT• USA• What does It cost USA to make 1 car?• 5 TACOS• ‘ Mexico• 4 TACOS• What does it cost USA to make 1 taco• 1/5 CARS• ‘ Mexico• ¼ CARS• NEW INCENTIVE-IF YOU DON’T BRING YOUR PACKETS YOU GET A ZERO FOR THE DAY!!!!!!!!

Rule of Hours-everything opposite• cars tacos

• Usa 4hrs 20hrs

• Mexico 10hrs 40hrs

• AA C• usa• AAT

usa• CAC• usa• CAT• mexico• What does It cost USA to make 1 car?• 1/5 of a TACO• What does it cost Mexico to make 1 car? • 1/4 TACOS• What does it cost USA to make 1 taco• 5 CARS• ‘ Mexico• 4 CARS

22ndnd M Most ost MMissed issed QQuestion On uestion On 95 AP E95 AP Exam [26% correct]xam [26% correct]

Country Food Clothing DuckyDucky 20 hours 20 hours 50 hours50 hours

WuckyWucky 10 hours10 hours 20 hours20 hours

a. DuckyDucky has a comparative advantage in the production of both food and clothing. b. WuckyWucky has a comparative advantage in the production of both food and clothing.c. DuckyDucky has a comparative advantage in food production, & WWuckyucky has a comparative advantage in clothing production.d. DuckyDucky has a comparative advantage in clothing production, & WuckyWucky has a comparative advantage in food production.e. Neither country has a comparative advantage in the

production of either good.CountryCountry FoodFood ClothingClothingDucky 20 hrs 50 hrsDucky 20 hrs 50 hrs 1C = 2.5F; .4C = 1F 1C = 2.5F; .4C = 1FWucky 10 hrs 20 hrs Wucky 10 hrs 20 hrs 1C = 2F; .5C = 1F 1C = 2F; .5C = 1F

Terms of Trade might be 1C = 2.2FTerms of Trade might be 1C = 2.2F

DuckyDucky WuckyWucky

(59%)(59%) 8. EconEcon can produce either 2 tons of cocoa or 4 cars2 tons of cocoa or 4 cars with 10 units of labor. NomicsNomics can produce either 5 tons of cocoa or 25 cars5 tons of cocoa or 25 cars with 10 units of labor. Based on this information, which of the following is true. a. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cocoa. b. Econ has a comparative advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. c. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. d. Econ has a comparative disadvantage in the production of both goods. e. Neither country has a comparative advantage in the production of either good.

Answer: For Econ, 1 cocoa = 2 cars so, 1/2 cocoa = 1 car

For Nomics, 1 cocoa = 5 cars so, 1/5 cocoa = 1 car

costscosts

costscosts Econ has a lower op cost for cocoa, Econ has a lower op cost for cocoa, 2 cars v. 5 cars. 2 cars v. 5 cars. So Econ will produce cocoa.So Econ will produce cocoa.

Nomics has a lower op cost for cars, Nomics has a lower op cost for cars, 1/5 cocoa v. 1/2 cocoa. 1/5 cocoa v. 1/2 cocoa. So Nomics will produce cars.So Nomics will produce cars.

costscosts

costscosts

Ap test do

• ECO-16,1a,1b,1c,• OC 46, 31a, 16b, 39c,• PPC-16a, 17a, 46a,17b,32b,46b,13c,26c• ABSOLUTE AND COMPARATIVE- 1,31B, 38C,• ESSAY 19E-2 • 31 b and 38c

• Macro-Essay 14E-3 and 16e-3, 18e-2

• 31b

• Food clothing

• G 10=.90 9-1.11

• O 5-.60 3-1.9

but, but, a a lot lot of of people people gain gain a little. a little.

