PPTSpecializationTradeUsingthePPFModel-1.pptx

trade

1. Specialization & Trade

2. Specialization & Trade Return to Tom the castaway Tom can produce 4 fish or 3 coconuts per hour Suppose he discovers another castaway on the island, Hank Hank can produce 1 fish or 4 coconuts per hour Initially Each is working alone and splitting their 10 hrs equally Resulting daily production and consumption bundles for each

3. Absolute Advantage Would they be better off working independently or specializing in one good and trading with each other? Absolute Advantage : Being able to produce more with the same amount of resources. Tom has the absolute advantage in fish Hank has the absolute advantage in coconuts Suppose each specializes according to their AA and then exchange half of their output with each other

4. Measuring the Gains From Trade Is cooperation and interdependence superior to self-sufficiency?

5. Gains from Trade The benefits of trade Allows each to consume beyond their PPF As if economic growth had occurred even without additional resources!

6. The Plot Thickens… Hank sprains his ankle Now only able to gather 1 fish or 2 coconuts per hour Hank no longer has an absolute advantage in either activity Tom is now reluctant to trade and insists they each fend for themselves Initially Tom produces 28 fish Hank produces 6 fish

7. Comparative Advantage Hank pleads with Tom Suggests they can still both benefit from trading Rather than focusing on what each is best at, they should specialize in doing the activity which they are least bad at and then trade Need to examine the opportunity cost of each good for each person Each day Tom can gather 40 fish or 30 coconuts Each day Hank can gather 10 fish or 20 coconuts OC of one Fish OC of one Coconut Tom Hank

8. Comparative Advantage Comparative Advantage : The person who has the lower opportunity cost of producing a good is said to have the comparative advantage in producing that good Whoever gives up less of good B in order to obtain one unit of good A, is said to have the comparative advantage in producing good A Tom has the comparative advantage in producing fish Hank has the comparative advantage in producing coconuts Everyone will have a comparative advantage in something

9. Measuring the Gains From Trade Tom specializes in fish, Hank specializes in coconuts They come together and trade 10 fish for 10 coconuts Is this still a mutually beneficial arrangement?

10. Comparative Advantage & Trade

11. Determining The Terms of Trade What determines the “price” Tom and Hank trade at? Based off of each person’s opportunity cost On his own, Tom must give up 1.33 fish for every coconut Willing to accept any trade for less than 1.33 fish per coconut as it offers a cheaper price than “trading” with himself for a coconut Hank must give up 2 coconuts for every fish Should refuse to trade if Tom tried to charge more than 2 coconuts per fish since he can do better on his own by “trading” with himself In order for it to benefit each person the price must be between: ½ to 4/3 fish per coconut or ¾ to 2/1 coconuts per fish 0.5 – 1.33 fish per coconut or 0.75 – 2.0 coconuts per fish