Download Weekly Lecture : Week 01

2016-2017 EOC101 Economics
Weekly Lecture: Week 01
Chaps 1, 2 & 3 – Getting Started, The U.S. and
Global Economies & The Economic Problem
Chapter 1 Getting Started
CHAPTER ROADMAP
■ What’s New in this Edition?
The chapter has been slightly revised from the previous edition. “Can the Pursuit of
Self-Interest Be in the Social Interest?” has been renamed and now includes an
introduction to Adam Smith and the invisible hand. “Government Budget Deficits
and Debt” is a renamed subheading. The six Economic Ideas have been reorganized
and the section on Rational Choice has been significantly rewritten. Several other
sections have been slightly rewritten and updated, but there are no major content
changes.
■ Where We Are
In Chapter 1, we review definitions and address questions that economics helps
answer. We also discuss how people make rational choices and preview the fact that
these are the choices that individuals and firms make everyday.
■ Where We’re Going
After laying out the basic ideas of economics in this chapter, and some basic facts
about the economy in the next, in Chapter 3 we’ll start building tools and models
that help us understand how the economy works. These tools and models, such as
the production possibilities frontier and the demand and supply framework, provide
valuable insight into how the economy that we operate in each day works.
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CHAPTER LECTURE
1.1
Definition and Questions
Scarcity

Economic questions arise because we always want more than we can get, so
we face scarcity, the inability to satisfy all our wants. Everyone faces scarcity
because no one can satisfy all of his or her wants.
Economics Defined

Economics is the social science that studies the choices that individuals,
businesses, governments and entire societies make when they cope with
scarcity, the incentives that influence those choices, and the arrangements that
coordinate them.

Microeconomics is the study of the choices that individuals and
businesses make and the way these choices interact and are influenced by
governments.

Macroeconomics is the study of the aggregate (total) effects on the
national economy and the global economy of the choices that individuals,
businesses, and governments make.
What, How, and For Whom?

Goods and services are the objects (goods) and actions (services) that people
value and produce to satisfy human wants.

Societies must answer three very basic questions:
 What?: What determines the quantities of the goods and services
produced?


How?: How are goods and services produced?
For Whom?: For whom are goods and services produced?
Can the Pursuit of Self-Interest Be in the Social Interest?

People make choices they are think are best for them, that is, choices in their
self-interest.

Choices that are the best for society as a whole are said to be in the social
interest.

A major question economists explore is “Could it be possible that when each
of us makes choices in our self-interest, these choices are in the social
interest?”
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
We can examine whether the self-interested choices serve the social interest
for a variety topics:

Globalization: The acceleration of economic growth in the last two
decades has made economic decision-making more complex as
multinational concerns must be taken into account. Rational business
decisions which bring a wider variety of lower-price choice to consumers
may have negative side-effects on some producers.

The ”information age”: The Information Revolution, an economic
restructuring comparable to the Agricultural Revolution and the Industrial
Revolution, has brought about new questions of social interest. Was the
development of computers and of the Windows operating system by
Microsoft in the social interest?

Climate change: Climatologists agree that global warming is at least in
part the result of economic activity. The warming may lead to large
economic costs. How can individuals and nations satisfy their
self-interested desire for goods and services while also protecting the
social-interest of the environment?

Government Budget Deficit and Debt: The U.S. government has been
running a budget deficit every year since 2001. In approximately 2020 the
deficit will come under increasing pressure because in that year payments
for retirement and health-care entitlements will exceed tax revenue for
those programs. Do our self-interested choices as voters conflict with the
social interest? Do choices made by politicians and bureaucrats promote
the social interest or only their self-interests?
1.2
The Economic Way of Thinking
Economic Ideas

Six core ideas describe the economic way of thinking:
 A choice is a tradeoff.
 Cost is what must be given up to get something.