With trade, a few people lose a lot, With trade, a few people lose a lot,

Free trade is like improved technologyFree trade is like improved technology[There [There areare some job some job losses, butlosses, but many many more more job job gains]gains]

[Their jobs][Their jobs]

[Lower prices & more [Lower prices & more choices]choices]

Haiti’s DCCHaiti’s DCC Cuba’s DCCCuba’s DCC1B1B = __ C = __ C 1B = __ 1B = __ CC__ B = __ B = 1C1C __ B = __ B = 1C1C

ComparativeComparative and and AbsoluteAbsolute Advantage Advantage[CComparative omparative AAdvantagedvantage can produce at a lower productive opportunity can produce at a lower productive opportunity

costcost]]

44 661/41/4 1/61/6

100100

1818

“Do what you do best & trade for the rest.”

Absolute AdvantageAbsolute Advantage - more efficient, can produce more with the same number of inputs [who can produce absolutely more]

““ExportExport”” what it can what it can produceproduce at a at a lower relative pricelower relative price and ““importimport”” goods it can goods it can buybuy at a at a lower relative pricelower relative price..

1. (Haiti/Cuba) has an absolute advantage in coffeeabsolute advantage in coffee and (Haiti/Cuba) has an absolute advantage in bread.absolute advantage in bread.2. HaitiHaiti will exportexport (bread/coffee) [[comparative advantagecomparative advantage]] & importimport (bread/coffee). [[comparative disadvantagecomparative disadvantage]] & Cuba Cuba will exportexport (bread/coffee) & importimport (bread/coffee).3. Advantageous tradeAdvantageous trade can occur between Haiti & Cuba when 1 bread1 bread is exchanged for (3/5/7) tons of coffeetons of coffee. Production in both reflects (increasing/constant) opportunity costs.

““Trade is the free lunch of economics.”Trade is the free lunch of economics.”

TermsTerms of of TradeTrade1 1 breadbread = __ = __coffeescoffees

World CCWorld CC11 BreadBread=__ Coffees=__ Coffees

__ Bread=1 Coffee__ Bread=1 Coffee55

55

1/51/5

8080

oo 2020

9090

00 1515

HaitiHaiti CubaCuba

“A prisoner of my own PPC.”

BreadBread BreadBread

Coff

ee

Coff

ee

Coff

ee

Coff

ee

““I can consume I can consume only on my PPC.”only on my PPC.”

4040

1010

4545

7.57.5

5050

99

costscosts costscosts

costscosts costscosts

XX 5 5

X X 1/51/5

PPC is still herePPC is still hereBut CPC is out hereBut CPC is out here

Brazil’s DCCBrazil’s DCC Chile’s DCCChile’s DCC1 W = __ S 1 W = __ S___W = 1S ___W = 1S

4. ChileChile has a comparative advantagecomparative advantage in (wheat/steel) & an absolute advantageabsolute advantage in (wheat/steel/both). BrazilBrazil has a comparative advantagecomparative advantage in (wheat/steel).

5. The opportunity cost of one unit of wheat for Chileopportunity cost of one unit of wheat for Chile is (2/4/6) units of steel. The opportunity cost of one unit of steel for Brazilopportunity cost of one unit of steel for Brazil is (1/2 or ¼ ) wheat.

6. If trade occurred, ChileChile would exportexport (wheat/steel) & import (wheat/steel). BrazilBrazil would exportexport (wheat/steel) & import (wheat/steel).

44 22¼¼ ½½

3030

44

Terms of TradeTerms of Trade1 1 WWheatheat== ___ ___ SteelsSteels33

World CCWorld CC1 1 Wheat Wheat == __ __ SteelsSteels

__ __ Wheat = Wheat = 11 Steel Steel1/3 1/3 33

1212

00 33

2020

00 1010

BrazilBrazil ChileChile

Ste

el

Ste

el

Ste

el

Ste

el

WheatWheat WheatWheat

66

1.51.5

1010

55

1515

22

costscosts costscosts

DCC DCC for for U.S.U.S. DCC DCC for for BrazilBrazil1 H = __ B 1 H = __ B___H = 1B ___ H = 1B

8. Brazil has a comparative advantageBrazil has a comparative advantage in (bread/ham) and a comparative disadvantagecomparative disadvantage in (bread/ham).9. The opportunity cost of producing 1 unit of ham opportunity cost of producing 1 unit of ham for thefor the U.S. U.S. is (10/12/14) breads. 10. Acceptable terms of tradeterms of trade might be 1 ham for (8/12/16) breads.

