Download 1/23) PP Curve and Terms of Trade

Production-Possibilities Curve/Frontier
Crystal
1 million
Crystal
A
B
700,000
80,000
A
B
40,000
C
0
30,000
100,000 Rum
Ireland
Crystal
Rum
A 1 million
0
B 700,000
30,000
C
0
100,000
0
40,000
C
80,000
Rum
Puerto Rico
Crystal
A 80,000
B 40,000
C
0
Rum
0
40,000
80,000
Crystal
1 million
Crystal
A
B
700,000
80,000
A
B
40,000
C
0
30,000
100,000 Rum
Ireland
0
40,000
C
80,000
Rum
Puerto Rico
Which country has the absolute advantage in the production
of Crystal? In the production of Rum?
What did I tell you to do with absolute advantages?
KICK IT OUT THE DOOR!!!
Crystal
1 million
Crystal
A
B
700,000
80,000
40,000
A
B
C
0
30,000
Ireland
100,000 Rum
0
40,000
C
80,000
Rum
Puerto Rico
Which country has the comparative advantage in Crystal?
In Rum?
Crystal
1 million
Crystal
A
B
700,000
80,000
40,000
A
B
C
0
30,000
Ireland
100,000 Rum
0
40,000
C
80,000
Puerto Rico
There are___steps
5
in figuring out which country has
the comparative advantage.
Rum
Crystal
1 million A
Crystal
B
700,000
80,000
40,000
0
30,000
C
100,000 Rum
0
A
B
40,000
C
80,000
Rum
Ireland
1. Know the definition of comparative advantage
One entity can produce something at a LOWER MARGINAL OPPORTUNITY
COST than another entity.
2. Set up a table:
Ireland
1 Rum = __Crystal
1 Crystal = __ Rum
3. Go to the Xtremes (X and Y Games)
Puerto Rico
1 Rum = __Crystal
1 Crystal = __Rum
Crystal
1 million A
Crystal
B
700,000
80,000
40,000
0
30,000
Ireland
1.
2.
3.
4.
5.
C
100,000 Rum
0
A
B
40,000
C
80,000
Rum
Puerto Rico
Know the definition of comparative advantage
Ireland
Puerto Rico
Set up a table:
1 Rum = 10
__Crystal
1 Rum = __Crystal
1
1 Crystal = ____
1 Crystal = __Rum
1/10 Rum
1
Go to the Xtremes (X and Y Games)
Fill in the blanks (starting with Puerto Rico first)
Circles and Arrows
Crystal
1 million A
Crystal
B
700,000
80,000
40,000
0
30,000
Ireland
C
100,000 Rum
0
A
B
40,000
C
80,000
Rum
Puerto Rico
We decided that Ireland should produce ALL the crystal and
Puerto Rico should produce ALL the rum. How much crystal should
Ireland produce? 1 million cases
How much rum should Puerto Rico produce? 80,000 barrels
Should Ireland just hold onto its cases of crystal and Puerto Rico just
hold onto its barrels of rum? NO!
What should each country do after specialization? Trade
Crystal
1 million A
Crystal
B
700,000
80,000
A
B
40,000
0
30,000
C
100,000 Rum
Ireland
Produces
Trades
0
40,000
C
80,000
Puerto Rico
Consumes
after specialization
and Trade
Consumes
before Trade
(Point B)
Gain from Trade
IRELAND
C 1 million -175,000
R
0
+35,000
825,000
35,000
700,000
30,000
175,000
45,000
40,000
40,000
+125,000
+ 5,000
PUERTO RICO
C
R
0
80,000
+175,000
-35,000
+135,000
+5,000
Rum
D
175,000
Crystal
1 million A
825,000
700,000
Crystal
D
B
80,000
A
B
40,000
35,000
0
30,000
C
100,000 Rum
Ireland
Produces
Trades
40,000
Puerto Rico
Consumes
after specialization
and Trade
IRELAND
C 1 million -175,000
R
0
+35,000
0
C
80,000
825,000
35,000
Plot
this
column
Consumes
before Trade
(Point B)
700,000
30,000
Gain from Trade
+125,000
+ 5,000
PUERTO RICO
C
R
0
80,000
+175,000
-35,000
175,000
45,000
40,000
40,000
+135,000
+5,000
Rum
175,000
Crystal
1 million A
825,000
700,000
D
Crystal
D
B
80,000
A
B
40,000
35,000
0
30,000
Ireland
C
100,000 Rum
45,000
0
40,000
C
80,000
Rum
Puerto Rico
Which country is obviously better off through this
specialization and trade--Ireland or Puerto Rico?