Benefit is what you gain from something.
People make rational choices by comparing costs and benefits.
Most choices are “how much” choices made at the margin.
Choices respond to incentives.
A Choice Is a Tradeoff

Because we face scarcity, we must make choices and select from the available
alternatives. A tradeoff is an exchange – giving up one thing to get something
else.
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Cost: What You Must Give Up

The opportunity cost of something is the best thing you must give up to get
it.

Choices have an opportunity costs; for example, the opportunity cost of
attending college include goods and services forgone from paying for tuition
and textbooks, and the goods and services forgone because the student does
not have the income from a full-time job.
Benefit: What You Gain

The benefit of something is the gain or pleasure it brings and is determined by
personal preferences – by what a person likes and dislikes and the intensity of
those feelings. Economists measure the benefit of something by what a person
is willing to give up to get it.
Rational Choice

A rational choice is one that uses the available resources to most effectively
satisfy the wants of the person making the choice. Rational choices compare
costs and benefits in order to maximize net benefit. Choices are made on the
margin and respond to incentives. Some choices are all-or-nothing choices
between two things, while most choices involve how much of an activity to do.
How Much? Choosing at the Margin

Making choices at the margin means comparing all the relevant alternatives
systematically and incrementally.

People make choices at the margin by comparing the benefit from a one-unit
change in an activity (which is the marginal benefit) to the cost of making a
one-unit change in an activity (which is the marginal cost).

If the marginal benefit of an action exceeds the marginal cost of the action,
then the rational choice is to take the action.
Choices Respond to Incentives

An incentive is a reward that encourages an action or a penalty that
discourages an action.

Changes in marginal benefits and marginal costs alter the incentives that we
face when making choices. When incentives change, people’s decisions
change. For example, if homework assignments are weighed more heavily in a
class’s final grade, the marginal benefit of completing homework assignments
has increased and more students will do the homework.
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Economics as Social Science

Economists try to understand and predict the effects of economic forces by
using the scientific method – a commonsense way of systematically checking
what works and what doesn’t work.

An economist begins with a question or a puzzle about cause and effect
arising from some observed facts.

An economist’s second step is to build an economic model, a description
of some feature of the economic world that includes only those features
assumed necessary to explain the observed facts.

The third step is to check the economic model against the facts by
using:

A natural experiment: a situation that arises in the ordinary
course of economic life in which the one factor of interest is
different and other things are equal (or similar).

A statistical investigation: looking for a correlation – a
tendency for the values of two variables to move together in a
predictable and related way.
An economic experiment: puts people in a decision-making
situation and varies the influence of one factor at a time to
discover how they respond.
Economists sometimes disagree about assumptions, models,


and policies. Disagreements that can’t be settled by facts are
normative statements, statements about “what ought to be,”
which are opinions and so are inherently not testable.
Disagreements that can be settled by facts are positive
statements, statements about “what is” and are testable. A
positive statement is “Raising the tax on a gallon of gasoline
will raise the price of gasoline and lead more people to buy
smaller cars” while a normative statement is “The tax on
gasoline should be raised.”

Correlation: Correlation is a tendency for the values of
two variables to move together (either in the same direction or
in opposite directions) in a predictable and related way.
Correlation versus causation is an issue of logic that can
represent a real challenge to students’ intuition. There is a
natural human tendency to conclude that when two variables
move together, or against one another, that there is causation.
There is a difference between correlation and causation.
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Suppose economists found that there is a positive correlation
between the level of education and worker health. We might
conclude that the increase in education is the cause of the
better health. But perhaps the higher income that workers
enjoy as the result of their higher education allows them to
purchase more health care. Or it could be that there are other
intervening variables at work. Perhaps education and health
move together because of characteristics that the two have in
common. That is, it might be possible that talent, motivation,
and work ethic, which help many people enjoy good health,
are the same characteristics that help the same people earn a
higher income.
Economics As Policy Tool


Economics is a tool which helps us make an endless array of decisions.
Personal Economic Policy involves decisions about an individual’s need for
shelter, transportation, and time management.