14141/141/14 1/101/10

7070

00 55

4040

4400HamHam HamHam

Bre

ad

Bre

ad

Bre

ad

Bre

ad

Terms of TradeTerms of Trade1 1 Ham =Ham = __ __ BreadBread

1010

1212

BrazilBrazilcostscosts costscosts

FroggyFroggy AA BB CC DD EE DCC: FroggyDCC: Froggy WoggyWoggy AA BB CC DD EE DCC: WoggyDCC: WoggyPorkPork(tons) 4 3 2 1 0 1P = __ B PorkPork(tons) 8 6 4 2 0 1P = __ B BeansBeans(tons) 0 5 10 15 20 __ P = 1B BeansBeans(tons) 0 6 12 18 24 __ P = 1B

Terms of TradeTerms of Trade1 1 Pork Pork == __ __ BeansBeans

15. Production in both countries is subject to (increasing/constant) opportunity costopportunity cost.

16. If these 2 nations specialize in accordance with comparative advantagecomparative advantage, FroggyFroggy will produce (pork/beans) & WoggyWoggy will produce (pork/beans).

17. In FroggyFroggy, the opportunity cost of 1 pork1 pork is (1/5 or 5 or 3) beans’

18. Assume that prior to specialization & trade, Froggy produced combo “C”Froggy produced combo “C” and Woggy produced “B”Woggy produced “B”. If these 2 nations now specialize according to comparativecomparative advantageadvantage, the total gainstotal gains will be (4/2/0) tons of beans & (4/2/0) ton(s) of pork.

19. Feasible terms of tradeterms of trade would be (1/6/4) ton of porkpork for (1/6/4) tons of beansbeans.

551/51/5

331/31/3

44

2.52.5 pork [10x1/4]pork [10x1/4]

88 beansbeans [2x4] [2x4]

After: After: 8 porks8 porks 88 – 8 = – 8 = 0 porks0 porks

Before: Before: 10 beans10 beans 6 beans6 beans 16 beans16 beans

Before: Before: 2 porks2 porks 6 porks6 porks 8 porks8 porks

After: After: 20 beans20 beans 1010 – 16 = – 16 = 4 beans4 beans

PiggyPiggy AA BB CC DD EE DCC: PiggyDCC: Piggy WiggyWiggy AA BB CC DD EE DCC: WiggyDCC: WiggyFish 80 60 40 20 0 1C = __ F Fish 240 180 120 60 0 1C = __FChips 0 5 10 15 20 __ C = 1F Chips 0 10 20 30 40 __ C = 1F

Terms of TradeTerms of Trade

1 Chip = __ Fish1 Chip = __ Fish

20. (Piggy/Wiggy) has an absolute advantage in bothabsolute advantage in both fish & chips.fish & chips..21. For WiggyWiggy, the opportunity cost of producing 1 ton of chipsopportunity cost of producing 1 ton of chips is (1/4/6) tons of fish.

22. WiggyWiggy should specialize should specialize (export) in (fish/chips) and importimport (fish/chips).

23. Before specialization and trade PiggyPiggy chose combochose combo “C”“C” and Wiggy chose “B”Wiggy chose “B”. After specialization, the gains from tradegains from trade were (20/40/60) tons of fishtons of fish and (0/10/20) tons of chipstons of chips.

441/41/4

661/61/6

55

5050 Fish [10x5] Fish [10x5]

1212 chipschips [60x1/5] [60x1/5]Before: Before: 40 fish40 fish 180 fish180 fish 220 fish220 fish After: After: 240 fish240 fish 240240 – 220 = – 220 = 20 fish20 fish

Before: Before: 10 chips10 chips 10 chips10 chips 20 chips20 chips

After: After: 20 chips20 chips 2020 – 20 = – 20 = 0 chips0 chips

24. If trade occurs, DoggyDoggy will exportexport (soup/peanuts) and import import (soup/peanuts).

WoggyWoggy will exportexport (soup/peanuts) and importimport (soup/peanuts). 25. For DoggyDoggy, the opportunity cost of 1 soupopportunity cost of 1 soup is (1/2/3) peanuts. For WoggyWoggy, the opportunity cost of 1 soupopportunity cost of 1 soup is (1/2/3) peanuts.