Both Countries are!!!
Both countries are now outside their own production
capabilities. Through specialization and trade all
parties are better off.
Click here for next slide.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
Assume that two countries, Atlantis and
Xanadu, have equal amounts of resources.
Atlantis can produce 30 cars or 10 tractors or
any combination, as shown by the line MN in
the figure above. Xanadu can produce 20 cars
or 40 tractors or any combination, as shown
by the line PQ in the figure above.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
(a) Which country has an absolute advantage in
the production of tractors? Explain how you
determined your answer.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
(b) Which country has a comparative advantage
in the production of cars? Using the concept
of opportunity costs, explain how you
determine your answer.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
(c) If the two countries specialize and trade with
each other, which country will import cars?
Explain why.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
(d) If the terms of trade are such that one car can
be exchanged for one tractor, explain how
Atlantis will benefit from such trade.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
Assume that two countries, Atlantis and
Xanadu, have equal amounts of resources.
Atlantis can produce 30 cars or 10 tractors or
any combination, as shown by the line MN in
the figure above. Xanadu can produce 20 cars
or 40 tractors or any combination, as shown
by the line PQ in the figure above.
30 M
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
N
10
Q
40 Tractors
(a) Which country has an absolute advantage in
the production of tractors? Explain how you
determined your answer.
Xanadu has the absolute advantage in tractors.
It can produce more tractors than Atlantis.
Atlantis
1car = 1/3
__ trac.
30 M
3
1 trac = __ cars
Xanadu
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
1 car = __
2 trac.
1 trac =1/2
__ cars
N
10
Q
40 Tractors
(b) Which country has a comparative advantage
in the production of cars? Using the concept
of opportunity costs, explain how you
determine your answer.
Atlantis has the comparative advantage in cars.
It’s marginal opportunity cost of producing a car
is less than Xanadu’s (1/3 trac. compared to ½).
Atlantis
1car = 1/3
__ trac.
30 M
3
1 trac = __ cars
Xanadu
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
1 car = __
2 trac.
1 trac =1/2
__ cars
N
10
Q
40 Tractors
(c) If the two countries specialize and trade with
each other, which country will import cars?
Explain why.
Xanadu should import cars. The opportunity
cost of producing a car in Xanadu is too high. It
would have to give up the production of 2 tractors.
Atlantis
1car = 1/3
__ trac.
30 M
3
1 trac = __ cars
Xanadu
20
P
Production Possibilities Curve for
Atlantis
Production Possibilities
Curve for Xanadu
1 car = __
2 trac.
1 trac =1/2
__ cars
N
10
Q
40 Tractors
(d) If the terms of trade are such that one car can
be exchanged for one tractor, explain how
Atlantis will benefit from such trade.
If Atlantis were to produce its own tractors,
it would have to give up the production of 3 cars. By
trading 1 tractor for 1 car, this is a good terms of trade
because Atlantis gets to a point outside its own PP curve.
Mars
Venus
Food
Clothing
0
2
4
5
8
10
30
24
18
12*
6
0
Food
0
4
8
12
16
20
Clothing
40
32
24*
16
8
0
Mars
Venus
Food
Clothing
0
2
4
5
8
10
30
24
18
12*
6
0
Food
0
4
8
12
16
20
Constant or Increasing?