Business Economic Policy involves decisions made at the margin to
accomplish a business’s goals such as increasing sales, opening a new branch,
or gaining market share.

Government Economic Policy is perhaps the most controversial of the three
types of economic policy. How should goals such as better education, military
preparedness, and safe food be balanced against limited tax revenue and the
desire of individual members of government to be reelected?
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Chapter 1 Appendix: Making and Using Graphs
CHAPTER ROADMAP
■ What’s New in this Edition?
The appendix is an updated version of the appendix in the sixth edition.
■ Where We Are
The appendix to Chapter 1 is a thorough review of the mathematics and geometry
used in the text. There are no economic concepts introduced in it, only
mathematical concepts.
■ Where We’ve Been
Chapter 1 introduced economics and presented information about important topics
in the course.
■ Where We’re Going
Chapter 2 continues presenting background economic material. Chapter 2 uses
none of the mathematical concepts covered in this appendix. However, starting in
Chapter 3, which presents the production possibilities frontier, most of the
remaining chapters use various parts of the review in this appendix.
CHAPTER LECTURE
Making and Using Graphs
Basic Idea

A graph presents a quantity as a distance. The vertical axis is the y-axis and
horizontal axis is the x-axis. The vertical line is the y-axis and the horizontal
line is the x-axis. Where they meet is the origin.
Interpreting Data Graphs

A scatter diagram graphs the value of one variable against the value of
another variable.

A time-series graph measures time on the x-axis and the variable or
variables of interest on the y-axis.
 A time-series graph shows whether a variable has a trend, the general
tendency for the value of the variable to rise or fall.

A cross-section graph shows the values of an economic variable for
different groups in a population at a point in time.
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Interpreting Graphs Used in Economic Models


When two variables move in the
same direction, they have a positive,
or direct relationship, as illustrated
in the figure.

A linear relationship is a special
case of a positive relationship in
which the function is graphed as a
straight line.
When two variables move in
opposite directions, they have a
negative, or inverse relationship, as
illustrated in the figure.

Some variables have a relationship
in which there is a maximum or a
minimum point.

When two variables are unrelated,
their graph is either a vertical or a
horizontal line.
The Slope of a Relationship
The slope of a relationship equals the change in the value of the variable measured on
the y-axis divided by the change in the value of the variable measured on the x-axis or,
in terms of a formula, the slope equals y  x.
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
The slope of a straight line is the
same at any point on the line.

The slope of a curved line at a point
equals the slope of a straight line
drawn so that it touches the curved
line at only that point. In the figure,
the slope of the curve at point A
equals the slope of the straight line
that is touching the curve at only
point A.
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Chapter 2 The U.S. and Global Economies
CHAPTER ROADMAP
█ What’s New in this Edition?
Chapter 2 contains updated data, rewritten Eye On sections, and reorganized and
rewritten content. The four groups of goods and services produced has been
consolidated into just consumption goods and services and capital goods and the
first two Eye On sections in 2.1 have been refocused and rewritten. The BRICS are
now identified, the How in the Global Economy has been heavily streamlined, the
Eye on the Dreamliner has replaced the iPhone example, and a new Eye on the
Global Economy has been added in 2.2. Coverage of government expenditures and
revenue has been heavily streamlined.
█ Where We Are
In Chapter 2, we describe what, how, and for whom goods and services are
produced in the United States. Then we examine these same three questions in the
global economy. Finally we use the circular flow model to provide a picture of how
households and firms interact. We also describe the economic activities of
governments in the United States.
█ Where We’ve Been
In the previous chapter, we covered the definition of economics and distinguished
between microeconomics and macroeconomics. We described what economists do
and some of the problems they encounter. In addition, we explored the four core
ideas that define the way economists think about macroeconomic questions. Finally,
we explained why economics is worth studying.
█ Where We’re Going
In the next chapter, we develop our first economic model, the production
possibilities frontier. We use the model to illustrate some of the concepts that have
been developed in Chapters 1 and 2, such as the “what” question, the “how”
question, and opportunity cost.
CHAPTER LECTURE
2.1
What, How, and For Whom?
What Do We Produce?
Goods and services produced are divided into two categories:
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 Consumption goods and services are items that are bought by individuals and
governments and are used up in the current period. Consumption goods and
services account for about 85 percent of total production.
 Capital goods are goods that are bought by businesses and governments to
increase their productive resources to use over future periods to produce other
goods and services. Capital goods account for about 15 percent of total
production.
How Do We Produce?
Goods and services are produced using four factors of production: land, labor,
capital, and entrepreneurship.
 Land is the “gifts of nature” or natural resources, which includes not only land
in the everyday sense but also minerals, energy, water, air, wild plants,
animals, birds and fish.
 Labor is the work time and work effort that people devote to producing goods
and services. Human capital is the knowledge and skills that people obtain
from education, on-the-job training, and work experience.
 Capital consists of the tools, instruments, machines, buildings, and other items
that have been produced in the past and that businesses now use to produce
goods and services. Capital does not include financial capital like money,
stocks, or bonds.
 Entrepreneurship is the human resource that organizes labor, land, and capital
to produce goods and services. Entrepreneurs make business decisions and
bear the risks that arise from these decisions.
※Students often take each of the terms too literally. For instance,
when economists use the term land, it is important to emphasize
that this term encapsulates all natural resources, not just the
obvious area of land in terms of acres or plots.