26. Prior to specialization, Doggy & Woggy chose combination “C”.Doggy & Woggy chose combination “C”. Now each specializes according to comparative advantagecomparative advantage. The gainsgains from tradefrom trade will be (0/20/40) units of soupsoup & (0/20/40) units of peanutspeanuts.

DoggyDoggy AA BB CC D D EE DCC: DoggyDCC: Doggy WoggyWoggy A B C D E DCC: WoggyDCC: WoggySoup 60 45 30 15 0 1S = __ P Soup 20 15 10 5 0 1S = __ PPeanuts 0 15 30 45 60 Peanuts 0 15 30 45 60 __ S = 1P

11 331/31/3

Terms of TradeTerms of Trade 1 1 Soup =Soup = __ __ PeanutsPeanuts22

6060 Peanuts [30x2] Peanuts [30x2]

1515 soups [30x1/2] soups [30x1/2]

Before: Before: 30 soups30 soups 10 soups10 soups 40 soups40 soups

After: After: 60 soups60 soups 6060 – 40 = – 40 = 20 soups20 soups

Before: Before: 30 peanuts30 peanuts 30 peanuts30 peanuts 60 peanuts60 peanuts

After: After: 60 peanuts60 peanuts 6060 – 60 = – 60 = 0 peanuts0 peanuts

FuzzyFuzzy A A BB C C D D EE FF DCC: DCC: FuzzyFuzzy WuzzyWuzzy AA B B CC DD EE FF DCCDCC:: Wuzzy WuzzyPlumsPlums 1500 1200 900 600 300 01500 1200 900 600 300 0 1G = __ P PlumsPlums 3500 2500 1500 1000 500 03500 2500 1500 1000 500 0 1G = __ PGrapesGrapes 0 100 0 100 200 300 400 500200 300 400 500 __ G= 1P GrapesGrapes 0 150 300 450 575 7000 150 300 450 575 700__ G = 1P

Terms of TradeTerms of Trade

1 1 Grape = __ PlumsGrape = __ Plums

1/31/3 55

1/51/5 1P1P

CC900900200200

BB25002500 150150

11. In WuzzyWuzzy, the opportunity cost of 1 grapeopportunity cost of 1 grape is (1/2/3/4/5) plums.

12. Fuzzy Fuzzy has a comparative advantagecomparative advantage in & should produce (plums/grapes).

13. The terms of tradeterms of trade will be 1 grape 1 grape for somewhere between (3&5/2&6) plums.

14. Assume that if Fuzzy did not specialize it would produceFuzzy did not specialize it would produce combo “combo “CC” ” and ifand if Wuzzy Wuzzy did not specialize it would produce combo “did not specialize it would produce combo “BB””. The gainsgains from from specializationspecialization and tradeand trade are: (0/100/150) plums and (0/100/150) grapes.

44

331G1G 35003500

The countries of:The countries of:

““Fuzzy”Fuzzy” andand “Wuzzy”“Wuzzy”

500500Before: Before: 900 plums900 plums 2500 plums2500 plums 3400 plums3400 plums

Before: Before: 200 grapes200 grapes 150 grapes150 grapes 350 grapes350 grapes

After: After: 3500 plums3500 plums35003500 – 3400 = – 3400 = 100 plums100 plums

After: After: 500 grapes500 grapes500 500 – 350 = – 350 = 150 grapes150 grapes

27. (Djibouti/Canada) has an absolute advantage in bothabsolute advantage in both commodities.

(Djibouti/Canada) has a comparative advantagecomparative advantage in in producing wheatproducing wheat.28. (Djibouti/Canada) has an absolute disadvantage in bothabsolute disadvantage in both, but a comparative advantage in fishcomparative advantage in fish.29. Advantageous tradeAdvantageous trade can occur between the two when 1 wheat is exchanged1 wheat is exchanged for (1/2.5/3) fish.