Clothing
40
32
24*
16
8
0
Mars
Venus
Food
Clothing
0
2
4
5
8
10
30
24
18
12*
6
0
Food
0
4
8
12
16
20
Absolute Advantage?
Clothing
40
32
24*
16
8
0
Mars
Venus
Food
Clothing
0
2
4
5
8
10
30
24
18
12*
6
0
Food
Clothing
0
4
8
12
16
20
Comparative Advantage?
40
32
24*
16
8
0
PP Curve Interactive, Part II
Price
P
Quantity Demanded
Qd
$9
8
2
3
5
9
7
6
Price
P
Quantity Demanded
Qd
$9
8
2
3
5
9
7
6
P
9
8
7
6
To be on the
demand curve
a person must
be WILLING
and ABLE to
purchase the
product or service. 2 3
Qd
just a point on the
curve.
D
is the entire
curve.
5
9
Q
Price
P
Quantity Demanded
Qd
$9
8
2
3
5
9
7
6
There is an
inverse
___________
relationship
between price
and quantity.
P
9
8
7
6
Qd
just a point on the
curve.
D
is the entire
curve.
2 3
5
9
Q
9
8
7
6
Definitions:
D
2 3
5
9
Q
Quantity demanded--it is the amount that will be
purchased at a specific P.
Demand--it is a schedule of quantities of goods and
services that will be purchased at various prices
at a specified time, all other things held constant.
9
8
7
6
D
2 3
5
9
Q
9
8
7
6
Qd
just a point on the
curve.
D
is the entire
curve.
2 3
5
9
Q
Price changes Quantity Demanded
Price DOES NOT CHANGE
DEMAND!!!!!!!!
Only one variable
Qd
PRICE
PRICE DOES NOT
DEMAND!!
GUESS HOW MANY
DETERMINANTS OF
DEMAND THERE ARE?
8
And if you don’t memorize these variables, YOU
WILL FAIL THIS CLASS!!
ARE THERE ANY QUESTIONS?
Eight Determinants of Demand:
1. # of consumers
6
$36.95
Eight Determinants of Demand:
1. # of consumers
2. Income--Normal Goods
As people’s incomes go up demand for
normal goods increases. As people’s income
go down, demand for normal goods
decrease.
3. Income--Inferior Goods
As people’s incomes go up demand for
inferior goods decreases. As people’s income
go down, demand for inferior goods
increases.
______Used Furniture Store
______Lazy Boy Store
$25
Eight Determinants of Demand:
1. # of consumers
2. Income--Normal Goods
3. Income--Inferior Goods
4. Preferences
Eight Determinants of Demand:
1. # of consumers
2. Income--Normal Goods
3. Income--Inferior Goods
4. Preferences
5. Price of related products: Substitutes
Eight Determinants of Demand:
1. # of consumers
2. Income--Normal Goods
3. Income--Inferior Goods
4. Preferences
5. Price of related products: Substitutes
6. Price of related products: Complements
Eight variables that shift Demand:
1. # of consumers
2. Income--Normal Goods
3. Income--Inferior Goods
4.
5.
6.
7.
8.
Preferences
Price of related products: Substitutes
Price of related products: Complements
Expected future P’s by consumers
Expected future Y by consumers
P
S
Definitions:
Q
Quantity supplied--it is the amount that will be
sold at a specific P.
Supply--it is a schedule of quantities of goods and
services that will be sold at various prices
at a specified time, all other things held constant.
GUESS HOW MANY
DETERMINANTS OF
SUPPLY THERE ARE?
5
And if you don’t memorize these variables, YOU
WILL FAIL THIS CLASS!!
ARE THERE ANY QUESTIONS?
Five determinants of Supply:
1. # of suppliers
2. Costs
3. Physical Availability of Resources
4. Technology
5. Expected Future Prices by Consumer