“Land” also includes water, oil, and other important and
strategic minerals.

Labor refers to human labor. There is a natural tendency for
students to think of the entire population and the labor force
as synonymous. Take care to mention that the labor force
includes not only people who are working but also people
who are unemployed and actively seeking work. In addition,
it is worth mentioning that the size of the labor force can
change from increases in population and also from changes
in demographics.
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
Capital is usually not a concept that is difficult for students
to grasp. However, it is sometimes confused with financial
capital. Point out that unless economists specifically say
“financial capital,” they are invariably referring to physical
capital such as factories, machines, and equipment. Inform
them that financial capital is a term that is used in business to
refer to cash, loans, stocks, and bonds.
Lastly is the term entrepreneurship. While the obvious icon
here is that of a business person who is responsible for
bringing together all the other factors of production, it is
worth noting that the most important characteristic of an

entrepreneur is that of being a risk taker. Explain that risk
taking is a trait that is quite scarce in supply. If students ask
for proof, merely ask them what most people do for a living.
The answer is that they work for someone else. The very act
of being an employee involves a certain implicit preference
of risk aversion.
For Whom Do We Produce?

Rent is paid for the use of land, wages are paid for the services of labor,
interest is paid for the use of capital, and entrepreneurs receive a profit or
incur a loss.

The functional distribution of income is the distribution of income among
the factors of production. In the United States in 2011 labor received 69
percent of total income.

The personal distribution of income is the distribution of income among
household. In the United States in 2011 the richest 20 percent of households
earned 51 percent of total income and the poorest 20 percent of households
earned only 3 percent of total income.

The distribution of income is constantly changing and is becoming
increasingly unequal.
2.2
The Global Economy

People: The world population was approximately 7.1 billion (approximately
315.8 million in the United States) as of May 9, 2013.

Countries: The International Monetary Fund classifies the 176 economies into
two broad categories:

Advanced economies. These are the 29 countries (or areas) that have the
highest standard of living. Included in this list are the United States, Japan,
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Germany, France, Italy, the United Kingdom, and Canada. Also included
are the newly industrialized Asian economies. Almost 1 billion people live
in advanced economies.

Emerging market and developing economies. The emerging market
economies are the 28 countries in Europe and Asia that were, until the
early 1990s, part of the Soviet Union or its satellites and today are moving
toward market-based economies. The developing economies are the 119
countries in Africa, Asia, the Middle East, Europe, and Central and South
America that have not achieved a high standard of living. Approximately
500 million people living in emerging market economies and more than
5.5 billion people live in developing economies. The BRICS (Brazil,
Russia, India, China, and South Africa) comprise 42% of the global
population and hold regular meetings to advance the issues of these
nations and draw attention to development problems.
What in the Global Economy?