DjiboutiDjibouti DCCDCC: Djibouti: Djibouti CanadaCanada DCCDCC: : CanadaCanadaFishFish 10 hours 1W = __F 10 hours 1W = __F Fish Fish 20 hours 1 W = __ F 20 hours 1 W = __ FWheat 20 hours ___ W=1FWheat 20 hours ___ W=1F W Wheaheat t 60 hours ___W = 1F60 hours ___W = 1F

Terms of Trade:Terms of Trade: 1 1 Wheat Wheat == __ __ FishFish

221/21/2

331/31/3

22..55

We are going togoing to turn inputs into outputsturn inputs into outputs.In 20 hours20 hours, DjiboutiDjibouti can produce an outputoutput of of 1 wheat1 wheat or or 2 fish2 fish.In 60 hours60 hours, CanadaCanada can produce an output of 1 wheatoutput of 1 wheat or or 3 fish3 fish.

costscosts costscosts

[lower # of hours gives absolute advantage] DCC: U.S.DCC: U.S. Russia Russia DCC:DCC: R RussiaussiaCaviar 6 hours 1C = __W Caviar 16 hours 1C = __ WWheat 3 hours __ C = 1W Wheat 4 hours __ C = 1W

30. (Russia/U.S.) has an absolute disadvantageabsolute disadvantage in bothin both commodities commodities. (Russia/U.S.) has a comparative advantage in wheatcomparative advantage in wheat.31. (Russia/U.S) has an absolute advantage in both commoditiesabsolute advantage in both commodities. (Russia/U.S.) has a comparative advantage in caviarcomparative advantage in caviar.31. Advantageous tradeAdvantageous trade can occur between the two nations when 1 caviar is exchanged1 caviar is exchanged for (1/3/5) tons of wheattons of wheat.

221/21/2

441/41/4

Terms of TradeTerms of Trade 1 1 Caviar Caviar = __ = __ WheatsWheats33

We are once again turning inputs into outputsturning inputs into outputs.In 6 hours6 hours, the the U.S.A.U.S.A. can produce an outputoutput of of 1 1 caviarcaviar or 2 or 2 wheatswheats.

In 16 16 hourshours, RRussiaussia can produce an outputoutput of of 1 caviar1 caviar or or 4 wheats4 wheats.

And with inputsinputs (hourshours), the smaller numbersmaller number indicates absoluteabsolute advantageadvantage; that country is more efficientmore efficient because it can produce a good absolutelyabsolutely fasterfaster than the otherthan the other with the same inputs.

Absolute AdvantageAbsolute Advantage [[OutputsOutputs v.v. InputsInputs]]

Remember that with outputsoutputs or quantityquantity, the larger larger numbernumber indicates absolute advantageabsolute advantage; that country can produce absolutelyabsolutely moremore with the same inputs, and is more efficientmore efficient.

ProductProductMarketMarket

ResourceResourceMarketMarket

22ndnd M Most ost MMissed issed QQuestion On uestion On 95 AP E95 AP Exam [26% correct]xam [26% correct]

Country Food Clothing DuckyDucky 20 hours 20 hours 50 hours50 hours

WuckyWucky 10 hours10 hours 20 hours20 hours

a. DuckyDucky has a comparative advantage in the production of both food and clothing. b. WuckyWucky has a comparative advantage in the production of both food and clothing.c. DuckyDucky has a comparative advantage in food production, & WWuckyucky has a comparative advantage in clothing production.d. DuckyDucky has a comparative advantage in clothing production, & WuckyWucky has a comparative advantage in food production.e. Neither country has a comparative advantage in the

production of either good.CountryCountry FoodFood ClothingClothingDucky 20 hrs 50 hrsDucky 20 hrs 50 hrs 1C = 2.5F; .4C = 1F 1C = 2.5F; .4C = 1FWucky 10 hrs 20 hrs Wucky 10 hrs 20 hrs 1C = 2F; .5C = 1F 1C = 2F; .5C = 1F