Where is the global pie baked?: The advanced economies produce 50 percent
of the world’s total production, including 19 percent in the United States. The
BRICS account for 28 percent, including 15 percent in China.

Some differences in what is produced: Developing economies have large and
growing manufacturing industries. Agriculture accounts for a small
percentage of total production within advanced economies and a large
percentage of total production within developing economies. Even so,
advanced economies produce about 33 percent of the world’s total agricultural
output. The contrast between the share of production of agriculture and the
total production results because total production is much larger in advanced
economies.

Some similarities in what is produced: Other advanced economies often have
similar stores and brands as those in the United States. Services are the most
rapidly growing sector in advanced economies, while agriculture and
manufacturing are declining as a share of total production.
How in the Global Economy?

Goods and services are produced using land, labor, capital, and
entrepreneurship, and the combination of these resources used are chosen to
produce at the lowest possible cost.

Human capital differences: Levels of education, training, and experience are
higher in advanced economies than in developing economies, meaning human
capital will play a more important role in production in advanced economies.
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
Physical capital differences: The more advanced the economy, the greater are
the amount and the level of sophistication of the capital equipment used in
production. While select regions and industries in developing economies may
have advanced technology and capital, it is not nearly as widespread as in
advanced economies.
For Whom in the Global Economy?

Personal distribution: The distribution of income in the global economy is
quite unequal—the lowest-paid 20 percent of the world’s population receives 2
percent of world income and the highest-paid 20 percent receives 70 percent
of world income.

International distribution: The United States has an average income of $137 a
day and the Euro area is $93 a day. Average incomes in China, India, and
Africa are $25, $10, and $7 a day, respectively.

A happy paradox and a huge challenge: Despite rising inequality within most
countries, inequality in the world income has decreased during the past 20
years because incomes in China and India, both heavily populated and poor
nations, have grown rapidly. Lifting Africa from poverty remains one of
today’s biggest challenges.
2.3
The Circular Flows
The circular flow model is a model of the economy that shows the circular flow of
expenditures and incomes that result from decision makers’ choices, and the way
those choices interact to determine what, how, and for whom goods and services are
produced.
Households and Firms

A household is an individual or a group of people living together. A firm is
an economic unit that organizes the production of goods and services.
Markets

A market is any arrangement that enables buyers and sellers to get
information and to do business with each other. Goods markets are the
markets in which goods and services are bought and sold; factor markets are
the markets in which the services of factors of production are bought and sold.
Real Flows and Money Flows

Firms and households interact in markets and it is this interaction that
determines what will be produced, how it will be produced, and who will get it.
The real flows are the goods and services and the factors of production. The
money flows go in the opposite direction to the real flows
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
Prices within markets coordinate firms’ and households’ decisions.
Governments in the Circular Flow
 The federal government has three major expenditure categories: public goods
and services, social security and welfare payments, and transfers to state and
local governments. It collects three main taxes: personal income taxes,
corporate (business) income taxes, and social security taxes.
 The state and local governments have two major expenditure categories: goods
and services, and welfare benefits. They collect three main taxes: sales taxes,
property taxes, and state income taxes.
 In the circular flow, governments buy goods and services from firms.
Households and firms pay taxes to, and receive transfers from, governments.
Circular Flows in the Global Economy

International Trade
 Imports are the good and services that we buy from households and firms
in other countries. Exports are the goods and services that we sell to
households and firms in other countries.

International Finance
 When firms, households, or governments want to borrow or lend money,
they can compare interest rates in their economy to interest rates in other
economies. They look for the lowest interest rate at which to borrow and
the highest at which to lend


When the value of our imports exceeds the value of our exports, we must
borrow from the rest of the world. When the value of our exports exceeds
the value of our imports, we lend to the rest of the world.
It is international trade and international finance flows that tie nations together
in the global economy and through which global booms and slumps are
transmitted.
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Chapter 3 The Economic Problem
CHAPTER ROADMAP
■ What’s New in this Edition?
Chapter 3 has been slightly revised for the seventh edition. The “Guns Versus
Butter” Eye On has been removed and a new Eye On concerning expanding the
PPF for the United States has been added. The introduction of absolute and
comparative advantage has been reorganized.
■ Where We Are
In Chapter 3, we use the production possibilities frontier to illustrate the economic
problem and calculate opportunity cost. We illustrate the effect of unemployed
resources using the production possibilities frontier model. We study how
technological change and capital accumulation increase production possibilities and
lead to economic growth. Then we explain how specialization and trade expand
production possibilities.
■ Where We’ve Been
In Chapter 2, we described what, how, and for whom goods and services are
produced in the United States, thereby motivating the production possibilities
frontier model developed in this chapter. In Chapter 2 we used the circular flow
model to provide a picture of how households and firms interact. We described the
economic activities of governments in the United States and included governments
in the circular flow.
■ Where We’re Going
The next chapter introduces the supply and demand model. We will distinguish
between quantity demanded and demand, and explain what determines demand.
Likewise we will distinguish between quantity supplied and supply, and explain
what determines supply. We will explore how demand and supply determine price
and quantity in a market, and explain the effects of changes in demand and supply.
CHAPTER LECTURE
3.1
Production Possibilities
Production Possibilities Frontier
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
The production possibilities
frontier (PPF) is the boundary
between those combinations of
goods and services that can be
produced and those that cannot.

Consider the production choices for
two goods: books and movies. The
table with the data for the PPF is
below and a figure showing the
PPF is to the right.
Books

Movies
A
0
600
B
200
500
C
400
300
D
600
0
Production points beyond the PPF are not attainable; production points on
and within the PPF are attainable.
Production Efficiency

Production is efficient only on the frontier of the PPF. These points are
production efficient, a situation in more of one good or service cannot be
produced without producing less of something else. Points within the PPF,
such as point Z, are inefficient.
Tradeoff Along the PPF

Moving along the PPF illustrates how scarcity creates the need to make
choices. Producing more books (moving from point A to point B) means
producing fewer movies, and producing more movies (moving from point C to
point B) means producing fewer books.
 These movements reflect a tradeoff, which is an exchange of giving up one
thing to get something else.
 A free lunch is a gift, getting something without giving up something else.
A movement from point Z to point C is free lunch because more of both
books and movies are obtained. When production is efficient – at a point
on the PPF – then there will be no opportunity for a free lunch, as attempts
to produce more of good requires a tradeoff.
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3.2
Opportunity Cost


The opportunity cost of an action is the best thing given up.
If the economy is at a production efficient point on the frontier, then the
opportunity cost of producing more books or movies is the tradeoff along the
frontier.

The magnitude of the slope of the PPF measures the opportunity cost of one
more unit of the good measured along the horizontal axis. The opportunity
cost equals the change in the quantity of the good forgone divided by the
change in the quantity of the good that is gained.
Opportunity Cost Is a Ratio

The opportunity cost of producing more of a product is the quantity of the
product forgone divided by the quantity of the product gained. Hence the
opportunity cost of a good or service is a ratio. Being a ratio, the opportunity
costs for two goods will be the inverse of each other – the opportunity cost of
producing good X in terms of good Y is the inverse of the opportunity cost of
good Y in terms of good X.
Increasing Opportunity Cost

As more of a product is produced, its opportunity cost increases. In the figure,
moving from point A to point B to point C and so on, the opportunity cost of
each additional book increases.
3.3

Increasing opportunity cost is reflected in the bowed-out shape of the PPF.