Terms of Trade might be 1C = 2.2FTerms of Trade might be 1C = 2.2F

DuckyDucky WuckyWucky

(59%)(59%) 8. EconEcon can produce either 2 tons of cocoa or 4 cars2 tons of cocoa or 4 cars with 10 units of labor. NomicsNomics can produce either 5 tons of cocoa or 25 cars5 tons of cocoa or 25 cars with 10 units of labor. Based on this information, which of the following is true. a. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cocoa. b. Econ has a comparative advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. c. Econ has an absolute advantage in the production of cocoa, while Nomics has a comparative advantage in the production of cars. d. Econ has a comparative disadvantage in the production of both goods. e. Neither country has a comparative advantage in the production of either good.

Answer: For Econ, 1 cocoa = 2 cars so, 1/2 cocoa = 1 car

For Nomics, 1 cocoa = 5 cars so, 1/5 cocoa = 1 car

costscosts

costscosts Econ has a lower op cost for cocoa, Econ has a lower op cost for cocoa, 2 cars v. 5 cars. 2 cars v. 5 cars. So Econ will produce cocoa.So Econ will produce cocoa.

Nomics has a lower op cost for cars, Nomics has a lower op cost for cars, 1/5 cocoa v. 1/2 cocoa. 1/5 cocoa v. 1/2 cocoa. So Nomics will produce cars.So Nomics will produce cars.

costscosts

costscosts

Product Market Product Market [outputs][outputs]

CountryCountry GunsGuns ButterButterRabbit Rabbit 40 40 unitsunits 120120 units units

WabbitWabbit 20 20 unitsunits 4040 units units

Resource MarketResource Market [inputs] [inputs]

CountryCountry GunsGuns ButterButterRabbit Rabbit 4040 hours hours 120120 hours hours

WabbitWabbit 2020 hours hours 4040 hours hours

WWhathat country has ancountry has an absolute absoluteadvantage inadvantage in gunsguns??

WWhat country has anhat country has an absolute absoluteadvantage inadvantage in gunsguns??RabbitRabbit WabbitWabbit

Why doesWhy does RabbitRabbit have an have an absolute advantageabsolute advantage in in gunsguns??

Why doesWhy does WabbitWabbit have an have an absolute advantageabsolute advantage in in gunsguns??

RabbitRabbit can producecan produce absolutelyabsolutelymore gunsmore guns thanthan WabbitWabbit [[40 units40 units v.v. 20 units20 units]]

Wabbit Wabbit can can produce guns produce guns absolutely fasterabsolutely faster thanthan RabbitRabbit [[20 hours v. 4020 hours v. 40 hourshours]]

RabbitRabbit

WWhat country has ahat country has a comparativecomparativeadvantage inadvantage in gunsguns??

WWhat country has ahat country has a comparativecomparativeadvantage inadvantage in gunsguns??WabbitWabbit RabbitRabbit

WabbitWabbit can produce guns at a lowercan produce guns at a loweropportunityopportunity costcost [[2 butters2 butters v.v. 3 butters3 butters]]

RabbitRabbit can can produce guns at a lowerproduce guns at a loweropportunityopportunity costcost [[1/3 butter1/3 butter v. v. 1/2 butter1/2 butter]]

RabbitRabbit1 G1 G = = 3 B3 B1/31/3 GG==1B1B

WabbitWabbit1 G1 G = = 2 B2 B1/21/2 GG==1B1B

RabbitRabbit1 B1 B = = 3 G3 G1/31/3 BB==1G1G

WabbitWabbit1 B1 B = = 2 G2 G1/21/2 BB==1G1GWabbitWabbit RabbitRabbit WabbitWabbit

““Let’s change Let’s change inputsinputs into into outputsoutputs.”.”

Terms of Trade: 1G = 2.5 BTerms of Trade: 1G = 2.5 B Terms of Trade: 1B = 2.5 GTerms of Trade: 1B = 2.5 G

OutputOutput v. v. InputInput Comparative Comparative andand Absolute Advantage Absolute Advantage