Opportunity costs increase because resources are not equally productive in
all activities. As resources are initially shifted into producing a good, the
most productive resources for that good (and least productive for an
alternative good) are chosen first – hence the low initial opportunity cost.
As more of that good is produced, less productive resources for producing
that good (and more productive resources for the alternative good) are
shifted towards producing that good – hence the opportunity cost
increases.
Economic Growth
Economic growth is the sustained expansion of production possibilities. Economic
growth shifts the PPF outward.
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The (Opportunity) Cost of Economic Growth

Economic growth requires that resources must be devoted to developing
technology or accumulating capital, which means that current consumption
decreases. The decrease in current consumption is the opportunity cost of
economic growth. This result demonstrates that economic growth is not “free.”

Countries that devote a higher share of resources to developing technology or
accumulating capital are more likely to grow faster.
3.4
Specialization and Trade
Specialization of labor results in greater productivity. Absolute advantage occurs
when one person (or nation) is more productive than another (needs fewer inputs or
takes less time to produce a good or perform a production task). A person has a
comparative advantage in an activity if that person can perform the activity at a
lower opportunity cost than anyone else.

Land Mine: Absolute advantage and comparative advantage
are concepts that give students trouble.
It flies in the face of intuition to say that even though someone has the ability to
produce something using fewer resources than someone else, nonetheless, it
still pays for the two to trade. It is an especially difficult concept to grasp when
you up the ante by saying that the same would still be true even if that person
enjoyed an absolute advantage in everything over their trading partner! This
might be a good opportunity to use a very concrete example that students
should be able to compute right in the classroom. Lay out the following
scenario: Assume Suzie, a computer consultant, is very good at repairing
computers and also happens to be a very good house painter. In fact, she is so
good that it turns out she is more productive at both things than her neighbor,
Bob, who happens to paint houses for a
Time it takes
Time it takes
living. To the right is a
Suzie
Bob
table that shows the
2 hours
24 hours
Repair a
amount of time it takes
computer
for Suzie and Bob to
30 hours
48 hours
Paint a house
perform each of the two
activities. In addition, let’s assume that Suzie and Bob earn $100 per computer
repaired and Bob and Suzie earn $960 per house painted. Ask the students to
compute the opportunity cost for Suzie and Bob repairing a computer and
painting a house.
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2016-2017 EOC101 Economics
The new table to the right contains the opportunity costs. (To calculate these
numbers, take Suzie’s
Opportunity
Opportunity
opportunity cost of
cost for Suzie
cost for Bob
painting a house. In the
$64
$480
Repair a
30 hours it takes her to
computer
paint a house, she could
$1,500
$200
Paint a house
have repaired 15
computers, so the
opportunity cost is 15 computers times $100 each, or $1,500.) The table reveals
that Suzie has the lower opportunity cost of repairing computers and Bob has the
lower opportunity cost of painting houses. What this example demonstrates so
powerfully is that a person can have an absolute disadvantage in everything, as is
the case for Bob, but still manage to have a comparative advantage in an activity.
Point out to students that this logic applies between individuals and also across
cities, states, and nations.

The PPF shows opportunity cost of
the goods. In the figure the
opportunity cost of a bushel of
wheat in Canada is 1/4 of a
computer and in Japan it is 1
computer. In Canada the opportunity
cost of a computer is 4 bushels of
wheat and in Japan it is 1 bushel of
wheat. Canada has a comparative
advantage in producing wheat and
Japan has a comparative advantage
in producing computers.
Achieving Gains from Trade

When countries specialize by producing the good in which each country has a
comparative advantage more goods in total can be produced. If Canada and
Japan each produce at point A, a total of 8 computers and 16 bushels of wheat
are produced. If they specialize according to comparative advantage, a total of
12 computers and 24 bushels of wheat are produced.

Trade allows consumption to be different than production for each nation, so
Canada can trade wheat for computers and Japan can trade computers for
wheat. Because more computers and more wheat are produced, both nations
can consume more than they can produce on their own.
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